Home currency depreciation occurs when the foreign currency becomes more valuable than the home currency, in which case, more units of the home currency would be exchanged for one unit of the foreign currency. Consider the following example.
Suppose Russia is the home country and the United States is the foreign country, and the nominal exchange rate between the US Dollar and the Russian Ruble is USD 1 = RUB 30. If the exchange rate changes to USD 1 = RUB 60, then we would say that the Ruble has depreciated against the US Dollar by 50 per cent. More units of the Russian Ruble will now be exchanged for one unit of the US Dollar in the foreign exchange market.
All around the world, with a few exceptions, employment contracts offered by domestic companies to foreign employees are indexed to the inflation rate that prevails in the domestic country. Should employment contracts also account for depreciation in the home currency when adjusting the salaries of foreign employees instead of just the inflation rate? Let me provide an example to illustrate my point.
Suppose the Russian Ruble falls by 50 per cent that would mean the monthly salaries of the foreign employees in Russia, in US dollar terms, will be reduced by half, while the overseas expenses of the foreign employees in Russia (the amount of Russian Ruble per US dollar spent) will be doubled.
Now if the annual inflation rate in Russia is 10 per cent, an inflation adjustment in salary will not compensate the foreign employees for their financial loss. Should foreign labour contracts make it mandatory to index the salaries of the foreign employees to the rate of depreciation in the home currency?
- The reader is a professor of Economics