Indeed, achieving lower unit cost of tradables by the mechanism of devaluation may, in many instances, be an illusion. Often devaluation raises imported goods prices to such an extent as to wipe out any potential competitive advantage. Only the most labor intensive goods are likely to gain competitive advantage and only then if domestic laborers can be forced to accept the lower real wages that result from the devaluation. If laborers are organized and resistant to such a depreciation in their real wages, then they may force wage increases that wipe out all the possible competitive gains of a devaluation. Thirdly, devaluations typically generate capital flight.
Hard currency is siphoned out of the country in question to safer havens.
Thus, a devaluation has the paradoxical result of worsening the capital account and fostering hard currency illiquidity in domestic financial institutions and firms. More seriously, many firms carrying heavy hard currency debt loads are faced with insolvency. Defaults and worsening capitalization ratios among banks produces a credit squeeze, worsening sentiment among investors and others, falls in government revenues from taxes, and so on in a chain reaction of negative consequences. Fortunately for China, most of the debt held by domestic firms, particularly state-owned enterprises, is in renminbi. This allows for the possibility of a more orderly solution to the debt problems faced by the banking system.