Q. Consider the following statements:
The effect of devaluation of a currency is that it necessarily
1.improves the competitiveness of the domestic exports in the foreign markets
2.increases the foreign value of domestic currency
3.improves the trade balance
Which of the above statements is/are correct?
a) 1 only
b) 1 and 2
c) 3 only
d) 2 and 3
Correct Answer: a) 1 only
Question from UPSC Prelims 2021 GS Paper
Explanation :
Impact of Currency Devaluation on Domestic Exports
When a country devalues its currency, it can lead to an improvement in the competitiveness of its domestic exports in foreign markets. A cheaper currency means that foreign buyers will find the exports less expensive, potentially increasing demand and export volume.
Effect on Foreign Value of Domestic Currency
Contrary to improving the foreign value, currency devaluation actually decreases the foreign value of the domestic currency. More of the devalued currency is required to purchase the same amount of a foreign currency, thus reducing its value internationally.
Devaluation and Trade Balance
The impact of devaluation on the trade balance is not straightforward. While there is potential for improved export competitiveness, the overall effect on the trade balance, which includes both exports and imports, is uncertain. Factors such as the cost of imports, economic conditions, and trade policies also play significant roles in determining the trade balance outcome.