Consider the following statements:
The effect of devaluation of a currency is that it necessarily
- Improves the competitiveness of the domestic exports in the foreign markets
- Increases the foreign value of domestic currency
- Improves the trade balance
Which of the above statements is/are correct?
[UPSC Civil Services Exam – 2021 Prelims]
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 2 and 3 only
Answer: (a)
Explanation:
- Statement 1 is correct.
- A devaluation refers to a decrease in the value of a currency, and its main effects are as follows:
- Exports become cheaper for foreign customers: When a currency, such as the rupee, is devalued against another currency like the dollar, it lowers the price of goods, such as cars sold by Indian manufacturers in America. Consequently, these goods become more affordable for foreign customers.
- Statement 2 and 3 are incorrect.
- Devaluation of a currency reduces the value of the domestic currency in relation to foreign currencies.
- Additionally, devaluation can lead to an increased burden of debt for loans denominated in foreign currencies when converted into the home currency. Therefore, devaluation may not necessarily improve the trade balance in the long run.
