UPSC Prelims 2021 Question:

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?

Explanation:

Devaluation of a currency:

• • Devaluation is the deliberate downward adjustment of a country's currency value. The government issuing the currency decides to devalue a currency.
    
    
  • Devaluing a currency reduces the cost of a country's exports and improves the competitiveness of domestic exports in foreign markets. So, statement 1 is correct.
    
    
  • Devaluation makes domestic currency cheaper as compared to foreign currency, resulting in decreased foreign value of domestic currency. So, statement 2 is not correct.
    
    

• When a country devalues its currency then the volume of exports increases and the volume of imports reduces. The improvement in trade balance is determined by the difference between the value of imports and exports as well as the preference of people in both countries. Thus, it cannot be concluded that devaluation will necessarily improve trade balance. So, statement 3 is not correct.
  

Therefore, option (1) is the correct answer.

Subject: Economics | Balance of Payments and Foreign Reserves