UPSC Previous Year Question | Prelims GS | 2021

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?

  1. 1 only
  2. 1 and 2
  3. 3 only
  4. 2 and 3

Answer

Correct Answer

1 only

Explanation

Devaluation makes exports cheaper in foreign-currency terms, improving their price competitiveness (statement 1). It lowers, not raises, the foreign value of the domestic currency (statement 2). An improvement in the trade balance depends on demand elasticities (Marshall-Lerner condition) and is therefore not a 'necessary' effect (statement 3).

Topics: economy, effects of currency devaluation, exchange rate, external sector