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 only
1 and 2
3 only
2 and 3
Answer is Wrong!
Answer is Right!
This question was previously asked in
UPSC IAS – 2021
1. Improves the competitiveness of domestic exports: When a currency is devalued, foreign buyers need less of their currency to buy goods from the devaluing country. This makes the domestic country’s exports cheaper in foreign markets, thus increasing their price competitiveness. This statement is generally true, assuming other factors like quality and supply capacity remain constant and demand is price-sensitive.
2. Increases the foreign value of domestic currency: This is incorrect. Devaluation by definition means the domestic currency is now worth *less* in terms of foreign currencies.
3. Improves the trade balance: Devaluation makes exports cheaper and imports more expensive. The *aim* is to increase exports and decrease imports, thereby improving the trade balance (reducing deficit or increasing surplus). However, this outcome is not *necessary*. The effect depends on factors like the price elasticity of demand for exports and imports (Marshall-Lerner condition), the time lag for these effects to materialize (J-curve effect), supply side constraints, and potential retaliatory measures by trade partners. Therefore, it does not *necessarily* improve the trade balance.
Only statement 1 is a necessary and direct consequence of devaluation in terms of price competitiveness.