Q8.
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?
Answer
A
Explanation
Devaluation means official lowering of the value of a country's currency within a fixed exchange rate system. Devaluation of a currency happens in countries with a fixed exchange rate (or also where it is managed floating rate). Example- Let us assume that prevailing exchange rate of $1 is 10 rs. So currently 1 rs is worth of $0.1. If devaluation of currency is done and now exchange rate of $1 is 20 rs, this means 1 rs is worth of $0.05. So the value of domestic currency (rs) is decreased in terms of value of foreign currency ($). Hence, statement 2 is not correct. Let us take another example to understand statement 1- If a shirt costs $8 in the US and Rs 400 in India, the rupee-dollar exchange rate should be Rs 50. To see why, at any rate higher than Rs 50, say Rs 60, it costs Rs 480 per shirt in the US but only Rs 400 in India. In that case, all foreign customers would buy shirts from India. So devaluation of currency improves the competitiveness of the