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? 

(a) 1 only 

(b) 1 and 2 

(c) 3 only 

(d) 2 and 3 

Answer: a

Explanation:

Appreciation of a currency is the increase in its value in terms of another foreign currency where as  Depreciation of a currency is the decrease in its value in terms of another foreign currency.

In case of devaluation by the government, the prices of Indian exports in terms of foreign currency (say dollar) will fall and will Improve the competitiveness of the domestic exports. This will cause the increase in quantity demanded of Indian exports. As a result  Indian exports will increase.

Devaluation or depreciation makes the imports from abroad expensive in terms of domestic currency (rupees in case of India), and therefore, the imports tend to fall. With exports increasing and imports declining it is expected that devaluation (depreciation) will reduce a country’s trade deficit.

However, it may be noted that the effect of devaluation or depreciation on balance of trade is ambiguous and quite uncertain because a good deal depends on the price elasticity of exports and imports of a country and necessarily need not improve trade balance. 

Hence, statement 1 is correct & statements 2, 3 are incorrect.

Read: Solved Economy PYQs With Explanation 2021 UPSC Prelims