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Q63 (CDS-II/2023) Economy › External Sector & Trade › Exchange rate dynamics Answer Verified

Which of the following is/are the effects of devaluation or depreciation of currency ? 1. It leads to increase in imports and decrease in exports. 2. It leads to increase in exports and decrease in imports. 3. It leads to increase in domestic inflation. 4. It leads to decrease in domestic inflation. Select the correct answer using the code given below : (a) 1 and 3 only (b) 2 and 3 only (c) 1 and 4 only (d) 3 only

Result
Your answer: —  Â·  Correct: B
Explanation

Currency devaluation (under fixed regimes) and depreciation (under floating regimes) both result in a decrease in the value of the domestic currency relative to foreign currencies [1]. This makes domestic goods cheaper for foreign buyers, leading to an increase in exports [4]. Conversely, foreign goods become more expensive for domestic consumers, which typically leads to a decrease in the volume of imports [4]. Furthermore, because imports like raw materials and fuel become costlier, devaluation leads to 'imported inflation,' increasing the overall domestic price level. Therefore, statement 2 (increase in exports, decrease in imports) and statement 3 (increase in domestic inflation) are correct. Statement 1 is incorrect as it describes the opposite trade effect, and statement 4 is incorrect because devaluation is an inflationary pressure rather than a deflationary one.

Sources

  1. [1] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 17: India’s Foreign Exchange and Foreign Trade > WHICH EXCHANGE RATE SYSTEM SUITS AN ECONOMY BEST? > p. 495
  2. [4] https://www.investopedia.com/terms/d/devaluation.asp
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SIMILAR QUESTIONS

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