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Q38 (IAS/2021) Economy › External Sector & Trade › Exchange rate dynamics Official Key

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?

Result
Your answer: —  ·  Correct: A

Explanation

The correct answer is Option 1 (1 only).

Devaluation involves a deliberate downward adjustment of a country's currency value relative to foreign currencies. This makes domestic goods cheaper for foreign buyers, thereby necessarily improving the competitiveness of domestic exports in international markets (Statement 1).

  • Statement 2 is incorrect because devaluation, by definition, decreases the foreign value of the domestic currency, making it weaker against others.
  • Statement 3 is not necessarily correct. While devaluation aims to improve the trade balance, its success depends on the Marshall-Lerner condition (the price elasticity of demand for exports and imports). If the demand is inelastic, or if the cost of essential imported raw materials rises significantly, the trade balance may actually worsen, as seen in the "J-curve" effect.

Since statement 1 is the only outcome that occurs by default through the mechanism of price reduction, 1 only is the most accurate choice.

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PROVENANCE & STUDY PATTERN

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Don’t just practise – reverse-engineer the question. This panel shows where this PYQ came from (books / web), how the examiner broke it into hidden statements, and which nearby micro-concepts you were supposed to learn from it. Treat it like an autopsy of the question: what might have triggered it, which exact lines in the book matter, and what linked ideas you should carry forward to future questions.
Q. Consider the following statements: The effect of devaluation of a currency is that it necessarily 1. improves the competitiveness of th…
At a glance
Origin: Books + Current Affairs Fairness: Moderate fairness Books / CA: 6.7/10 · 3.3/10
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This is a classic 'Mechanism vs. Outcome' trap. UPSC tests if you distinguish between the immediate price effect (competitiveness) and the conditional final result (trade balance). The word 'necessarily' is the key filter—it validates the definition (S1) but invalidates the conditional outcome (S3).

How this question is built

This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.

Statement 1
Does devaluation of a country's currency necessarily improve the competitiveness of that country's domestic exports in foreign markets?
Origin: Direct from books Fairness: Straightforward Book-answerable
From standard books
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 16: Balance of Payments > Measures taken by the Government/RBI to overcome BOP Imbalance > p. 484
Presence: 5/5
“• Credit control measures to decrease money supply in the economy, which helps to reduce a. the purchasing power and thereby results in decrease in aggregate demand. • Devaluation of domestic currency (not always) which stimulates exports and reduces b. demand for imports. • Export promotion and import control measures such as more of export incentives and c. subsidies and restriction on imports through licensing, import quota, etc. • d. Structural reforms to put the economy on a competitive path.”
Why this source?
  • Explicitly qualifies devaluation with '(not always)', denying automatic effectiveness.
  • Presents devaluation as one measure among others to address BOP, implying conditional outcomes.
  • Links devaluation to export stimulation but frames it as a conditional, not guaranteed, tool.
Macroeconomics (NCERT class XII 2025 ed.) > Chapter 6: Open Economy Macroeconomics > National Income Identity for an Open Economy > p. 97
Presence: 4/5
“A higher R makes foreign goods relatively more expensive, thereby leading to a decrease in the quantity of imports. Thus, imports depend positively on Y and negatively on R. The export of one country is, by definition, the import of another. Thus, our exports would constitute of foreign imports. It would depend on foreign income, Yf , and on R. A rise in Yf will increase foreign demand for our goods, thus leading to higher exports. An increase in R, which makes domestic goods cheaper, will increase our exports. Exports depend positively on foreign income and the real exchange rate.”
Why this source?
  • Identifies the real exchange rate as the determinant of exports and competitiveness.
  • Shows exports depend on foreign income and the real exchange rate, so nominal devaluation helps only if the real rate (and external demand) changes accordingly.
Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > Before 1993: > p. 40
Presence: 4/5
“But if due to inflation the burger price in India becomes Rs. 20 then exports from India will stop (i.e., inflation in India is making its exports less competitive). But in that situation when price has increased to Rs. 20, if RBI devalues the exchange rate to $1 = Rs. 30 then again exports from India will start. Because now foreigners will get Rs. 30 in $1 and in Rs. 30 they will get one and a half burger in India. Hence, to increase its exports and improve the balance of payment situation, India consistently devalued its currency till 1993.”
Why this source?
  • Provides a concrete conditional example: domestic inflation can make exports uncompetitive and devaluation can restore competitiveness only in that situation.
  • Implicates that effectiveness of devaluation depends on underlying price levels and relative prices, not on devaluation alone.
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SIMILAR QUESTIONS

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Consider the following statements: 1. Tight monetary policy of US Federal Reserve could lead to capital flight. 2. Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs). 3. Devaluation of domestic currency decreases the currency risk associated with ECBs. Which of the statements given above are correct?

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Assertion (A) : Devaluation of a currency may promote export. Reason (R) : Price of the country’s products in the international market may fall due to devaluation.

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With reference to the Indian economy, consider the following statements : 1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee. 2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness. 3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER. Which of the above statements are correct ?

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Consider the following actions which the Government can take:

  1. Devaluing the domestic currency.
  2. Reduction in the export subsidy.
  3. Adopting suitable policies which attract greater FDI and more funds from FIIs.

Which of the above action/actions can help in reducing the current account deficit?