Q. Consider the following statements :

1. The effect of devaluation of a currency is that it necessarily 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? (UPSC Prelims 2021)
Answer: 1 only
Notes: The correct answer is [A] 1 only. Devaluation refers to the deliberate downward adjustment of the value of a country's currency relative to another currency, group of currencies, or currency standard.

• Improves competitiveness of domestic exports (Statement 1 – Correct): When a currency is devalued, domestic goods become cheaper for foreign buyers using stronger currencies. This "necessarily" makes exports more price-competitive in international markets, assuming other factors like quality and global demand remain constant.
• Increases foreign value of domestic currency (Statement 2 – Incorrect): Devaluation, by definition, decreases the value of the domestic currency in terms of foreign currencies. One unit of domestic currency will now buy fewer units of a foreign currency.
• Improves the trade balance (Statement 3 – Incorrect): While devaluation makes exports cheaper and imports more expensive, it does not necessarily improve the trade balance. This depends on the Marshall-Lerner Condition, which states that a trade balance improves only if the sum of the price elasticities of demand for exports and imports is greater than one. If the demand for imports (like oil or essential tech) is inelastic, the trade deficit might actually widen (known as the J-Curve effect).

Historically, many countries have used devaluation to boost their export-led growth, but it often carries the risk of "imported inflation" as the cost of essential imports rises significantly.