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?
Explanation
Statement 1 is correct: Devaluation lowers the exchange value of the domestic currency against foreign currencies. Consequently, domestic goods become cheaper in foreign currency terms, which directly and necessarily improves the price competitiveness of exports abroad.
Statement 2 is incorrect: Devaluation, by definition, reduces (not increases) the foreign purchasing power or value of the domestic currency.
Statement 3 is incorrect: A currency devaluation does not necessarily improve the trade balance. According to the Marshall-Lerner Condition, the trade balance improves only if the sum of the price elasticities of demand for exports and imports is greater than one (Ex + Em > 1). In the short run, trade balance may even worsen before improving (known as the J-curve effect).
Therefore, only statement 1 is necessarily true — Option A.