CDS (II) 2023 General Knowledge · Question 32 of 120

Correct — C, 2 and 3 only. Devaluation, and its market cousin depreciation, mean that the home currency now buys less foreign currency than before, so foreign currency costs more rupees. NCERT defines the policy version plainly — government action that increases the exchange rate, thereby making the domestic currency cheaper, is called devaluation. Two consequences follow from that single price change. First, on the trade side, domestic goods become cheaper for the foreign buyer while foreign goods become dearer for the domestic buyer. NCERT states both legs: a higher exchange rate 'makes foreign goods relatively more expensive, thereby leading to a decrease in the quantity of imports', and 'an increase in R, which makes domestic goods cheaper, will increase our exports'. That is statement 2, and it is why statement 1 — imports up, exports down — is exactly inverted. Second, because imports are now dearer in rupee terms, and because India imports crude oil, fertiliser, electronics and industrial inputs, the higher rupee cost of those imports feeds into domestic prices; a devaluation raises the prices of imported goods in the domestic economy and so fuels inflation. That is statement 3, and it is why statement 4, which claims a fall in domestic inflation, cannot stand alongside it.

• (a)1 and 3 only — Gets the inflation effect right but reverses the trade effect. A cheaper home currency makes exports more competitive abroad and imports dearer at home, so exports rise and imports fall — the opposite of statement 1.
• (b)1 and 4 only — Both statements are the wrong way round. This is the answer a candidate reaches by thinking that a weaker currency is bad for the country in every respect, and therefore must hurt exports and cool prices; in fact it helps exports and pushes prices up.
• (d)3 only — Correct on inflation but drops the trade leg, which is the better-established half of the answer. Statement 2 is the textbook consequence of devaluation and cannot be left out.

The exchange rate can be quoted as the number of rupees per unit of foreign currency. When that number rises, the rupee is worth less. If it happens because the government or the central bank sets it that way under a fixed or managed regime, it is called devaluation; if the market moves it under a floating regime, it is called depreciation. The economics of the two is the same. Exports become cheaper in foreign currency, imports become dearer in rupees, and the import bill for essentials such as crude oil rises in rupee terms even if the barrel price abroad is unchanged.

Work it from the point of view of the buyer on each side. A foreign importer paying in dollars now needs fewer dollars for the same Indian good, so Indian exports look cheaper and volumes should rise. An Indian importer paying in rupees now needs more rupees for the same foreign good, so imports look dearer and volumes should fall. That kills statements 1 and settles 2 in one step. For the price level, note that the dearer imports are not only finished goods — they include oil, fertiliser and components that enter Indian production costs, so the effect spreads well beyond the import basket. Two honest caveats belong on this card. NCERT itself states the trade legs but does not state the inflation leg, which comes from the standard account of devaluation elsewhere; and the improvement in the trade balance is not automatic — it depends on how strongly export and import volumes respond, and volumes often adjust slowly, which is why UPSC has separately keyed that a devaluation does not necessarily improve the trade balance.

• NCERT: 'when some government action increases the exchange rate (thereby, making domestic currency cheaper) is called Devaluation.'
• NCERT: 'A higher R makes foreign goods relatively more expensive, thereby leading to a decrease in the quantity of imports.'
• NCERT: 'An increase in R, which makes domestic goods cheaper, will increase our exports.'
• A devaluation raises the domestic-currency price of imported goods, which feeds into the domestic price level.
• Devaluation is the policy act under a fixed or managed rate; depreciation is the same movement produced by the market under a floating rate.

• Treating a weaker currency as uniformly bad and therefore assuming it must reduce exports; it makes exports cheaper abroad.
• Assuming the trade balance must improve. Whether it does depends on how far export and import volumes actually respond.
• Mixing up the two names — devaluation is a policy decision under a fixed or managed rate, depreciation is a market outcome under a floating one.

As a multi-statement item on the effects of devaluation, as an assertion-and-reason pair on exports, or as a one-liner distinguishing devaluation from depreciation.

• practice — not a real PYQ

  A depreciation of the rupee against the US dollar is most likely to have which one of the following immediate effects?

  • (a)Indian exports become costlier for foreign buyers
  • (b)Indian imports become cheaper in rupee terms
  • (c)India's crude oil import bill rises in rupee terms
  • (d)The domestic price level falls

  Answer(c) India's crude oil import bill rises in rupee terms — even at an unchanged dollar price per barrel, a weaker rupee means more rupees are needed for the same imports.

• practice — not a real PYQ

  Which one of the following correctly distinguishes devaluation from depreciation of a currency?

  • (a)Devaluation is a market outcome; depreciation is a policy decision
  • (b)Devaluation is a policy decision under a fixed or managed rate; depreciation is a market outcome under a floating rate
  • (c)Devaluation applies only to the current account; depreciation only to the capital account
  • (d)There is no difference between the two terms

  Answer(b) Devaluation is a policy decision under a fixed or managed rate; depreciation is a market outcome under a floating rate — the economic consequences of the two are the same.