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Foreign Exchange, FDI & External Debt (Part – I)

📆 October 21, 2024

Total Questions: 50

21. Consider the following statements and select the correct answer from the code given below: [I.A.S. (Pre) 1999, U.P.U.D.A./L.D.A. (Pre) 2001]

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.

Correct Answer: (a) Both A and R are true and R is the correct explanation of A
Solution:Devaluation means a reduction in the value of domestic currency related to foreign currencies in a fixed exchange rate system. It is the deliberate downward adjustment of the value of a country's currency relative to another currency, group of currencies, or currency standard. It generally decreases the prices of exports in foreign countries and provides a boost to exports by making them more competitive. On the other hand it increases the cost of imports. If imports are more expensive, domestic consumers are less likely to purchase them, further strengthening domestic businesses. Because exports increase and imports decrease, there is typically a better balance of payments due to the trade deficit shrinks.

22. Statement (A): Devaluation of currency is done for increasing exports. [U.P. Lower Sub. (Pre) 2004]

Reason (R): Domestic items become cheaper in the foreign market.

Select the correct answer from the codes given below:

Correct Answer: (a) (A) and (R) both are correct and (R) is the correct explanation of (A)
Solution:Devaluation means a reduction in the value of domestic currency related to foreign currencies in a fixed exchange rate system. It is the deliberate downward adjustment of the value of a country's currency relative to another currency, group of currencies, or currency standard. It generally decreases the prices of exports in foreign countries and provides a boost to exports by making them more competitive. On the other hand it increases the cost of imports. If imports are more expensive, domestic consumers are less likely to purchase them, further strengthening domestic businesses. Because exports increase and imports decrease, there is typically a better balance of payments due to the trade deficit shrinks.

23. The outcome of devaluation of currency is [U.P.R.O./A.R.O. (Pre) 2014]

Correct Answer: (c) Increase of exports and decrease of imports in the country
Solution:Devaluation means a reduction in the value of domestic currency related to foreign currencies in a fixed exchange rate system. It is the deliberate downward adjustment of the value of a country's currency relative to another currency, group of currencies, or currency standard. It generally decreases the prices of exports in foreign countries and provides a boost to exports by making them more competitive. On the other hand it increases the cost of imports. If imports are more expensive, domestic consumers are less likely to purchase them, further strengthening domestic businesses. Because exports increase and imports decrease, there is typically a better balance of payments due to the trade deficit shrinks.

24. When a country devalues its currency, its effect would be: [U.P.P.C.S. (Spl.) (Mains) 2008]

Correct Answer: (b) imports become costly and exports become cheaper
Solution:Devaluation means a reduction in the value of domestic currency related to foreign currencies in a fixed exchange rate system. It is the deliberate downward adjustment of the value of a country's currency relative to another currency, group of currencies, or currency standard. It generally decreases the prices of exports in foreign countries and provides a boost to exports by making them more competitive. On the other hand it increases the cost of imports. If imports are more expensive, domestic consumers are less likely to purchase them, further strengthening domestic businesses. Because exports increase and imports decrease, there is typically a better balance of payments due to the trade deficit shrinks.

25. A country resorts to devaluation of its currency to: [U.P.P.C.S. (Mains) 2003]

Correct Answer: (a) Fix the balance of trade
Solution:Devaluation means a reduction in the value of domestic currency related to foreign currencies in a fixed exchange rate system. It is the deliberate downward adjustment of the value of a country's currency relative to another currency, group of currencies, or currency standard. It generally decreases the prices of exports in foreign countries and provides a boost to exports by making them more competitive. On the other hand it increases the cost of imports. If imports are more expensive, domestic consumers are less likely to purchase them, further strengthening domestic businesses. Because exports increase and imports decrease, there is typically a better balance of payments due to the trade deficit shrinks.

26. Which one of the following is not the effect of devaluation of currency? [U.P. Lower Sub. (Pre) 1998]

Correct Answer: (a) This causes deflation in the importing country.
Solution:Devaluation does not lead to deflation in the importing country, as the price level rises due to the increase in the prices of imported goods in the country. Devaluation raises the domestic prices of imports and it will tend to raise the prices of import substitutes, of potential exports, and of intermediate goods required for their production. Thus, unless the monetary authorities restrict credits in order to force price reductions in other sectors of the economy, the price level will be somewhat increased as a result of the devaluation.

27. Assertion of growth of India's exports has shown an appreciable increase after 1991. [I.A.S. (Pre) 2000]

Reason (R): The Govt. of India has resorted to devaluation.

Correct Answer: (a) Both A and R are true and R is the correct explanation of A
Solution:To restore the competitiveness of Indian exports and reduce trade deficit and CAD, the exchange rate of the rupee was adjusted downwards sharply by about 18 percent in two stages-on July 1 and July 3, 1991. Various export promotion measures were also launched by the government. These were the reasons that the rate of growth of India's exports had shown an appriciable increase after 1991. Hence, both A and Rare true and R is the correct explanation of A.

28. The problem of International liquidity is related to the non-availability of: [I.A.S. (Pre) 2015]

Correct Answer: (c) Dollars and other hard currencies
Solution:The term 'International Liquidity' means all the financial resources and facilities that are available to the monetary authorities of individual countries for financing the deficit in their international balance of payments. The components of the International Liquidity consist of gold reserves with the Central Bank and with the IMFC (SDR), and foreign currencies. Hard currency refers the money that is stable and widely accepted around the world as a form of payments for goods and services etc. They are US Dollar, Pound and Euro etc.

29. The economic crisis in the later half of 1990s most seriously affected Indonesia, Thailand, Malaysia and South Korea. The cause of the crisis was: [i.A.S. (Pre) 1999]

Correct Answer: (b) the prolonged over-valuation of local currencies vis-a-vis the western currencies
Solution:The economic crisis in the later half of 1990s most seriously affected South-East Asian countries including Indonesia, Thailand, Malaysia and South Korea. The main cause of the crisis was the prolonged over-valuation of local currencies vis-a-vis the western currencies. The crisis was caused by the collapse of the currency exchange rates and hot money bubble. It started in Thailand in July, 1997 after the Thai baht plunged in value and then swept over East and South-East Asia. As a result of the financial crisis, currency values, stock markets, and other asset values in many South- East Asian Countries collapsed.

30. What has been the impact of the heavy devaluation of currencies in South-East Asian countries in the recent months on Indian exports? [M.P.P.C.S. (Pre) 1998]

Correct Answer: (b) Unfavourable
Solution:Due to the South-East Asian crisis in the year 1997-98, the currency values of these countries had declined. Since the goods exported by India are competitive to those exported by these countries, the depreciation in the currency values of these countries had the unfavourable effect on India's exports.

India's Exchange Rate Policy:
Past trends:

  • India has primarily followed a managed-float regime for three decades.
  • From 2010, the Reserve Bank of India (RBI) managed the rupee asymmetrically:
  • Under excess demand: Depreciated the rupee and sold foreign reserves.
  • Under excess supply: Accumulated reserves to avoid appreciation.

Post-COVID shifts:

  • Between 2022 and late 2024, the RBI temporarily adopted a fixed exchange rate-like regime to stabilize the rupee.
  • Recent sharp devaluation suggests a return to the managed-float approach, driven by:
  • Capital outflows.
  • Rising import costs amid high crude oil prices.
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