Correct Option
Statement 1 is correct: Devaluation refers to the official reduction in the value of a country's currency relative to foreign currencies. This action makes the country's exports cheaper for foreign buyers, thereby enhancing their price competitiveness in international markets. For example, if the exchange rate shifts from $1 = ₹70 to $1 = ₹90, a product priced at ₹70 would effectively cost $1 before devaluation but approximately $0.78 after devaluation, making it more attractive to foreign consumers.
Incorrect Options
Statement 2: Devaluation leads to a decrease, not an increase, in the foreign value of the domestic currency. When a currency is devalued, a larger quantity of the domestic currency is required to purchase a given amount of foreign currency. Consequently, each unit of the domestic currency can acquire less foreign currency than before, indicating a reduction in its purchasing power abroad.
Statement 3: While devaluation is typically implemented with the aim of improving the trade balance by making exports more affordable and imports more expensive, this outcome is not guaranteed to occur necessarily. The effectiveness of devaluation in improving the trade balance depends on several factors, including the price elasticity of demand for exports and imports, the presence of domestic supply-side constraints, and the time lag for the 'J-curve effect' to materialize. If the demand for exports and imports is inelastic, or if domestic production cannot readily expand to meet increased export demand, the trade balance may not improve, and could even worsen in the short term. Therefore, it does not necessarily improve the trade balance.