Devaluation Worsens Terms of Trade

Steps:

• Devaluation reduces a currency's external value, making exports cheaper abroad and imports more expensive domestically.
• Export prices in foreign currency fall, boosting competitiveness.
• Import prices in domestic currency rise due to the weaker exchange rate.
• Terms of trade, defined as (export price index / import price index), deteriorate as import prices increase relative to exports.

Why D is correct:

• Terms of trade worsen because devaluation raises the domestic cost of imports while export earnings in foreign currency decline, lowering the export-to-import price ratio.

Why the others are wrong:

• A: Devaluation increases, not decreases, the domestic price of imports.
• B: The value of imports rises in domestic currency terms due to higher prices.
• C: Balance of payments may improve over time via cheaper exports if demand is elastic, not always worsen.

Final answer: D