CDS Economics · Indian Economy
Exchange Rates and Trade Policy
Fixed and floating exchange rates, what a weaker rupee does to exports, imports and prices, and India's trade agreements and export schemes.
Why this matters
Eleven CDS questions, three of them in 2025. The effect of a falling currency was asked three times (2017 (II), 2023 (II) and 2025 (I)): exports up, imports down, prices up.
Concept 1 of 3: Exchange rate systems
An exchange rate is the price of one currency in another. A government can fix that price and defend it, or let the market set it, or do something in between. The history runs from gold, to a dollar peg, to the floating rates of today.
Definition
The systems:
- Fixed rate: set by government decision and kept there by government action (the central bank buys and sells foreign currency to hold it).
- Floating rate: set by demand and supply in the market, without government intervention.
- Managed float: market-set, but the central bank steps in to smooth sharp swings. India has had a market-determined, managed rate since 1993.
- Classical gold standard (to 1914): each currency fixed in terms of gold.
- Bretton Woods (1944 to the early 1970s): currencies pegged to the US dollar, and the dollar to gold at 35 dollars an ounce. It was a system of pegged, not floating, rates.
- Devaluation is an official cut in a fixed rate (India in 1966 and 1991); depreciation is a fall set by the market.
| System | Rate set by | Period |
|---|---|---|
| Gold standard | Fixed in terms of gold | Up to 1914 |
| Bretton Woods | Pegged to the dollar, the dollar to gold | 1944 to the early 1970s |
| Floating | The market alone | Major currencies since 1973 |
| Managed float | The market, with central bank smoothing | India since 1993 |
Practice this concept3 quick reps
The same idea in a real exam question:
CDS · 2021 · CDS (I) 2021 — General Knowledge · Q28Hard
Example 1 · Indian Economy · Exchange Rates and Trade Policy
Exchange rates state the value of one currency in terms of other currencies. Which one of the following statements with respect to the exchange rate of currency is correct ?
Floating means no intervention
If governments buy and sell their currency to hold a rate, the rate is fixed or managed, not floating. And under the gold standard, rates were fixed in terms of gold, not the dollar.
Concept 2 of 3: What a weaker rupee does
When the rupee falls, a foreign buyer needs fewer dollars to buy the same Indian goods, so Indian exports become cheaper abroad. An Indian buyer needs more rupees for the same foreign goods, so imports become dearer at home. Dearer imports, especially oil, push up costs and prices inside India.
Definition
The effects of a depreciation or devaluation:
- Exports rise: Indian goods are cheaper in foreign currency.
- Imports fall: foreign goods are dearer in rupees. Depreciation does not make imports cheaper.
- Domestic inflation rises: imported inputs and fuel cost more.
- The export gain lasts only if domestic prices stay constant. If Indian prices rise as much as the rupee fell, the advantage is wiped out.
- A shock to crude oil imports works the same way: higher input costs and inflation, a bigger import bill, and a weaker rupee.
Rupee price of a foreign good
- exchange rate: rupees per dollar
Worked example
A machine costs 1,000 dollars. The rupee falls from 80 to 88 per dollar. What happens to the machine's price in India, and to the dollar price of an Indian shirt priced at 800 rupees?
Practice this conceptself-check · 3 quick reps
The same idea in a real exam question:
CDS · 2023 · CDS (II) 2023 — General Knowledge · Q32Moderate
Example 2 · Indian Economy · Exchange Rates and Trade Policy
Which of the following is/are the effects of devaluation or depreciation of currency ?
1. It leads to increase in imports and decrease in exports.
2. It leads to increase in exports and decrease in imports.
3. It leads to increase in domestic inflation.
4. It leads to decrease in domestic inflation.
Select the correct answer using the code given below :
A falling rupee makes imports dearer
Depreciation raises the rupee price of imports. It helps net exports by making exports cheaper abroad, not by making imports cheaper.
Concept 3 of 3: Trade agreements and export schemes
India signs trade agreements to cut tariffs with partners, and runs schemes to help small and new exporters. Whether an agreement lifts exports depends on more than the tariff cut: the rules for claiming it, the partner's health and safety rules, India's own roads and ports, and the partner's income all matter.
Definition
The facts:
- Export gains from an FTA depend on: the tariff cut below MFN rates, the rules of origin, sanitary and phytosanitary measures, India's infrastructure, and the income of the partner countries.
- RCEP (Regional Comprehensive Economic Partnership): the 10 ASEAN states and their FTA partners China, Japan, South Korea, Australia and New Zealand; signed 2020. India withdrew in November 2019, fearing an import surge, above all from China.
- India's newer deals include the UAE (CEPA, 2022), Australia (ECTA, 2022) and the EFTA states (TEPA, 2024).
- India runs a steady trade surplus with the USA, its largest export market; with China and Saudi Arabia it runs deficits.
- Niryat Bandhu (DGFT): mentoring first-generation and new exporters.
- Districts as Export Hubs (launched 2019, restated in the Foreign Trade Policy 2023): export products identified in every district, with logistics and infrastructure support.
| Item | Key fact |
|---|---|
| What FTA export gains depend on | Tariff cut, rules of origin, SPS rules, home infrastructure, partner incomeQ |
| RCEP | ASEAN plus five partners; India withdrew in 2019 |
| Trade surplus partner | USA, India's largest export marketQ |
| Niryat Bandhu | Mentoring first-generation exportersQ |
| Districts as Export Hubs | Every district, not a chosen few; 2019Q CDS 2025 (II): limiting DEH to selected districts was the wrong statement. |
Practice this conceptself-check · 4 quick reps
The same idea in a real exam question:
CDS · 2024 · CDS (I) 2024 — General Knowledge · Q114Moderate
Example 3 · Indian Economy · Exchange Rates and Trade Policy
Consider the following statements about the Regional Comprehensive Economic Partnership (RCEP) :
1. It is a comprehensive free trade agreement between the ASEAN member States and ASEAN's free trade agreement partners.
2. India opted out of RCEP.
Which of the statements given above is/are correct?
Every district, not a few
Districts as Export Hubs covers every district. A statement that it boosts only selected districts is wrong.
Surplus with the USA, deficit with China
India sells more to the USA than it buys, but buys far more from China and Saudi Arabia (manufactures and crude oil) than it sells.
Summary — formulas & gotchas at a glance
A revision cheat-sheet for the formulas and gotchas above. Click any concept name to jump back to its full explanation.
Formulas (1)
- What a weaker rupee does
Rupee price of a foreign good
Reference tables (2)
Exchange rate systems4 rows
| System | Rate set by | Period |
|---|---|---|
| Gold standard | Fixed in terms of gold | Up to 1914 |
| Bretton Woods | Pegged to the dollar, the dollar to gold | 1944 to the early 1970s |
| Floating | The market alone | Major currencies since 1973 |
| Managed float | The market, with central bank smoothing | India since 1993 |
Trade agreements and export schemes5 rows
| Item | Key fact |
|---|---|
| What FTA export gains depend on | Tariff cut, rules of origin, SPS rules, home infrastructure, partner incomeQ |
| RCEP | ASEAN plus five partners; India withdrew in 2019 |
| Trade surplus partner | USA, India's largest export marketQ |
| Niryat Bandhu | Mentoring first-generation exportersQ |
| Districts as Export Hubs | Every district, not a chosen few; 2019Q CDS 2025 (II): limiting DEH to selected districts was the wrong statement. |
Watch out for (4)
- Floating means no intervention→ Exchange rate systems
- A falling rupee makes imports dearer→ What a weaker rupee does
- Every district, not a few→ Trade agreements and export schemes
- Surplus with the USA, deficit with China→ Trade agreements and export schemes
Test yourself on Indian Economy
15 past CDS questions from this chapter, timed at 15 minutes and marked the way the exam marks it. You see your score and every answer the moment you finish. Free to start.