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Unformatted text preview: affects the exporter’s ability to compete globally due to the fact that if a US importer pays $ 1 for a product , the Indian exporter will get Rs 44 , which is the nominal exchange rate, which is worth only Rs 40 because of effect of inflation in India. Thus to maintain the real exchange rate as 44, the nominal exchange rate should depreciate by 10% i.e 48.4 in this example. Then the exporter get the true value of 44 (which is the real exchange rate) The essence of this theory is that one must export to a country whose inflation rate is higher than the domestic inflation rate. In the case of imports, one must import from a country whose inflation rate is lower than the domestic country. Drawbacks of PPP theory: Doesn’t take into account actual practice factors such as current account performance, portfolio decisions, interest rates, economic growth and central bank’s intervention, which have an effect...
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