What is a likely consequence of a currency being overvalued for an extended period?

When a currency is overvalued for an extended period, it often leads to higher foreign currency costs for domestic borrowers, which impacts their ability to manage their debt levels effectively. An overvalued currency makes imported goods cheaper, potentially increasing consumption of those goods and reducing demand for domestically produced items. This situation can stress local businesses and lead to decreased competitiveness in the international market. As domestic firms struggle to compete, they may resort to excessive borrowing, which can become unsustainable if the cost of servicing foreign debt rises.

Consequently, firms facing higher costs associated with a stronger currency may also find themselves strained financially, leading to rallying growth in debt levels. This can create a vicious cycle where the increasing foreign currency debt leads to further financial instability, making option B the most likely consequence of a prolonged overvaluation of a currency.

Other choices, such as increased competitiveness of exports or a decrease in current account deficit, contradict the typical economic response to overvaluation, where export prices rise relative to foreign competitors, thus negatively affecting competitiveness. Similarly, while there could be scenarios where external debt reduces, the pressure from an overvalued currency and higher borrowing costs generally leads to the opposite effect.