Prelims 2011 · archive
MediumConsider the following actions which the government can take:
- 1.Devaluing the domestic currency.
- 2.Reduction in the export subsidy.
- 3.Adopting suitable policies which attract greater FDI and more funds from FIIs.
Which of the above action/(s) can help in reducing the current account deficit?
Answer & explanation
Answer: (d) 1 and 3
A current account deficit means a country's payments abroad for imports and other current items exceed its earnings from exports and other current receipts. Devaluation makes domestic goods cheaper for foreigners and imported goods dearer, so it helps narrow the deficit. Cutting export subsidies hurts exports, so it does the opposite. Attracting FDI and FII money brings in foreign exchange to pay for the deficit, and FDI also helps exports grow. So actions 1 and 3 help, and action 2 does not.
- ✓ 1. In a devaluation, a government action raises the exchange rate, so the domestic currency becomes cheaper. Exports then cost foreigners less, and imports become relatively more expensive, so fewer are bought. More exports and fewer imports narrow the current account deficit.
- ✗ 2. An export subsidy is support tied to the firm exporting, for example by meeting export targets. It is meant to raise exports. Cutting it makes exporters less competitive, so exports fall and the deficit widens instead of shrinking.
- ✓ 3. FDI and FII inflows come in through the capital account and pay for the gap in the current account. An RBI study describes FDI as the most stable component of the capital flows needed to finance the current account deficit. It also notes that FDI promotes exports, which narrows the gap over time.
Remember · Current account deficit = current payments abroad (imports and other items) exceeding current receipts (exports and other items). Devaluation and export support narrow it. FDI/FII inflows finance it through the capital account, and FDI also boosts exports.
📘 Read it in NCERT: Class 12 Introductory Macroeconomics, Ch 6 (practise this chapter) · Class 12 Introductory Macroeconomics, Ch 6 (practise this chapter)
Sources
- NCERT Class 12 · Introductory Macroeconomics, Chapter 6 “In a fixed exchange rate system, when some government action increases the exchange rate (thereby, making domestic currency cheaper) is called Devaluation.”
- NCERT Class 12 · Introductory Macroeconomics, Chapter 6 “Recall that the real exchange rate is defined as the relative price of foreign goods in terms of domestic goods. A higher R makes foreign goods relatively more expensive, thereby leading to a decrease in the quantity of imports.”
- WTO – Understanding the WTO: Anti-dumping, subsidies, safeguards ↗ “Prohibited subsidies: subsidies that require recipients to meet certain export targets, or to use domestic goods instead of imported goods.”
- RBI – Foreign Direct Investment Flows to India (2011) ↗ “FDI is generally known to be the most stable component of capital flows needed to finance the current account deficit. Moreover, it adds to investible resources, provides access to advanced technologies, assists in gaining production know-how and promotes exports.”
Question: UPSC Civil Services (Preliminary) 2011, General Studies paper. Explanation: Minimalist IAS, checked 25 Oct 2026 (how we verify). ·