UPSC Prelims 2011 · Question 50 of 100
UPSC Prelims 2011 question on Current Account Deficit Measures
- ExamUPSC CSE
- Year2011
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicExternal Sector of India
- DifficultyMedium
- TypeStatement
Consider 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/actions can help in reducing the current account deficit?
Show answer
Answer: D. 1 and 3
Verdict
Correct Answer: 1 and 3 only
Analysis
To reduce the Current Account Deficit (CAD), a country must either increase foreign exchange earnings or reduce foreign exchange outflow.
Statement by statement
1. Devaluing the domestic currency — Correct
Devaluation makes exports cheaper for foreign buyers and imports costlier for domestic consumers. This can increase exports, reduce imports and improve the trade balance, thereby helping reduce CAD.
2. Reduction in export subsidy — Incorrect
Export subsidies make exports more competitive. Reducing them may increase export prices and reduce export competitiveness, which can worsen the trade deficit.
3. Attracting FDI and FIIs — Correct
FDI and FII inflows are part of the capital account, not the current account. However, they help finance the CAD and improve the overall Balance of Payments position. FDI can also improve production capacity and exports in the long run.
Extra UPSC info
CAD occurs when imports of goods, services and transfers exceed exports and receipts.
CAD is part of the Current Account of the Balance of Payments.
High CAD may put pressure on the domestic currency.
Measures to reduce CAD include export promotion, import substitution, reducing non-essential imports and attracting stable capital inflows.
FDI is more stable than FII, as FIIs are more volatile and can exit quickly.
How to crack it
Devaluation can improve export competitiveness, and foreign investment can help finance the deficit. Reducing export subsidy does not help. Therefore, the correct answer is 1 and 3 only.