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?

The correct answer is D, that is 1 and 3.

• Statement 1 is correct. Devaluation makes imports dearer and exports cheaper in rupee-foreign currency terms. Over time this can narrow the trade gap, which is the largest part of the current account deficit (CAD).
• Statement 2 is wrong. Export subsidies lower the effective cost of Indian goods abroad. Cutting them makes exports less competitive, so the CAD would widen, not shrink.
• Statement 3 is correct, but indirectly. FDI and FII inflows sit in the capital account, not the current account. They help by financing the CAD and building forex reserves. FDI is the more stable form and can also add export capacity over time. FII flows are volatile and can reverse suddenly, so this is a weaker tool than the first.

The core concept is the balance of payments: the current account (trade in goods and services, transfers) must be financed by capital account flows. This links directly to Mains GS-III questions on external sector management and the rupee.

Trap: Aspirants treat every capital inflow as a direct cure for the CAD. Inflows finance the gap; they do not shrink the trade deficit by themselves.