(a) What is meant by devaluation? (b) Explain the measures by which a country can correct its balance of payments deficit.

Answer Details

(a) Meaning of devaluation. Devaluation is the deliberate official reduction in the exchange value of a country's currency relative to other currencies (or to gold) under a fixed exchange rate system. It makes the country's exports cheaper to foreigners and its imports more expensive, and is used mainly to correct a persistent balance of payments deficit.

(b) Measures to correct a balance of payments deficit

• Devaluation: lowering the currency's value makes exports cheaper and imports dearer, encouraging exports and discouraging imports.
• Deflationary (contractionary) policies: reducing government spending and money supply lowers domestic incomes and demand, thereby cutting spending on imports.
• Import restrictions: imposing tariffs, quotas and outright bans reduces the volume and value of imports.
• Export promotion: giving subsidies and incentives to exporters and diversifying exports raises export earnings.
• Exchange control: government rations and controls the use of foreign exchange so that scarce foreign currency is used only for essential imports.
• Import substitution: producing locally the goods formerly imported reduces reliance on imports.