Current Account Deficits Pressure Devaluation in Fixed Exchange Rates

Steps:

• In a fixed exchange rate, the central bank intervenes to maintain the currency's value against reserves.
• Pressure to devalue occurs when there's persistent excess supply of domestic currency in forex markets.
• A current account deficit reflects more imports than exports, increasing demand for foreign currency.
• This depletes reserves as the bank sells foreign currency to defend the peg, building devaluation pressure.

Why C is correct:

• Per balance of payments theory, a widening current account deficit creates sustained currency outflows, forcing devaluation to restore equilibrium without endless reserve loss.

Why the others are wrong:

• A: Lower relative inflation boosts export competitiveness, improving the trade balance and pressuring appreciation.
• B: Reducing import tariffs may increase imports and deficits indirectly, but does not directly cause devaluation pressure like the deficit itself.
• D: Higher relative interest rates attract capital inflows, strengthening the currency and pressuring appreciation.

Final answer: C