Financing current account deficit via capital inflows

Steps:

• Current account deficit means outflows exceed inflows from trade and transfers, requiring external financing.
• Balance of payments identity requires capital account surplus to offset the deficit.
• Capital account includes foreign direct investment (FDI) as inflows from abroad.
• Attracting FDI provides funds to cover the shortfall without depleting reserves.

Why B is correct:

• FDI represents capital inflows in the balance of payments, directly creating a surplus in the financial account to finance the current account deficit per the BOP equilibrium.

Why the others are wrong:

• A: Adopting a fixed exchange rate manages currency value but does not generate financing inflows.
• C: Decreasing income tax rates boosts domestic demand, potentially increasing imports and worsening the deficit.
• D: Lowering interest rates discourages foreign capital inflows by reducing returns on investments.

Final answer: B