Balance-of-payments crisis

A balance-of-payments (BOP) crisis, also known as a currency crisis, is a situation where a country experiences a severe shortage of foreign exchange reserves, making it unable to pay for essential imports or service its external debt obligations.
Updated: May 30, 2024

3 Key Takeaways

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  • A balance-of-payments crisis occurs when a country struggles to meet its international financial obligations.
  • It is often triggered by a rapid decline in foreign exchange reserves and a sharp depreciation of the domestic currency.
  • The consequences of a BOP crisis can be severe, including economic recession, inflation, and social unrest.

What is a Balance-of-Payments Crisis?

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A balance-of-payments crisis is a critical economic situation where a country’s balance of payments, which tracks its international transactions, becomes unsustainable. This typically happens when a country’s foreign exchange reserves dwindle rapidly, leading to a sharp depreciation of its currency and a loss of confidence in its ability to meet its external debt payments.

Importance of Understanding Balance-of-Payments Crises

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  • Economic Stability: A BOP crisis can destabilize a country’s economy, causing a sharp decline in output, investment, and employment.
  • Financial Contagion: It can trigger financial contagion, spreading to other countries and causing a regional or global crisis.
  • Social Impact: A BOP crisis can lead to social unrest, as the economic hardship and rising prices can fuel discontent and protests.
  • Policy Implications: Understanding the causes and consequences of BOP crises is crucial for policymakers to design effective preventive measures and crisis management strategies.

Real-World Applications

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Balance-of-payments crises have occurred throughout history, with devastating consequences for the affected countries. The Asian financial crisis of 1997-98, the Russian financial crisis of 1998, and the Argentine economic crisis of 2001 are some prominent examples. These crises often resulted from a combination of factors, such as large current account deficits, excessive external borrowing, fixed exchange rate regimes, and weak financial systems.

More recently, the global financial crisis of 2008 highlighted the interconnectedness of economies and the potential for a balance-of-payments crisis to trigger a global economic downturn. In response, many countries have taken steps to strengthen their economic fundamentals, build up their foreign exchange reserves, and implement more flexible exchange rate regimes to reduce their vulnerability to future crises.

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