What is Balance of Payment Crisis?

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What is Balance of Payment Crisis?
Balance of Payment (BoP) is an accounting record that reflects the financial transaction between a country, when compared to the rest of the world. Generally, a BoP account including international transactions is maintained for a particular period, i.e. generally a year, and in a particular currency, which is usually the domestic currency of the concerned nation.

Balance of Payment Crisis

A weak trade deficit could often trigger a BoP crisis. This is also referred to as a currency crisis, which occurs when the total imports of an economy far exceeds the total exports. Consequently, the economy fails to maintain its debt payments. Further, the BoP crisis that is a kind of financial crisis impacts the foreign exchange market considerably. The value of the affected nation's currency witnesses rapid change, as a result the currency's ability to function as a medium of exchange is undermined. More often, the value of the currency depreciates driven by huge outbound capital flows.

The occurrence of BoP crisis can be attributed to several reasons. Among them, budget crisis, which is the deficit in budget is one of them.

BoP crisis is also an indication of real-time economic crisis. The crisis could prove to be destructive for small open economies as well as larger economies. However, the extent of destruction experienced by stable economies on account of the BoP crisis is likely to be far low.

Options with the government for fending-off the crisis

To tackle the issue, the government addresses the increased demand for a currency by making use of its own foreign reserves ( generally in the Pound sterling, Euro or United States dollar) or its currency reserves. The government can also increase the interest rates for preventing further depreciation in the value of its currency.

Asian Currency Crisis is the classic example of Balance of Payment crisis.

Read more about: trade deficit, balance of payment
Story first published: Tuesday, July 2, 2013, 14:36 [IST]
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