How can a balance of payments crisis emerge?

A balance of payments crisis can emerge when a country cannot meet its international financial obligations.

A balance of payments crisis typically arises when a country is unable to pay for necessary imports or service its debt repayments. This is often the result of a significant deficit in the current account, which records all transactions between a country and the rest of the world that involve goods, services, and income. When a country imports more than it exports, it runs a trade deficit. If this deficit is large and sustained, it can lead to a balance of payments crisis.

The situation can be exacerbated by capital flight, where investors withdraw their investments en masse due to perceived economic instability or lack of confidence in the country's ability to service its debts. This can lead to a rapid depreciation of the country's currency, making imports more expensive and exacerbating the current account deficit.

In addition, a country with high levels of external debt is more vulnerable to a balance of payments crisis. If a country is heavily reliant on foreign borrowing to finance its deficit, it is at risk of a crisis if lenders suddenly decide to stop lending or to increase interest rates. This can happen if lenders lose confidence in the country's ability to repay its debts, or if there are changes in global financial conditions that make lending riskier or less attractive.

A balance of payments crisis can have severe economic consequences. It can lead to a sharp devaluation of the currency, which can increase the cost of imports and lead to inflation. It can also cause a severe contraction in the economy, as the government is forced to implement austerity measures to reduce the deficit. This can lead to high levels of unemployment and social unrest.

In order to avoid a balance of payments crisis, countries need to manage their current account deficits and external debt levels carefully. This can involve implementing policies to increase exports or reduce imports, attracting foreign investment, and ensuring that the level of external debt is sustainable. It may also involve seeking financial assistance from international organisations such as the International Monetary Fund.