Why might a government experience a balance of payments crisis?
It has a positive current account deficit
It has a negative exchange rate.
It has a negative current account deficit .
It has a positive exchange rate .
The correct answer and explanation is:
The correct answer is: It has a negative current account deficit.
A balance of payments (BOP) crisis occurs when a country faces severe difficulty in financing its current account deficit, leading to a depletion of foreign exchange reserves or an inability to meet its external debt obligations. The current account records a country’s transactions related to imports and exports, including goods, services, income from investments, and transfers. A negative current account deficit indicates that a country is importing more than it is exporting, which can lead to the outflow of foreign currency.
When a country runs a large and persistent current account deficit, it needs to borrow or attract foreign investment to finance this shortfall. If external borrowing becomes unsustainable or foreign investors lose confidence in the country’s ability to repay its debts, it may lead to a crisis. This situation can occur when there is a lack of foreign currency reserves to cover the deficit, and the country’s exchange rate starts to depreciate.
A negative current account deficit signals an imbalance in trade and financial flows, leading to pressure on the country’s currency. This pressure can result in a sharp depreciation, making imports more expensive and worsening the deficit. In extreme cases, the country might be forced to devalue its currency or seek assistance from international financial institutions like the International Monetary Fund (IMF).
A positive current account deficit (which is an oxymoron) would still indicate a trade imbalance but might suggest different economic conditions or policies. A positive or negative exchange rate does not directly cause a balance of payments crisis, but a depreciating currency often exacerbates it by increasing the cost of servicing foreign debt or importing goods and services.