Question

Q: Carefully explain what it means to say that a country has a balance of payments problem. What part or parts of a country's balance of payments accounts might provide an "alert" that there is potential for crisis?

Answer 1

Balance of payments = Current account + Capital account

Current account = Receipts for exports - Payments for imports + Income from foreign investment+ Unilateral payments - Income given to foreign investors in domestic securities.

Capital account = Foreign exchange reserve + loans to other countries- loans from other countries

When we say there are BOP problems, we generally refer to the current account deficit i.e. when exports lag the imports. So we need to analyse if this deficit ifs a long term phenomenon or a self correcting one, and then act accordingly. Therefore we need to track the the difference bet ween the export and the imports, which shows in the balance of trade in the current account to act as an alert for an upcoming crisis.