(a) What is balance of payments deficit? (b) How is it financed?

Answer Details

(a) Balance of payments (BOP) deficit. The balance of payments is a record of all economic transactions between a country and the rest of the world in a given year. A BOP deficit exists when a country's total payments to other countries (for imports of goods, services and capital outflows) exceed its total receipts from them (from exports and capital inflows). In other words, outflows of foreign exchange are greater than inflows, so the overall balance is unfavourable (negative).

(b) How a deficit is financed. A deficit must be settled by drawing on external means of payment, mainly:

• Running down external (foreign exchange) reserves: using accumulated reserves of gold and foreign currencies to pay the difference.
• Borrowing from abroad: loans from foreign governments, the IMF, the World Bank or the international capital market.
• Drawing on IMF facilities/Special Drawing Rights (SDRs): using the country's reserve position and SDR allocation at the Fund.
• Attracting foreign investment and aid: inflows of foreign private capital or grants help cover the gap.
• Sale of gold and foreign assets held abroad.

These are short-term financing measures; a lasting cure requires correcting the deficit itself, for example by boosting exports, cutting imports or devaluing the currency.