At the Root of Country Risk: The Balance of Payments from Liquidity to Solvency Crisis

Abstract

External debt crises are rooted in balance of payments problems. Protracted imbalances between inflows and outflows translate sooner or later in, first, liquidity problems, and subsequently, in solvency tensions. This is because the balance of payments is the financial link between a country and the rest of the world. It records all cross-border transactions, including the trade of goods and services as well as capital flows. More precisely, it is the accounting framework and statistical record of all economic and financial flows that take place over a specified time period between residents of the reporting country and the world economy. The different accounts in the balance of payments make it possible to see whether or not a country lives “beyond its means,” hence helping the country risk analyst to anticipate upcoming liquidity, and solvency difficulties.