Previous Year Question

International liquidity refers to internationally acceptable reserve assets available to a country for financing imports, servicing external debt and meeting other international-payment obligations.

If a country does not possess sufficient dollars or other widely accepted hard currencies, it may face difficulty in making external payments even if it possesses domestic currency and physical goods. This constitutes a problem of international liquidity.

The principal components of international liquidity include:

• Foreign-exchange reserves, especially dollars, euros, yen and other convertible currencies.

• Monetary gold.

• IMF-created Special Drawing Rights—SDRs.

• The country’s reserve position in the IMF.

• Other liquid and internationally acceptable foreign reserve assets.

A hard currency is one that:

• Is widely accepted in international trade and finance.

• Can be readily converted into other currencies.

• Maintains relatively stable value and credibility.

• Possesses adequate liquidity in foreign-exchange markets.

A country may face an international-liquidity problem because of:

• Persistent current-account or balance-of-payments deficits.

• Insufficient foreign-exchange earnings from exports.

• Sudden capital outflows.

• Heavy external-debt repayment obligations.

• A rapid decline in foreign-exchange reserves.

• Lack of international convertibility of its domestic currency.

Testing the options:

• Non-availability of goods and services is a production or supply problem, not the definition of international liquidity.

• Gold can constitute a reserve asset, but option (b) also includes silver and does not adequately describe modern international liquidity.

• Non-availability of dollars and other hard currencies directly constrains a country’s international-payment capacity.

• An exportable surplus may help earn foreign exchange, but its absence is not the direct definition of international liquidity.

International liquidity versus domestic liquidity

Domestic liquidity refers to money and banking-system liquidity available for payments within a country. International liquidity concerns reserve assets acceptable to foreign countries and international creditors.

A country may, therefore, have sufficient domestic currency but cannot simply print that currency to pay for foreign debt or imports unless its currency is internationally accepted.

Current position (2026)

Along with foreign currencies, SDRs remain an important component of international liquidity. In August 2021, the IMF made a historic general allocation of approximately SDR 456 billion, equivalent at that time to about US$650 billion.

An SDR is not itself a currency. It is an international reserve asset created by the IMF that member countries can exchange for freely usable currencies when required.