These include slower economic growth, particularly in low-income countries, as well as crippling debt crises, financial market turmoil, and even secondary effects such as a rise in human-rights abuses. In some cases, external debt takes the form of a tied loan, which means that the funds secured through the financing must be spent in the nation that is providing the financing. For instance, the loan might allow one nation to buy resources it needs from the country that provided the loan. As people and businesses sometimes need to borrow money to pay their expenses, the same goes for the government of any country. The government sometimes may need to borrow money from either inside the country or outside the country.
Hence, Country A takes on external debt from Country B to fulfill its requirement. Country A must fulfill its obligation in time to prevent any impact on its credit ratings. First, they provide loans at non-concessional interest rates to high and middle-income countries. Like any form of debt, borrowing money from foreign sources can be good or bad. It may be a useful, cost-effective way to access much-needed capital or trigger a vicious cycle of debt. The external debt statistics also include indicators of net external debt (i.e. gross external debt net of external assets in debt instruments).
World Bank Data
If large amounts of external debt need to be repaid, then there is less money left for investment purposes. This means that the borrower must utilize the loan amount to only make expenditures in the lender’s country. For example, a loan might only allow a country to purchase the required resources from the nation that sanctioned the loan.
- Foreign debt also includes obligations to international organizations such as the World Bank, Asian Development Bank (ADB), and the International Monetary Fund (IMF).
- The example, though simplified, gives an accurate estimate of how damaging a debt cycle can be.
- The nations that follow the U.S. in the list are —- United Kingdom- France- Germany- Japan- The Netherlands, etc.
Since it cannot raise further debt, the country might fail to repay external debt, a phenomenon known as sovereign default. Therefore, the debt cycle culminates in an almost bankrupt nation, and many other lender-nations facing bad loans. External debt is the portion of a country’s debt that is borrowed from foreign lenders. Internal debt is the opposite, referring to the portion of a country’s debt incurred within its borders. Poor debt management, combined with shocks such as a commodity-price collapse or severe economic slowdown, can also trigger a debt crisis.
When a government’s expenditure exceeds how much it earns in a year, it faces a fiscal deficit. In order to finance the adverse gap, the government borrows money from another country. In the next year, with the additional expense of interest payment and loan repayment, the government might face a deficit again and be forced to take another external loan. In subsequent years, there might be a situation where it borrows money in order to repay its previous loans. Countries borrow from foreign creditors mainly to finance their own excess expenditures, build additional infrastructure, finance recovery from natural disasters, and even to repay its previous external debt. Suppose Country A requires significant capital expenditure to recover from a natural disaster.
Understanding Foreign Debt
This is often exacerbated because foreign debt is usually denominated in the currency of the lender’s country, not the borrower. That means if the currency in the borrowing country weakens, it becomes that much harder to service those debts. Foreign debt, also known as external debt, has been rising steadily in recent decades, with unwelcome side-effects in some borrowing countries.
In the case of external debt, all repayments must be made in the currency in which the debt was issued. Internal debt can be defined as money borrowed by the government from inside the country. Sources for internal debts can include citizens, the country’s banks, the country’s financial institutions, business houses, etc. Internal debts are mostly used by the government for the betterment of education and health within the country. External debt refers to liabilities governments usually owe foreign lenders, such as international financial institutions, foreign governments, and commercial banks. Nations may take on this debt for various purposes, like meeting additional expenses, building infrastructure, etc.
Let us look at a few external debt examples to understand the concept better. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more.
Indicators
A government or a corporation may borrow from a foreign lender for a range of reasons. For one thing, local debt markets may not be deep enough to meet their borrowing needs, particularly in developing countries. Moreover, the loan repayment leaves the borrower with little funds to invest in economic development. Besides this, the borrowing country’s exposure to interest rate risk increases when it takes on foreign debt. According to one estimate, the amount of money developing country governments are paying toward foreign debt nearly doubled from 2010 to 2018, as a percentage of government revenues.
Foreign Debt: Definition and Economic Impact
Likewise, if a country needs to build up its energy infrastructure, it might leverage external debt as part of an agreement to buy resources, such as the materials to construct power plants in underserved areas. Internal, external, and public debt might confuse an individual who is not familiar with these terms. All three are a source of financing for governments, companies, and individuals. The table below compares these three concepts to get a clear idea about them. Besides pledging more funds, Antony Blinken urged Pakistan to look for debt restructuring and relief from China, its largest creditor.
Such financial aid could be used to address humanitarian or disaster needs. For example, if a nation faces severe famine and cannot secure emergency food through its own resources, it might use external debt to procure food from the nation providing the tied loan. A country with a high amount of external debt raises caution among prospective lenders, and they become unwilling to lend more money.
The borrowed money is known as Debt, and the modes of borrowing money can be classified into two categories – External Debt and Internal Debt. External Debt can be defined as money borrowed from outside the country, and Internal Debt can be defined as money borrowed from inside the country. In addition to the suffering that results from economic stagnation, the United Nations has also linked high levels of foreign debt and a government’s dependency on foreign assistance to human rights abuses. Economic distress causes governments to cut social spending, and reduces the resources it has to enforce labor standards and human rights, the U.N. On the other hand, internal debt refers to the money owed to domestic financial institutions and what is external debt commercial banks.