External Debt Overview, Types, Economic Times
These indicators can be thought of as measures of the country’s “solvency” in that they consider the stock of debt at certain time in relation to the country’s ability to generate resources to repay the outstanding balance. While debt can be a vital tool for economic growth and development, it becomes a problem when repayment costs outpace a country’s capacity to pay. External debt or external debt It is the total amount of money that a country owes to all foreign or international institutions that is, abroad.
The increasing burden of external debt can make Country X go bankrupt in a few years. The most crucial disadvantage of external debt is that it often leads to a vicious cycle of debt for countries. The debt cycle refers to the cycle of continuous borrowing, accumulating payment burden, and eventual default. 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 what is external debt previous external debt. External debt takes various forms depending on the borrower, lender, and terms of the agreement.
Internal debts are mostly used by the government for the betterment of education and health within the country. Sources for external debts can include foreign governments, International Monetary Funds (IMF), Foreign Direct Investments (FDI), Foreign Portfolio Investments (FPI), etc. Government is forced to borrow funds from external sources when the internal sources do not have adequate funds to support the operations of the government. Borrowing from foreign sources introduces complexities not present in domestic borrowing. Governments and corporations issuing internal debt primarily engage with local investors, financial institutions, or central banks, simplifying regulatory oversight and reducing exposure to foreign legal frameworks. Argentina’s External Debt Crisis (1998)The Argentine economic crisis that started in late 1997 was primarily caused by a combination of unsustainable public spending and overvalued currency.
The nature of External debts is more complex as compared to Internal debts as it uses the concept of foreign currency. The government offers money from external sources to boost its economy after facing any economic crunch, to invest in multiple sectors, etc. External debt refers to the loans raised through foreign lenders, such as foreign commercial banks, foreign governments, and international financial institutions. In the case of external debt, all repayments must be made in the currency in which the debt was issued. External debt is the portion of a country’s debt that is borrowed from foreign lenders, including commercial banks, governments, or international financial institutions.
Advantages of internal debt include reduced exposure to external market risks, as the principal and interest repayments are denominated in the borrower’s local currency. Additionally, accessing local financing may be easier than securing foreign funding, as there is generally less administrative complexity involved. However, relying on domestic sources for debt can potentially restrict a country’s ability to diversify its investor base and limit economic growth by reducing the available pool of capital for investments. When discussing debt, the terms external and internal debt may frequently appear interchangeably, but they represent distinct concepts for institutional investors. External debt refers to borrowings made by a country or organization from foreign lenders, whereas internal debt is debt owed to domestic creditors (lenders within the same nation). Understanding the differences between these two debt types can help investors make informed decisions concerning risk management and investment strategies.
Unexpected devaluation of domestic currency
External debts can pose risks for borrowers due to various factors such as exchange rate risk, credit rating downgrades, and the potential for default. However, they also offer benefits such as access to lower interest rates, diversification of financing sources, and economic development opportunities. Effective management strategies, including hedging and risk diversification, can help mitigate external debt risks. External debt, as the name suggests, refers to the financial obligations that a country, organization, or individual owes to foreign lenders or creditors. It is the accumulated sum of money borrowed from external sources, which can include commercial banks, foreign governments, or international financial institutions like the World Bank.
However, the debt will need to be repaid, along with interest, within one year of receiving the loan. The French government will face the pressure of repaying the loan even before the project starts yielding a stable return. The higher-than-expected expenditure highlights the increasing pressure of debt obligations on the nation’s fiscal sustainability. The PUNCH observed that the debt servicing costs recorded in 2024 surpassed the budgeted allocation of N12.3tn for the year. Also, Nigeria spent a total of N13.12 tn on debt servicing in 2024, representing a 68 per cent increase from the N7.8 tn recorded in the previous year, according to an analysis of data from the Debt Management Office. However, the agency warned that risks to Nigeria’s external and fiscal position remained, particularly if oil prices fall or policy implementation slows down.
In subsequent years, there might be a situation where it borrows money in order to repay its previous loans. Interest payments on sovereign bonds may be subject to tax regulations in both the issuing and investor’s country. Under U.S. tax law (IRC Section 871(h)), interest on certain foreign-issued bonds is exempt from U.S. withholding tax if structured as portfolio interest. Besides pledging more funds, Antony Blinken urged Pakistan to look for debt restructuring and relief from China, its largest creditor. The loan amount Pakistan still must repay includes the balance of payments supports worth $6 billion. Foreign debt, especially tied loans, might allow a borrower to fulfill certain purposes defined by the two parties.
Understanding these pros and cons is crucial for making informed decisions in the financial world. Learn the differences between external and internal debt in finance, including definitions and types. Gain a deeper understanding of financial concepts with our comprehensive guide.
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It is distinguished from the internal debtwhich is the money owed by the State to the citizens of its own country. External Debt can be defined as money borrowed from outside the country from sources like foreign governments, International Monetary Funds (IMF), Foreign Direct Investments (FDI), Foreign Portfolio Investments (FPI), etc. As people and businesses sometimes need to borrow money to pay their expenses, the same goes for the government of any country.
- A DSCR below 1.0 indicates insufficient cash flow to meet debt obligations, potentially triggering default clauses.
- The borrowed money is known as Debt, and the modes of borrowing money can be classified into two categories – External Debt and Internal Debt.
- The key is striking a balance between accessing beneficial financing opportunities and mitigating potential risks to create a sustainable financial position.
- Understanding the various forms of external debt is crucial for investors, policymakers, and economists as they navigate the complexities of international finance.
- External debt includes various instruments such as bonds, loans, and trade credits, where the lenders can be governments, international organizations like the International Monetary Fund (IMF), or commercial banks.
Defaulting on External Debt
In 2023, a historic 54 developing nations – nearly half in Africa – dedicated at least 10% of government funds to debt interest payments. Today, 3.3 billion people live in countries that spend more on debt payments than on health or education. The argument is that debt cancellation can make a significant contribution to improving economic development because it frees up resources to invest in the recipient country – rather than send abroad in debt interest payments. However, countries with large financial sectors, such as the UK and Hong Kong have both higher levels of liabilities, but also a higher level of assets because of its role as a financial centre. The example, though simplified, gives an accurate estimate of how damaging a debt cycle can be.
- In subsequent years, there might be a situation where it borrows money in order to repay its previous loans.
- A country with a high amount of external debt raises caution among prospective lenders, and they become unwilling to lend more money.
- Investors need to stay informed about these regulations and monitor changes that could influence their investments.
- As you navigate through the intricate world of finance, remember to consider the role of external debt and its impact on economies around the world.
- Argentina’s sovereign debt crises, for example, were driven by reliance on external borrowing and difficulties in repayment when foreign reserves fell.
- Learn the differences between external and internal debt in finance, including definitions and types.
The situation became unsustainable when investors began to lose confidence in Argentina’s ability to repay its debt. When the government refused, it led to a significant outflow of capital from Argentina as foreign investors sold their Argentine assets. This resulted in a sharp devaluation of the peso by over 50% and a deep recession that lasted for several years. Greece’s External Debt Crisis (2010)The Greek debt crisis, which began in late 2009, was triggered by an unsustainable fiscal deficit, coupled with rampant corruption and an overly generous social welfare system. The crisis came to a head when it became clear that Greece had underreported its budget deficit for several years, leading to an estimated deficit of 15% of its GDP.
Fitch said general government debt was expected to remain at about 51 per cent of GDP in 2025 and 2026. For over 45 years, the Debt Management and Financial Analysis System (DMFAS) has helped more than 80 institutions across 60 countries improve transparency, governance and economic stability. Debt distress now looms over more than half of the 68 low-income countries eligible for the International Monetary Fund’s Poverty Reduction and Growth Trust – more than double the number in 2015. FocusEconomics provides data, forecasts and analysis for hundreds of countries and commodities.
What Is the Meaning of External Debt in Finance?
There are various indicators for determining a sustainable level of external debt. While each has its own advantage and peculiarity to deal with particular situations, there is no unanimous opinion amongst economists as to a sole indicator. These indicators are primarily in the nature of ratios—i.e., comparison between two heads and the relation thereon and thus facilitate the policy makers in their external debt management exercise.
The government sometimes may need to borrow money from either inside the country or outside the country. The borrowed money is known as Debt, and the modes of borrowing money can be classified into two categories – External Debt and Internal Debt. In addition to internal debt, external debt serves as one of the two primary sources of borrowing of individuals, organizations, and national governments. Interest payments on internal debt are subject to local tax laws, with exemptions or deductions often available to encourage domestic investment. External debt, on the other hand, may be subject to withholding taxes, transfer pricing regulations, and double taxation treaties, which influence the net cost of borrowing.
What are External Debt and Internal Debt?
Foreign commercial loans come from international banks, financial institutions, or private lenders. Many are structured as syndicated loans, where multiple lenders share the risk. Short-term external debt, due within a year, can create liquidity pressures if refinancing options are limited. Credit ratings from agencies like Moody’s, S&P, and Fitch affect borrowing terms, as lower-rated entities face higher interest rates due to perceived default risk. In the following sections, we delve deeper into various aspects of external debt, including its advantages and disadvantages, types, and impact on economies.
Understanding external debt is crucial for investors, economists, and policymakers alike to assess risks, opportunities, and the implications of these obligations on global economic stability and financial markets. Understanding the global debt landscape is crucial for institutional investors in making informed decisions regarding foreign investments and risk management strategies. Among the most relevant reporting agencies that compile, monitor, and publish external debt statistics are the International Monetary Fund (IMF), The World Bank, and other international financial institutions.