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External Debt And Its Adverse Effects On The Economy

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What is External Debt?

The meaning of external debt is self-explanatory. It is the debt that a country owes to the lending country. In other words, when a country borrows loans from other countries, the amount of money it owes to the funding country is called external debt.  The loans are usually funded in the lending country’s currency. Also, interest rates are levied on the loans provided. To repay the debt, the borrowing country must pay in the lending country’s currency. So, the borrowing country sells and exports its goods to the lending country.

When a country is cannot produce goods and sell them for a profitable return, it borrows loan from other countries. Also, the external debt crisis occurs when it is unable to repay the debt. Therefore, an agency named the International Monetary Fund (IMF) established to regulate a country’s external debt. And, the World Bank is the one that publishes external debt statistics.

Now, if a country is unable to repay the debt, it is referred to as sovereign default. The lending country can take action on this by restraining itself from giving back the assets of the borrowing country. This situation causes further damage to the borrowing country and eventually, it collapses.

What does the country do with the fund acquired? It buys resources from the lending country. It used to set up power plants for the generation of energy. Apart from that, it is also used as calamity relief funds during a natural disaster.

External debt is classified into:
  • Public guaranteed debt
  • Private non-guaranteed credits
  • Central bank deposits
  • Loans due to the IMF
Causes for the rise in external debts in borrowing countries
  • The difficulty of BOP deficit by the oil crisis
  • Recession in developed countries
  • Low export earning
  • Limited availability resources

Impact of External Debt on the economy

In developing countries, when the country does not possess a sufficient amount of capital for the development of the resources, loans are borrowed from other countries which are termed as external debts. These debts have both good and adverse impacts on the economy of a nation. Thinking straight forward, when the borrowing countries acquire additional resources from the lending countries, it helps them develop the nation and hence, achieve better economic growth. The fiscal and monetary discipline is maintained under proper levels as the government does not vary the inflation rate in order to reduce the debt burden. In the long run, as the external debt builds up, complications in the country start to pile up. It is observed that a high external debt brings down the economy of a country. In most developing countries, foreign debts are continuously rising. So, the government makes efforts in reducing the levels of fiscal deficits by promoting the foreign investment process. A rise in the interest rates increases the borrowing rate, which in turn shoots up the bond yield of the country. These factors affect the exchange of a country as well, which will be discussed in further sections.

Reliable sources of information on External Debts

Information regarding external debts plays an essential role to economists and investors as these numbers can determine the present situation of a country. We know that external debt is the debt of a country. Hence, it is measured usually measured in USD, CAD, GBP, JPY, NZD, CHF, AUD, EUR, etc.  Some websites allow one to access the data regarding external debt.

The following are the links to access information on the external debts of different countries. The link contains information about the actual external debt, historical data, forecast, statistics, graphical representation (bar graphs), etc.

USA (unit – USD)https://tradingeconomics.com/united-states/external-debt

Australia (unitAUD) – https://tradingeconomics.com/australia/external-debt

UK (unitGBP) – https://tradingeconomics.com/united-kingdom/external-debt

Japan (unitJPY) – https://tradingeconomics.com/japan/external-debt

Canada (unitCAD) – https://tradingeconomics.com/canada/external-debt

Euro area (unitEUR) – https://tradingeconomics.com/euro-area/external-debt

New Zealand (unitNZD) – https://tradingeconomics.com/new-zealand/external-debt

Switzerland (unitCHF) – https://tradingeconomics.com/switzerland/external-debt

What do traders care about External Debts and what is its impact on the currency?

External debt is the debt of a country and hence plays an important role in determining the economic growth of a nation. Based on the data regarding external debt, investors take their investing decisions.

A country having external debt can have positive and negative effects on it. In developing countries, they make use of the funds and develop the country by utilising the resources available in an efficient way. Hence, this external debt has a positive effect on the country. These are the counties; investors look forward to investing in. While, some countries are unable to efficiently make use of the loans, and end up borrowing more funds, which makes it quite difficult for the counties to repay the debt. This will have a harmful impact on the economy of the county, and investors don’t seem to be interested in such counties.

The impact of exchange rates on the currency is simple to comprehend. The external debt is related to the GDP and economic growth of an economy and hence has its impact on the currency of the nation. If the external debt of a country is seen to rise high, the economic growth will have a negative impact on it, and hence the currency of the borrowing county will see a decline in its currency rate. So, it can be said that an increase in external debt decreases the value of the currency. Considering the country is able to repay the debt, by accumulating a considerable amount of profit from its resources, then, this can lead to good economic growth, and eventually a rise in its exchange rate.

Frequency of release

The frequency of release of the reports on the external debt of different countries is usually the same. The numbers are measured in terms of the country’s currency unit and are released every quarter. This quarterly release is sufficient for economists for their analysis.

Bottom line

Developing countries when they do not possess sufficient capital to set up resources, they borrow funds from lending countries to meet their requirement, which is termed as external debt. If the export rate is more than the external debt rate, the ratio of debt to exports will be brought to lower ratios. If a country makes efforts in the replacement of external debt to Foreign Direct Investment will surely lead to the betterment of the country. Therefore, a sustained improvement in export performance, in addition to Foreign Direct Investment, a country can manage itself to get away with its external debt.

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