External Debt

 

 

External debt, also known as foreign debt, is that portion of a nation’s net liability which is owed to international creditors. The debtors, in case of external debt can be:[br]

• A private corporation

• An individual

• The government (state or central)

 

Conversely, a creditor of external debt may be:

• A private commercial bank

• A government

• An international financial institution, such as the World Bank or IMF

Types of External Debt

Generally, external debt is categorized as follows:

• Public or publicly guaranteed debt: The guarantee in this case may be full or partial. The latter assures either the repayment of the principal amount or the interest accrued.

• Private non-guaranteed credit: These are long-term external obligations of private debtors. Their repayments are not backed by a public entity. 

In addition, the loans owed to the IMF also constitute a part of a nation’s external debt.                                                              

External Debt and Economic Growth

Empirical evidence suggests that external debt impacts the status of economic growth in a nation. If the level of external debt is too high, the economy ceases to grow. Higher external debt retards economic growth by hindering physical capital accumulation and net factor productivity. Consequently, low growth enlarges the indebtedness by reducing net economic revenues, paving the way for a vicious circle. This results in enlarged debt ratios.

 

However, lowering external debt is not the only solution for attaining economic growth. It must be supported with structural reforms, which addresses other key bottlenecks to progress. 

External Debt Sustainability: A Tool for Economic Growth[br]

External debt sustainability is a situation when the amount of debt is such that it enables debtors to repay their present and future external credit obligations comfortably, along with maintaining a comfortable economic growth rate. The World Bank and IMF encourage developing nations to achieve external debt sustainability by negotiating to write-off a part of the indebted nation’s loans. This helps them to reach the sustainable level.

 

Types of external debt sustainability relief are: 

• Bilateral debt relief: Discharging a part of debt owed by a nation’s government to another’s.

• Multilateral debt relief: Dismissing a portion/whole of the outstanding amount owed to the international financial institutions.       

 

The importance of such external debt forgiveness programs is greater for developing nations as their currency is weaker, while they have to repay debt in a stronger currency, which in turn can widen global economic-status gaps.