What Is External Debt?
Let me explain external debt directly: it's the part of a country's debt that's borrowed from foreign lenders, like commercial banks, other governments, or international financial institutions. You need to know that these loans, including the interest, usually have to be paid back in the currency the loan was made in. To get that currency, the borrowing country often has to sell and export goods to the lending country.
Key Takeaways
Here's what you should remember: external debt is specifically the debt a country owes to foreign lenders, including those banks, governments, or institutions. If a country can't repay it, that's called sovereign default, and it leads to a debt crisis. Also, external debt can come as a tied loan, where you, as the borrower, have to spend the money in the country that's lending it to you.
Understanding External Debt
External debt, sometimes called foreign debt, includes both the principal and interest, but it doesn't cover contingent liabilities—those are potential debts that might come up later based on uncertain events. The IMF defines it as debt owed by a resident to a nonresident, based on where they're located, not their nationality.
In some situations, external debt is a tied loan, meaning the funds you get have to be spent in the lending nation. For example, this could let one country buy needed resources from the lender.
External debt, especially tied loans, might be earmarked for specific purposes agreed upon by you and the lender. This could address humanitarian needs or disasters. Say a nation is hit by severe famine and can't get food on its own—it might use external debt to buy food from the lending country. Or, if it needs to build energy infrastructure, external debt could fund materials for power plants in underdeveloped areas.
Defaulting on External Debt
A debt crisis happens if a country with a weak economy can't repay its external debt because it can't produce and sell goods profitably. The IMF tracks this, and along with the World Bank, they put out quarterly reports on external debt statistics. They even have an online database updated every three months for 55 countries.
If a nation can't or won't repay, it's in sovereign default. Lenders might then hold back future assets you need, creating a chain reaction: your currency could collapse, and economic growth stalls. Default conditions make it hard to pay back what's owed plus penalties. Country defaults are handled differently from personal ones, and sometimes countries can avoid repaying entirely.
What are External Debt and Internal Debt?
External debt is what a country borrows from foreign lenders. Internal debt is the opposite—it's debt incurred within the country's own borders.
What are the Types of External Debt?
- Public and publicly guaranteed debt
- Non-guaranteed private-sector external debt
- Central bank deposits in the name of a nonresident
- Loans from the International Monetary Fund (IMF) or other international bodies
What are the Effects of External Debt?
High external debt can be dangerous, especially for developing economies. It raises the risk of default, puts you in another country's debt in more ways than one, damages credit ratings, leaves less money for investments and growth, and exposes you to exchange rate fluctuations.
The Bottom Line
Like any debt, borrowing from foreign sources can be positive or negative. It might be a smart way to get capital cheaply for key investments, better than domestic options. But for struggling economies forced into bad terms just to survive, it can start a vicious debt cycle.
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