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 what is external debt 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.
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). Total foreign debt can be a combination of short-term and long-term liabilities. Foreign debt can be useful as it allows the country to fund investment in different sectors, thus improving economic growth. Moreover, a country can utilize the funds received from a foreign lender to meet various expenditures.
External debt can be defined as the debt borrowed by the government from outside 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. Foreign debt is money borrowed by a government, corporation or private household from another country’s government or private lenders.
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.
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Extraordinarily low interest rates in place since the 2008 Global Financial Crisis have made it easier for governments, businesses, and consumers to take on higher levels of debt. And with a severe global economic downturn unfolding due to the spread of the novel coronavirus, a disruptive debt crisis in one or more countries seems likely in the not-too-distant future. If governments lack the funds required for capital expenditures to boost income levels and out in the economy, they often take on foreign debt.
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External debt entails the payment of principal and/or interest by the debtor at a single or several points in the future. The IMF and The World Bank produce an online database of external debt statistics for 55 countries that is updated every three months. A debt crisis can occur if a country with a weak economy is not able to repay the external debt due to an inability to produce and sell goods and make a profitable return.
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.
Foreign Debt: Definition and Economic Impact
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.
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 commercial banks.
- The IMF is one of the agencies that keeps track of countries’ external debt.
- Usually, governments take on this debt to fulfill certain objectives like meeting additional expenses and boosting economic recovery after a natural disaster.
- This is often exacerbated because foreign debt is usually denominated in the currency of the lender’s country, not the borrower.
- For instance, the borrower might only be able to utilize the funds to recover from a natural disaster by purchasing resources from the lender country.
- Defaults and bankruptcies in the case of countries are handled differently from defaults and bankruptcies in the consumer market.
The loan amount Pakistan still must repay includes the balance of payments supports worth $6 billion. This sub-type refers to private debtors’ long-term external obligations that a public entity does not guarantee to repay. If the currency of the borrowing country depreciates with respect to that of the lending country, then the real value of interest (as denominated in the domestic currency) will rise.
External debt is the portion of a country’s debt that is borrowed from foreign lenders, including commercial banks, governments, or international financial institutions. These loans, including interest, must usually be paid in the currency in which the loan was made. To earn the needed currency, the borrowing country may sell and export goods to the lending country. External debt refers to the loans raised through foreign lenders, such as foreign commercial banks, foreign governments, and international financial institutions.
