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. These resources enable investors to analyze external debt trends on a global scale, thereby providing them with valuable insights into macroeconomic conditions, potential risks, and opportunities. Understanding the various forms of external debt is crucial for investors, policymakers, and economists as they navigate the complexities of international finance. By being aware of the different types and their implications, one can make more informed decisions in managing external debt risks and opportunities.

Economic growth occurs when governments and companies incur capital expenditures that boost production and increase output and income levels. If large amounts of external debt need to be repaid, then there is less money left for investment purposes. Loan agreements specify repayment terms, collateral requirements, and covenants. For example, a debt-to-equity ratio covenant may require a company to maintain a certain level of financial leverage. Additionally, foreign commercial loans may be subject to withholding tax on interest payments, depending on tax treaties between the borrower’s and lender’s countries. Under U.S. tax law (IRC Section 871), a 30% withholding tax applies to interest paid to foreign lenders unless reduced by a treaty.

A mix of factors has fuelled this surge, including increased borrowing for development projects, volatile commodity prices, and widening public deficits. The COVID-19 pandemic worsened the situation, as countries borrowed heavily to offset the economic fallout and fund public health measures. Their external debt – money owed to foreign creditors – has quadrupled in two decades to a record $11.4 trillion in 2023, equivalent to 99% of their export earnings. Greece was unable to meet its debt obligations and subsequently asked for financial assistance from the European Union (EU) and the IMF in May 2010. The subsequent bailout package included strict austerity measures, such as significant spending cuts, tax increases, and privatizations.

A sovereign default can impact the global economy and international relations, while high levels of external debt may lead to downgraded credit ratings or increased exchange rate risk. By understanding these potential consequences, institutional investors can make informed decisions regarding their exposure to external debt. Investors should be aware that defaulting on external debts can have severe consequences for both borrowers and lenders. A sovereign debt crisis occurs when a country cannot repay its external obligations due to an inability to generate sufficient revenue or produce goods and services to meet the required payments.

This revelation caused foreign investors to lose confidence in the Greek economy, resulting in a sharp increase in borrowing costs and a downward spiral in the country’s credit rating. External debts can be denominated in various currencies, including the borrowing country’s local currency or foreign currencies such as US dollars, Euros, or Yen. The nature of external debt is characterized by its cross-border aspect, with the borrower and lender residing in different countries. While both external and internal debts might be necessary for growth and development, maintaining a balance between these two is crucial to ensure financial stability and sustainable economic progress. On the other hand, internal debt refers to the money owed to domestic financial institutions and commercial banks. External debt must be accurately recorded in financial statements to reflect an entity’s liabilities and financial health.

Secretary of State, pledged more funds to help Pakistan cope with the devastating flood that killed over 1,600 people. With the country already struggling to address its existing economic challenges and repay its external debt amid the diminishing cash reserves, the natural disaster certainly worsens things. External debt is the portion of a country’s debt that is borrowed from foreign lenders.

External Debt: Definition, Types, vs. Internal Debt

Together with The World Bank, it publishes a quarterly report on external debt statistics. 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. Despite this, Fitch expects the country’s reserves to average five months of current external payments over the medium term, above the median for similarly rated economies. Although Nigeria’s external debt service remains within manageable levels, Fitch warned that high-interest costs, weak revenue performance, and limited fiscal space remain significant concerns.

A defining moment for global debt reform

In 2023, developing nations paid $847 billion in net interest, a 26% increase from 2021. They borrowed internationally at rates two to four times higher than the United States and six to 12 times higher than Germany. But, a key factor is whether a country can satisfactorily meet debt interest payments from export earnings. Regarding creditors, they can be private financial entities, such as foreign banks, or financial cooperation organizations such as the International Monetary Fund (IMF), among others. 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. The external debt of an economy represents, at any given time, the outstanding actual (rather than contingent) liabilities (and assets) vis-à-vis non-residents.

As with personal debts, The terms will depend largely on the margin of confidence inspired by the economy of the debtor country. The most common indicator of external debt is gross external debt, which measures the total debt a country owes to foreign creditors, i.e. it considers only the liabilities of that country. Debt covenants often require compliance with specific financial ratios, such as the debt service coverage ratio (DSCR) or interest coverage ratio (ICR). A DSCR below 1.0 indicates insufficient cash flow to meet debt obligations, potentially triggering default clauses. IFRS 7 mandates disclosures on liquidity risks, requiring entities to outline how they will manage upcoming debt maturities.

Random Glossary term

These organizations play a significant role in providing accurate, up-to-date information on countries’ external debt positions, enabling investors to gain valuable insights into their potential investment opportunities or risks. External debt as a percentage of Gross Domestic Product (GDP) is the ratio between the debt a country owes to non-resident creditors and its nominal GDP. External debt is the part of a country’s total debt that was borrowed from foreign lenders, including commercial banks, governments or international financial institutions.

External debt is a crucial component of global finance and investment, primarily constituting a country’s debt obligations towards foreign creditors. To gain a deeper understanding of external debt, it is essential to delve into its different types. In this section, we will discuss various forms of external debt, including public and publicly guaranteed debt, non-guaranteed private sector debt, central bank deposits, IMF loans, and tied loans. In conclusion, managing external debt risks requires a comprehensive approach that incorporates various strategies. By focusing on these strategies, countries can minimize risks and ensure a more stable financial future. In summary, external debt carries considerable risks for both borrowing and lending nations.

External Debt vs Internal Debt vs Public Debt

For example, a Brazilian government bond issued in London and denominated in U.S. dollars is a Eurobond. Foreign currency bonds are issued in a specific foreign market and denominated in that market’s currency, such as a Japanese government bond issued in the U.S. and denominated in dollars. Like any form of debt, borrowing money from foreign sources can be good or bad. It may be a useful, cost-effective way to access much-needed capital or trigger a vicious cycle of debt. It added that recent policy reforms had contributed to increased foreign exchange inflows and better monetary stability, with inflation projected to average 22 per cent in 2025. If the French government borrows money from the U.S. to set up a pharmaceutical factory, it will take time for the factory to become functional, start production, and earn money through sales.

  • External debt takes various forms depending on the borrower, lender, and terms of the agreement.
  • If large amounts of external debt need to be repaid, then there is less money left for investment purposes.
  • The nature of external debt is characterized by its cross-border aspect, with the borrower and lender residing in different countries.
  • Foreign debt is of various types, like non-guaranteed private sector external debt and public and publicly guaranteed debt.
  • External debt often requires foreign currency reserves, which can strain a country’s balance of payments if export revenues decline.
  • Eurobonds are issued outside the borrower’s home country and may not be denominated in its currency.

External Debt: Understanding Its Significance and Risks for Institutional Investors

  • In conclusion, managing external debt risks requires a comprehensive approach that incorporates various strategies.
  • By focusing on these strategies, countries can minimize risks and ensure a more stable financial future.
  • External debts can be denominated in various currencies, including the borrowing country’s local currency or foreign currencies such as US dollars, Euros, or Yen.
  • These resources enable investors to analyze external debt trends on a global scale, thereby providing them with valuable insights into macroeconomic conditions, potential risks, and opportunities.

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. Understanding the advantages and disadvantages of external debt helps investors and policymakers make well-informed decisions when it comes to managing risk, allocating resources, and structuring financial instruments. The key is striking a balance between accessing beneficial financing opportunities and mitigating potential risks to create a sustainable financial position. External debt refers to financial obligations assumed by borrowers outside their domestic jurisdiction in various currencies, including bonds, loans, and other forms of what is external debt credit extended by foreign entities.

These loans often have concessional terms, including lower interest rates and extended repayment periods, making them more favorable than commercial loans. Understanding external debt is crucial because it affects financial stability, exchange rates, and economic growth. If governments lack the funds required for capital expenditures to boost income levels and out in the economy, they often take on foreign debt. That said, one must note that a substantial debt increases the default risk, and failure to repay the loan significantly impacts the borrower’s credit ratings. External debt refers to liabilities governments usually owe foreign lenders, such as international financial institutions, foreign governments, and commercial banks. Nations may take on this debt for various purposes, like meeting additional expenses, building infrastructure, etc.

These obligations influence repayment schedules, interest costs, and financial risk exposure. This is an external obligation of public debtors, like national governments, autonomous public bodies, etc. The borrower guarantees to repay the outstanding borrowings to the lender and fulfill the obligation. If it means procuring money for important investments at a cheaper rate than can be found domestically, then it can ultimately be viewed as a good thing. However, the same cannot be said when struggling economies are effectively forced to borrow from other countries on ridiculous terms just to stay afloat. The IMF and The World Bank produce an online database of external debt statistics for 55 countries that is updated every three months.