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• | December 8, 2023
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External Debt What Is It, Types, Effects, Examples, Pros & Cons

As you navigate through the intricate world of finance, remember to consider the role of external debt and its impact on economies around the world. Moreover, the loan repayment leaves the borrower with little funds to invest in economic development. Besides this, the borrowing country’s exposure to interest rate risk increases when it takes on foreign debt. If a nation is unable or refuses to repay its external debt, it is said to be in sovereign default. This can lead to the lenders withholding future releases of assets that might be needed by the borrowing nation. The borrower’s currency may collapse, and the nation’s overall economic growth will stall.

All three are a source of financing for governments, companies, and individuals. This sub-type refers to private debtors’ long-term external obligations that a public entity does not guarantee to repay. 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.

What is External Debt?

The PUNCH earlier reported that Nigeria expended a total of $5.47bn on external debt servicing between January 2024 and February 2025, according to data from the Central Bank of Nigeria. The credit rating agency disclosed this in its latest rating action commentary published on Friday, in which it upgraded Nigeria’s long-term foreign-currency issuer default rating to ‘B’ from ‘B-’, with a stable outlook. As developing nations face record-high debt burdens, DMFAS 7 offers advanced tools to help them manage public debt effectively – without compromising development goals. Yet, because existing debt workout mechanisms are inefficient and costly, most governments avoid default at all costs – even if it means sacrificing development goals and climate action. External debt is a country’s point in time stock of liabilities to non-residents other than those arising from transactions in equity or financial derivative contracts. Eurobonds are issued outside the borrower’s home country and may not be denominated in its currency.

Foreign debt interest

Stay tuned for more valuable insights for institutional investors in the dynamic world of finance and investment. Institutional investors must remain aware of international agreements, such as the International Monetary Fund (IMF) and The World Bank’s guidelines on external debt management. These organizations provide a framework for monitoring countries’ compliance with sustainable borrowing practices.

These measures led to widespread protests and social unrest within Greece, further complicating the situation. Foreign or external debt represents the amount a country (both public and private sector) owe to other countries. However, it should be noted that high levels of international debt may also be due to a very active and resource-demanding economy despite the fact that it continues to be an economy dependent on foreign capital. Therefore, the external debt figure should not be taken alone as a clear indicator of wealth or poverty. The external debt statistics also include indicators of net external debt (i.e. gross external debt net of external assets in debt instruments). External debt is broken down by instrument, original maturity and institutional sector.

High levels of external debt can be risky, especially for developing economies. Among other things, it could increase the risk of default and being in another country’s pocket, ruin credit ratings, leave little funds to invest and spur growth, and expose the borrower to exchange rate risk. Internal debt can be defined as money borrowed by the government from inside the country. Sources for internal debts can include citizens, the country’s banks, the country’s financial institutions, business houses, etc.

From investments and savings to loans and debts, our financial landscape is complex and constantly evolving. In this blog post, we will explore the concept of external debt, its definition, types, and compare it to internal debt. Whether you are a finance enthusiast, a student, or a policy-maker, this article will provide you with a comprehensive understanding of this crucial element of global finance. Loans from international lenders may have fixed or variable rates, with the latter tied to benchmarks like the Secured Overnight Financing Rate (SOFR) or the Euro Interbank Offered Rate (EURIBOR). Some governments and corporations use hedging strategies, such as interest rate swaps, to manage this risk.

Loans from Multilateral Agencies

Assume that all subsequent deficits arise out of loan repayments, and X takes further external loans to finance the deficits at the same terms as the first loan. Also, assume that the infrastructure project starts to yield an annual return of 10% on the initial investment from the third year. 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.

• Likewise, foreign exchange regulations can dictate how much and in what currency external debt can be incurred.
• These indicators are primarily in the nature of ratios—i.e., comparison between two heads and the relation thereon and thus facilitate the policy makers in their external debt management exercise.
• Moreover, a country can utilize the funds received from a foreign lender to meet various expenditures.
• In 2023, a historic 54 developing nations – nearly half in Africa – dedicated at least 10% of government funds to debt interest payments.

What Is the Meaning of External Debt in Finance?

• 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.
• Among the most relevant reporting agencies that compile, monitor, and publish external debt statistics are the International Monetary Fund (IMF), The World Bank, and other international financial institutions.
• Effective management strategies, including hedging and risk diversification, can help mitigate external debt risks.
• Besides this, the borrowing country’s exposure to interest rate risk increases when it takes on foreign debt.
• 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.

The term “external” differentiates it from internal debt, which consists of liabilities incurred within a country’s borders. Internal debt is typically serviced using domestic revenue streams, including tax collections or local earnings, making repayment more predictable. External debt often requires foreign currency reserves, which can strain a country’s balance of payments if export revenues decline. Countries with persistent current account deficits may face higher refinancing risks.

The discussions will focus on building resilience, managing risks and navigating the complexities of global crises. 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. For the 2025 budget, the Federal Government has earmarked N16tn for debt servicing, reflecting the government’s anticipation of continued debt-related expenses. The agency observed that Nigeria’s gross reserves rose to $41bn at the end of 2024, before declining to $38bn due to debt service payments. The agency also cited a minor delay in the payment of a Eurobond coupon due on March 28, 2025, as a reflection of persistent challenges in public finance management. At the conference, UNCTAD will launch DMFAS 7, the latest version of its cutting-edge debt management software.

External debt entails the payment of principal and/or interest by the debtor at a single or several points in the future. Gestation period is the what is external debt interim period between the initial investment in a project and the time the project becomes productive. When external debt is used to fund infrastructure projects, it takes a few years for the project to start giving a return on the investment. For companies using derivative instruments to hedge currency or interest rate risks, IFRS 9 – Financial Instruments governs hedge accounting.

The nations that follow the U.S. in the list are —- United Kingdom- France- Germany- Japan- The Netherlands, etc. First, they provide loans at non-concessional interest rates to high and middle-income countries. External debt, particularly tied loans, might be set for specific purposes that are defined by the borrower and the lender. For example, if a nation faces severe famine and cannot secure emergency food through its own resources, it might use external debt to procure food from the nation providing the tied loan. When governments must prioritize debt repayments over public services and investments, people pay the price.

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. Per rules, countries taking on this debt must repay the loans in the currency in which the lender issued the loan. Foreign debt is of various types, like non-guaranteed private sector external debt and public and publicly guaranteed debt.

Additionally, adherence to agreements like the Paris Club, which coordinates creditor countries to reschedule or cancel debts for countries facing temporary payment difficulties, can impact external debt negotiations. Country-specific regulations impact borrowers’ ability to access and manage external debt. For example, capital flow restrictions could hinder the process of repaying or issuing new debts. Likewise, foreign exchange regulations can dictate how much and in what currency external debt can be incurred. Investors need to stay informed about these regulations and monitor changes that could influence their investments. By 1998, external debt reached a staggering $132 billion, equivalent to approximately 65% of the country’s Gross Domestic Product (GDP).