What Is External Debt?
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.
Key Takeaways
- External debt is the portion of a country’s debt that is borrowed from foreign lenders, including commercial banks, governments, or international financial institutions.
- If a country cannot repay its external debt, it is said to be in sovereign debt and faces a debt crisis.
- External debt can take the form of a tied loan, whereby the borrower must apply any spending of the funds to the country that is providing the loan.
Understanding External Debt
External debt, or foreign debt as it is sometimes called, factors in both principal and interest and does not include contingent liabilities, which are debts that may be incurred at a later date based onthe outcome of an uncertain future event. It is defined by the International Monetary Fund (IMF) as debt liabilities owed by a resident to a nonresident, with residence being determined by where the creditors and debtors are ordinarily located rather than by their nationality.
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.
External debt can take the form of a tied loan, obligating the borrower to spend the funds it’s lent in the nation that’s providing the financing.
External debt, particularly tied loans, might be set for specific purposes that are defined by the borrower and the lender. Such financial aid could be used to address humanitarian or disaster needs. 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.
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.
Defaulting on External 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 IMF is one of the agencies that keeps track of countries’ external debt. Together with The World Bank, it publishes a quarterly report on external debt statistics.
The IMF and The World Bank produce an online database of external debt statistics for 55 countries that is updated every three months.
If a nation is unableor refusesto 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. Such instances can have a rolling effect. The borrower’s currency may collapse, and the nation’s overall economic growth will stall.
The conditions of default can make it challenging for a country to repay what it owes plus any penalties that the lender has brought against the delinquent nation. Defaults and bankruptcies in the case of countries are handled differently from defaults and bankruptcies in the consumer market. It is possible that countries that default on external debt may potentially avoid having to repay it.
What are external debt and internal debt?
External debt is the portion of a country’s debt that is borrowed from foreign lenders. Internal debt is the opposite, referring to the portion of a country’s debt incurred within its borders.
What are the types of external debt?
External debt is money borrowed by a government or corporation from a foreign source. It can include:
- Public and publicly guaranteed debt
- Non-guaranteed private-sector external debt
- Central bank deposits
- Loans from the International Monetary Fund (IMF)
What are the effects of external debt?
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.
The Bottom Line
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.
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.
FAQs
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.
What is internal and external debt? ›
Internal and External Debt
The government's borrowing within the country is known as internal debt. The government can borrow this debt from sources like banks, individuals, business firms and other internal sources. On the other hand, the government's borrowing from abroad or international is known as external debt.
What are the internal sources of debt? ›
The main sources of funds for internal debts are commercial banks and other financial institutions. Internal public debt owed by a government (money a government borrows from its citizens) is part of the country's national debt.
What is US external debt? ›
Gross external debt is the overall magnitude of U.S. indebtedness to foreigners. The gross external debt position divides that debt among five institutional sectors (government, monetary authorities, banks, other, and direct investment).
What is another name for external debt? ›
A country's gross external debt (or foreign debt) is the liabilities that are owed to nonresidents by residents.
What are examples of internal and external debt? ›
Internal debt refers to borrowings that a country, company, or individual owes domestic lenders. Also known as government debt, public debt refers to a country's overall outstanding debt. External debt sources are foreign commercial banks, governments, and international financial institutions.
What is the difference between internal and external financing? ›
Internal financing comes from the business. It's a type of self-sufficient funding. External financing comes from outsider investors, which can include shareholders or lenders who may expect either a percentage of the business or interest paid in exchange.
What do you mean by internal debt? ›
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.
What is the internal debt of the United States? ›
As of December 2023, total federal debt was $33.1 trillion; $26.5 trillion held by the public and $12.1 trillion in intragovernmental debt.
Is a bank loan internal or external? ›
External sources of finance refer to money that comes from outside a business. There are several external methods a business can use, including family and friends, bank loans and overdrafts, venture capitalists. and business angels, new partners, share issue, trade credit, leasing, hire purchase, and government grants.
Gross external debt, at any given time, is the outstanding amount of those actual current, and not contingent, liabilities that require payment(s) of interest and/or principal by the debtor at some point(s) in the future and that are owed to nonresidents by residents of an economy.
What person has the most debt? ›
Former financial arbitrage trader Jerome Kerviel is the most indebted man on the planet, owing his former employer $6.3 billion. The amount Kerviel owes to French bank Societe Generale for fraudulent trades made in 2007 and 2008 would make Kerviel one of the 50 richest people in America if those debts were assets.
Who has the most external debt? ›
The U.S. has the highest total external debt of any country by far, almost at the same level of the next three largest total external debt holders combined.
What is the difference between debt and external debt? ›
External debt is the portion of a country's debt that is borrowed from foreign lenders. Internal debt is the opposite, referring to the portion of a country's debt incurred within its borders.
What are the consequences of external debt? ›
High and unsustainable levels of external debt can be especially risky for developing countries, exposing them to exchange rate fluctuations, sudden-stops in capital flows and sharp capital outflows, which may precipitate into a banking or currency crisis (Hemming et al., 2003).
What causes high external debt? ›
Development financing, trade imbalances, economic crises and political instability are some key causes of foreign debt.
Is debt collection internal or external? ›
Debt collection is a regulated activity that takes place when a creditor has engaged an external company to recover payments that are past due.
What is the difference between total debt and external debt? ›
National debt is the accumulated level of debt owed by the government of a country. External debt is debt owed by the government, businesses and people of a country to overseas lenders such as banks, the IMF, foreign companies and other creditors.
What is an example of an external liability? ›
External Liability – All obligations which a business has to pay back to external parties i.e. lenders, vendors, etc. are termed as external liabilities. Example – Borrowings, Creditors, Taxes, Overdraft, etc.
Is debt financing internal or external? ›
External sources of finance are funds available to business organisations that are derived from outside the boundaries of the organisation itself. As discussed at the beginning of Section 1.1, these can be further divided into debt and equity finance.
