What is Foreign Debt
Foreign debt is an outstanding loan or set of loans that one country owes to another country or institutions within that country. Foreign debt also includes obligations to international organizations such as the World Bank, Asian Development Bank or Inter-American Development Bank. Total foreign debt can be a combination of short-term and long-term liabilities. Also known as external debt, these outside obligations can be carried by governments, corporations or private households of a country.
BREAKING DOWN Foreign Debt
A country may borrow abroad to diversify its currency denominations of debt or because its own country's debt markets are not deep enough to meet their borrowing needs. In the case of third-world countries, borrowing from international organizations like the World Bank is an essential option, as they can provide attractive lending rates and flexible repayment schedules. The World Bank, in conjunction with the International Monetary Fund (IMF) and Bank for International Settlements (BIS), gathers short-term foreign debt data from the Quarterly External Debt Statistics (QEDS) database. Long-term external debt data compilation is also collectively accomplished by the World Bank, individual countries that carry foreign debt, and multilateral banks and official lending agencies in major creditor countries.
One measurement of foreign debt burden is the amount of foreign exchange reserves relative to outstanding foreign debt. Foreign exchange reserves consist of foreign currencies held by a central monetary authority. They include banknotes, bank deposits, bonds, treasury bill and other government securities denominated in other currencies. The U.S. dollar dominates most foreign exchange reserves of debtor countries, but the euro, British pound, Japanese yen and Chinese yuan are also prominent in these reserves. Foreign debt as a percent of reserves indicates the level of creditworthiness of a country. Also tracked are foreign debt to exports (as many of the debtor nations rely on exports of commodities and goods to service loans) and foreign debt to gross domestic product (GDP).
Lessons of Foreign Debt Management
In the past, countries have experienced trouble repaying foreign loans due to bad luck or bad fiscal management. Factors beyond their control such as a drought that wiped out a season's worth of crops or a flood that shut down factories producing export goods have had adverse impacts on loan repayment. Sometimes governments or companies have brought difficulties on themselves by mismatching maturities of their foreign loans and the cash flows of the projects that the loans were used for. Also, currency pegs have been ignored. The Asian currency crisis, sparked by the sudden devaluation of the Thai baht in 1997, caused extreme stress to foreign debtors in that region. Sounder foreign debt management practices have since been emphasized.