What is External Debt (causes, consequences, characteristics and types)

The external debt is the sum of all debts of a country with foreign entities.

In this sense, external debt includes credit granted by foreign financial agents to the State (public debt) and to individuals (private debt).

For example, Mexico’s total external debt in 2018 was 446,097 million dollars.

Causes of external debt

The reasons why a State contracts external debt may be due to:

Natural disasters: moment when they need to finance reconstruction or rescue plans.
Investments: Depending on economic policies, investments can generate higher income, such as in cases of an economic crisis.
Negligence: bad public administration can request unnecessary credit.
Corruption: cases in which a public debt is contracted for private uses.

Consequences of external debt

The increase in external debt over time can have serious consequences for the country’s economy, such as, for example, causing:

The fall in foreign investment and the fall in incomeCapital flightThe fall in the price of exported raw materialsIncrease in povertyDecrease in democracy

Characteristics of external debt

Public external debt is contracted in order to stabilize economies in crisis or economic depression and boost the country’s growth.

In emerging countries, for example, external debt has become a source of financing the public deficit. Deficit indicates that the difference between income and expenses is negative and the public is associated with the public administrations of a country that includes its governorates, municipalities and autonomous regions.

Another characteristic of the external debt is that the main lenders are represented by private commercial banks.

Furthermore, external debt is generally represented by the proportion of the country’s Gross Domestic Product (GDP), such as, for example, Mexico’s external debt in 2018 reached 18% GDP.

Types of external debt

External debt is classified into 2 types: public external debt and private external debt.

The public external debt is that contracted by the State and government institutions, while the private external debt is that which belongs to individuals, whether natural or legal persons.

The credit granted to the State, which constitutes the public external debt, can be contracted for internal or external use.

Credit for internal use is granted by financial agents in the domestic market and is financed in national currency. For example, the net internal debt of the federal public sector in Mexico was 6 trillion 938.7 billion pesos.

Credit for external use, on the other hand, is granted by foreign financial agents in foreign currency and must be paid outside the country. This type of credit, which is part of the external debt, is generally granted through the World Bank and the International Monetary Fund (IMF). For example, the net external debt of Mexico’s federal public sector was $202.3 billion.

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