RESEARCH PAPEREXTERNAL DEBT IMPACT BY: MOEZZA MIR 12/5/2011
1 Introduction:External Debt is usually considered as a main source of income for developing countries. Twoforms of Debt are internal or external aid or loan for long and short time. Foreign or externaldebts are those loans which are taken from the international agencies or organizations anddeveloped countries. Agencies like International Monitoring Fund and World Bank are majorlenders. Countries like France, Germany, and United States of America are the major lenders forthe underdeveloped countries. Pakistan is also a major borrower of loan from these countries.Foreign or the external debts are considered as significant source for the economy but also it ishard to repay those debts in future. External debts have also a dark side for underdevelopedcountries with some of its benefits regarding investment and economic growth. Therelationship between external debt, economic growth and capital inflows can becomecomplicated for several reasons. Firstly, there is a relationship between external debt servicingand economic growth. According to Awan, Asghar & Rehaman (a, 2011)” Other than externaldebt major problem is shortening of funds due to external debt servicing which also affectsother affairs of economy and BOP. Past statistical results regarding external debt servicing areshowing excess of external debt load”.Secondly, government policies designed to influence the balance of payments, domesticinterest rates and employment may affect the stock of foreign debt and hence, debt servicingand economic growth both directly and indirectly through their effects on exports, domesticsavings and foreign capital inflows. “The major reason for external debt accumulation is due touseless expenditure of government, to finance existing spending, improper investments in lowranked projects and inefficient utilization on projects of foreign aid”(Hameed, Ashraf &Chaudhary 2008).Thirdly, there may be a two way relationship between debt stock and debt servicing. Finally,long term capital inflows, depending on its characteristics may also affect economic growth,investment and debt stock. According to Malik, Hayat , Hayat (2010) “From all over era Pakistanis experiencing swear problems of debt regarding economic growth and investment which isleading to greater frequency of scarcity.”Country like Pakistan is majorly affected by long-term and short-term debts. Due to theinsufficient infrastructure, government policies and poor developmental projects these debtswere not used efficiently in the past and still in present. The debts also cause low growth inGDP and over all GNP.Foreign aid and external debt was considered a significant source of income for developingcountries. According to Awan, Asghar & Rehaman (b, 2011) “ To raise growth rate of LDC like
Pakistan external debts are taken but it has an after effect which are difficult to maintain, but ifcountry can sustain its competence than they become helpful for any country.” From the late1950’s current account deficit was considered normal. The countries facing current accountdeficit were encouraged to borrow from international community to boost their economicgrowth. During the last fifty years the external debt problem is one of the main challengesfaced by the developing countries like Pakistan. External debt and its repayments act as ahindrance to the economic growth and development of developing countries. In the past threedecades it has been observed that external debt has been the main cause of decline ininvestment and the growth performance of many nations. This external debt is like anunfavorable tax on future generations, which they have to pay for nothing.”Heavy external debtdoes not necessarily imply a slow economic growth. It is a country’s inability to meet its debtobligations compounded by the lack of information on the nature, structure and magnitude ofthe external debt.” (Were 2001). Countries may have heavy external debt along with relativelyhigher level of exports that can help them to sustain their level of external debt. “To maintainhigh external debt countries should maintain their level of exports but if it has not been able tomaintain than it will lead the wealth of economy down and deficit will come to happen due tohigh debt servicing and it will extend country’s debt beyond its limit.” (Shabbir) But external debt, if not sustainable, imposes higher risk to the economic prosperity, as itsservicing which is also an indicator of higher current account deficit, may lead to debt overhangin a country. For any economy, debt either public or publically guaranteed, which also includesthe contingent liabilities, plays a crucial role towards overall economic progress. Developingeconomies typically have limited sources to fetch revenues. If they fail to utilize their debtproductively, mobilize investment and create new employment opportunities; they willeventually get stuck up with the dilemma of lower revenue base which will affect their spendingcapacity, thereby leading to higher debt servicing. Inability to service debt on time not onlymakes it harder for the developing countries to get aid at concessional rates with lessconditionality’s from the donor agencies but it also increases the country risk. That not onlyreduces the overall level of foreign direct investment but forces a country to rely on domesticborrowing. This higher domestic borrowing increase the domestic interest rate which leads tocrowding out that further slows down the economic growth.Traditionally, while assessing the external debt vulnerabilities and risk factors that can hampereconomic growth, economists’ give emphasis on two types of indicators, namely external debtindicators and macroeconomic indicators1. External debt indicators include the assessment of
external debt to GDP ratio, external debt to exports ratio that helps in analyzing the burden ofdebt services, and short-term debt to total debt ratio, that gauges the liquidity problemsassociated with external debt. In case of macroeconomic indicators, focus lies on a number ofvariables mainly comprising the level of net international reserves, real effective exchange rate,level of inflation, GDP, openness of trade, lending and borrowing rates, domestic credit, level ofinvestment and fiscal deficit.