What is External Debt?
External debt, otherwise known as 'foreign debt,' is the component of total debt held by creditors of foreign countries, i.e. non-residents of the debtor's country.
How Does External Debt Work?
To meet the definition of external debt, the debt must be owed by a resident to a non-resident. Residence is determined not by nationality, but by where the debtor and creditor have headquartered their centers of economic interest.
Debtors can be sovereign nations, corporations or private individuals. The debt itself can take the form of money owed to private banks, outside governments or global financial institutions like the World Bank or International Monetary Fund (IMF).
External debt is placed within four broad categories:
- Private non-guaranteed debt
- Public and publicly guaranteed debt
- Central bank deposits
- Loans due to the World Bank and IMF
Investors who invest abroad must take into account the sustainability of a foreign government's debt. So-called 'sustainable debt' represents the amount of debt that still allows a debtor country to fully meet its current and future debt service obligations without having to resort to debt relief or restructuring.
A generally applied benchmark for an acceptable level of external debt is that the net present value (NPV)'s external public debt should be less than 150% of its exports or 250% of its revenues.
Why Does External Debt Matter?
Savvy individual investors, economic analysts, mutual fund managers, government officials and big institutional investors often conduct an 'external debt sustainability analysis' in an attempt to determine the suitability of a country for investment. This analysis takes into account monetary and fiscal policies; micro- and macroeconomic situations; and various scenarios that consider possible instabilities and adverse events.
Investors of all stripes must keep an eye on external debt, whether it applies to their home economy or to foreign ones. Recent debt crises in Europe -- most notably in countries with high external debt such as Greece, Portugal, Ireland, Spain and Italy -- have exerted adverse ripple affects against the Eurozone and international stock markets. It is incredibly difficult, and some say impossible, for a country to experience long-term economic growth, increased business activity and/or foreign investment without sustainable levels of external debt.
