Foregin Debt Crises

Economies and governments can accumulate debt to external creditors, meaning creditors from other parts of the world. External financing for productive investments can expand opportunities for economic development and accelerate economic growth. Just as households and businesses can sink too deeply into debt, countries and individual economies can accumulate debt to the point that external debt obligations cannot be met. Measures of indebtedness compare the amount of debt with income. A household with a moderate amount of debt can double its debt if its income doubles and remain only moderately in debt. If a country’s gross domestic product (GDP) doubles, it can double its external debt without increasing its debt burden. A country that is able to meet its external debt obligations is said to be able to “service” its debt.

Analysis of an individual country’s debt to the rest of the world takes on a macroeconomic perspective because it involves converting one currency into another currency. In addition to an individual borrower’s ability to repay, in the case of foreign borrowing there are aggregate credit conditions that must be met by the whole economy. Exceeding aggregate credit limitations can lead to sharp adjustments in domestic interest rates or exchange rates. Often a foreign debt is denominated in a foreign currency. In that case, a country must be able earn enough foreign currency in exports and capital inflows to service the debt. If a country’s debt is denominated in its own currency, it still needs to service its debt without upsetting exchange rates. A country can in effect default on its external or foreign debt by suspending convertibility of its domestic currency into foreign currencies. If a country is unable to earn sufficient foreign currency from exports and capital inflows to service its foreign debt, it can increase capital inflows by increasing domestic interest rates. These higher interest rates will be a burden on the economy and can force an economy into recession.

The debt that a sovereign government owes to external creditors is called “sovereign debt.” When a government defaults on obligations to external creditors, it is called a “sovereign debt crisis.” Russia, Ecuador, and Argentina furnish examples of outright debt default. Ukraine, Pakistan, and Uruguay avoided outright default through debt restructuring. Mexico, Brazil, and Turkey averted default with the help of large-scale support from the International Monetary Fund. Some debtor governments are more cooperative than others in resolving default situations. Uncooperative governments can harm the ability of private domestic corporations to access international debt markets. Risk of foreign debt default or restructuring appears to be lowest when total external debt as a percent of GDP is less than 49.7 percent, short-term debt as a percent of foreign currency holdings is less than 130 percent, public external debt is less than 214 percent of fiscal revenue, and the exchange rate not over appreciated above 48 percent.

Economists have developed indicators to measure a degree of a country’s indebtedness. For poor, debt-laden countries, some type of debt restructuring is likely to occur when net present value of debt exceeds 200 percent of exports. For other, nonindustrial countries, it appears that the risk of debt exposure starts to rise when external debt as a percent of GDP rises above 40 percent (Daseking, December 2002). Countries can sustain higher debt ratios if exports are growing rapidly, or if exports represent a large proportion of GDP, or if a large share of external debt is denominated in domestic currency.

The United States is a debtor nation, but its debt ratios are well below the threshold levels that signal a possible foreign debt crisis. Given the role of the U.S. dollar as a world currency, it is not clear if the same debt–ratio threshold levels apply to the United States. The rise of foreign debt in the United States is worrisome to some observers. Easy access to foreign credit sometimes allows countries to delay painful but inevitable reforms.