Limitations of External Debts
1. Debt burden: Excessive external debts can become a burden on a country’s finances. Interest payments and principal repayments can strain government budgets, diverting resources away from essential services.
2. Economic Shocks and Interest rates: Countries heavily reliant on external debts are more vulnerable to economic downturns. A sudden drop in revenue or an increase in interest rates can worsen their debt situations.
3. Exchange Rate Risks: If a country borrows in foreign currencies, fluctuations in exchange rates can lead to increased debt servicing costs, especially if depreciation of currency takes place.
4. Credit Rating Risks: High levels of external debts can lead to lower credit ratings, making it more expensive for a country to borrow in the future.
External Debt | Types, Effects, Merits and Demerits
External Debt can be defined as money borrowed from outside the country from sources like foreign governments, International Monetary Funds (IMF), Foreign Direct Investments (FDI), Foreign Portfolio Investments (FPI), etc. As people and businesses sometimes need to borrow money to pay their expenses, the same goes for the government of any country. The government sometimes may need to borrow money from either inside the country or outside the country. The borrowed money is known as Debt, and the modes of borrowing money can be classified into two categories – External Debt and Internal Debt.