Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Foreign Debt

What it is:

Foreign debt, otherwise known as external debt, is the part of total debt held by creditors of foreign countries, i.e. non-residents of the debtor's country.

How it works (Example):

To qualify as foreign debt, the debt must be owed by a resident to a non-resident. Residence is determined not by nationality, rather by where the debtor and creditor have established their centers of economic interest.

Debtors can be sovereign nations, corporations or private individuals. The debt can be in the form of money owed to private banks, outside governments or global financial institutions like the World Bank or International Monetary Fund (IMF).

Foreign 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 should take into account the sustainability of a foreign government's debt. This "sustainable debt" represents the amount of debt that still allows a 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) of a country's external public debt should be less than 150% of its exports or 250% of its revenues.

Why it Matters:

Individual investors, economic analysts, mutual fund managers, government officials and institutional investors often conduct an "external debt sustainability analysis" to help determine the suitability of a country for investment. This analysis considers monetary and fiscal policies; micro- and macroeconomic situations; and various scenarios that take into account possible instabilities and adverse events.

It's important for investors to 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 and Portugal -- have created 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.