The Importance Of External Debt

Based on the World Bank, every government faces policy choices concerning how to manage its debt, including the sources of financing, the scope of the debt to be managed, how to manage contingent liabilities, how to coordinate debt management with other public policy objectives, and how to structure the legal authority for borrowing and the institutional arrangements for carrying out this authority. Although practices differ, there is a growing convergence on the basic principles of sound public debt management. These include: The importance of clear objectives for public debt management and the need for careful coordination of debt management objectives and practices with other public policies. Second, the benefits of transparency of debt

The main point to make about the level of external debt is that it should not become too large. While there is an obvious advantage in foreign borrowing from the standpoint of a capital-poor country where the rate of return on marginal investment exceeds the world interest rate plus the country-specific risk premium, this benefit is rather modest, and easily outweighed by the macroeconomic risks of foreign indebtedness. Debt should therefore be kept sufficiently small to avoid it becoming a significant macro threat.

This focus on different types of external claims on the country brings us to the second major issue, that of composition of the "debt". Here there is an obvious convenience in adopting a broad definition of "debt" that includes equity claims. With that definition, one can distinguish four broad categories of external claims: First is the FDI. Second is the portfolio equity. Next is the long-term loans and lastly the short-term

Moreover, this inflow has typically been disproportionately in the form of short-term capital, which is the form that foreign lenders often seem most willing to supply, presumably believing that it gives them the opportunity of liquidating their position if things begin to go wrong (a belief that cannot be simultaneously right for the majority of them, at least without a bailout from the international community). Hence it seems all too easy to believe that the observed association between the absence of capital controls and the occurrence of financial crisis was causal and not merely coincidental. This conclusion is reinforced by the reflection that an abrupt reversal of capital flows usually involves an outflow of capital owned by residents ("capital flight") as well as that owned by foreigners, a flow that is facilitated by an absence of capital