External Debt Problem

External debt refers to debt owing by one country to another.  External debt is a more serious problem than internal debt because the payment of interest and repayment of the capital sum form debit items in the balance of payments.

The cause of third world debt is the unwise borrowing and lending during the 1970s.  The oil crisis made conditions extremely difficult for many third world countries.  For the same reason the Euro currency markets were awash with money and real interest rates were low.  Therefore poor countries need to borrow and banks were anxious to lend where they could get better return than on the domestic market.  The bulk of this lending was by commercial banks and not by international institutions such as the IMF and World Bank.  This has the consequence that, while the international institutions could write-off the debt, it is very difficult for commercial ones to do so.

The problem turned into a crisis in the early 1980s.  As the world fell into recession this hit the debtor nations particularly hard.  Many developing economies are highly dependent on the export of primary products and the price of these dropped dramatically.  At the same time real interest rates rose sharply and most of the debt was at variable interest.  The debtor nations were caught in a vice between falling income and rising costs.  When this happened the banks which had been so anxious to lend in the 1970s were no longer willing to do so.

This meant that the debtor nations had to turn to international agencies for help.  However, the international agencies do not have sufficient funds to substantially affect the situation.  For such help as they were able to give, they demanded very stringent conditions.  These deflationary conditions have often impoverished further the debtor nations.

Much of the money that was borrowed was not used for development purposes but simply balance the books for the nations' overseas payments.  Little found its way into the sort of projects which development economies would suggest.

Many measures have been suggested for instance by the World Bank.  Among them has been suggestion for reducing interest rates on non-concessional debt, rescheduling with longer grace periods and maturities or outright conversion of bilateral loans to grants.  International Development Association (IDA) has converted its repayments to be used to reduce International Bank for Reconstruction and Development (IBRD) debt owed by low income third world countries.