By Prashansa Srivastava
India has consistently maintained a prudent approach to managing its external debt. The inflow of foreign exchange payments in the 1980s from the Gulf, combined with fiscally prudent import policies, has resulted in a history of sustainable debt. With the external debt stock standing at USD 495.7 billion for the quarter ending at September 2017, the country has successfully managed to not be among the world’s top debtor countries.
Understanding external debt
External or foreign debt is the total debt of a country to its foreign creditors. When there is a gap between domestic savings and investments, and foreign direct investment inflows are not significant, a country may have to borrow from internal or external sources.
One of the purposes of an economic policy is to improve the standard of living of the people. From a macroeconomic perspective, this can be achieved through promotion of investment leading to faster economic growth. However for the promotion of investment, a country must have enough resources; otherwise, it will have to borrow from other countries. This is indeed one of the constraints faced by most developing countries. They do not have enough resources; therefore, they have to incur external debt as a channel to spur economic growth.
A country may also borrow from external sources to finance its current account deficit. Developing countries frequently run up current account deficit forcing borrowings from external sources. Since Independence, India has been borrowing from both internal and external sources to finance its investment programme and deficits.
Relation of external debt with the economy
External debt allows a country to invest and consume beyond its current domestic production. This helps to harness domestic savings and mobilize it for capital formation.According to neoclassical economists, external debt is one of the important sources of capital for a country. It positively impacts investment and subsequently leads to economic growth. Growth theorists believe that capital accumulation is key to economic growth. The rate of interest, population, technology, and international trade are essential ingredients that lead to output expansion. Thus, when a country borrows from external sources to finance its government expenditure it leads to the creation of productive capital assets. This external debt helps bridge the savings gap and increase foreign exchange.
This view can also be contradicted with claims that external debt leads to the problem of debt accumulation, puts debt sustainability in jeopardy, increases the inability of a country to meet its debt obligations and obstructs them to raise foreign loans in its own currency. Thus, when a country holds debt in foreign currency, the foreign exchange rate depreciates. This erodes the purchasing power of domestic output due to foreign claims, and it makes it more problematic for a country to service its debt. This can lead to a country losing its financial credibility and insolvency. External debt also puts undue pressure on exports since they have to be increased to meet the debt obligation.
Though India has maintained a cautious approach to external debt, the need for more investment to improve the standard of living may warrant more debt in the future. However, the government may be hesitant to raise this debt due to the increasing fiscal and current deficit, hampering possible investment and economy grow.
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