EXTERNAL FINANCING/DEBT

EXTERNAL FINANCING/DEBT

Subject : Economics

Context : The Budget is expected to turn to external financing of the fiscal deficit during FY22. The gross marketing borrowing, however, is likely to be less than the enhanced amount for the current fiscal.

Concept :

• It refers to money borrowed from a source outside the country. External debt has to be paid back in the currency in which it is borrowed.
• External debt can be obtained from foreign commercial banks, international financial institutions like IMF, World Bank, ADB etc and from the government of foreign nations.
• Normally these types of debts are in the form of tied loans, meaning that these have to be used for a predefined purpose as determined by a consensus of the borrower and the lender.
• Government and corporations are eligible to raise loans from abroad. These are in the form of external commercial borrowings.
• The interest rate on foreign loans is linked to LIBOR (London Interbank Offer rate) and the actual rate will be LIBOR plus applicable spread, depending upon the credit rating of the borrower.

External Debt Risks

• Interest Rates – There is greater unpredictability and unexpected changes in the interest rates can result in defaulting of loans and precipitate a crisis.
• The raising of interest rates by the U.S. Federal Reserve has already caused borrowing rates to rise in various countries.
• Exchange Rate – Unexpected changes in the exchange rates of currencies, like say a steep fall in the value of the rupee, for instance, is a big risk.
• This can cause severe difficulties for Indian borrowers who will now have to shell out more rupees than previously, to pay back dollar-denominated loans.
• Lenders generally take possible currency fluctuations into account when determining their lending rates, but currency predictions are prone to failures.
• While there could also be gains from such fluctuations, emerging market currencies usually tend to depreciate when the world economy is reviving.