International debt

Question 1

Introduction

Answer 1

Introduction: Developing countries’ debt is external debt incurred by the governments of Third World countries, generally in quantities beyond the governments’ political ability to repay. The developing world now spends $13 on debt repayment for every $1 it receives in grants. For the poorest countries (approximately 60), $550 billion has been paid in both principal and interest over the last three decades, on $540bn of loans, and yet there is still a $523 billion dollar debt burden.

Question 2

Three points

Answer 2

Implications for Government Budgets

FDI

Foreign currency gap

Question 3

Government budget point

Answer 3

Implications for Government Budgets: For some of the poorest countries in the world, debt repayment constitutes a very significant cost to government. The repayment provides an opportunity cost – i.e. preventing funds from being spent elsewhere – for example of education or health programmes, infrastructure programmes, or in welfare programmes to alleviate poverty. In the longer term this can result in significant losses in productivity and resulting international competitiveness.

Question 4

Government budget evaluation

Answer 4

Evaluation: Why did these governments become indebted in the first place? If the debts were used for large scale capital projects, perhaps the country’s development has not be constrained? Whilst this is certainly a theoretical possibility, in reality it is more common that debt has been accrued because of previous mis-managed spending or poor negotiations by ex-colonies in achieving independence.

Question 5

FDI point

Answer 5

FDI: When debt levels reach high levels uncertainty exists as to whether governments will be able to make repayments. “Unpayable debt” is a term used to describe external debt when the interest on the debt exceeds what the country’s politicians think they can collect from taxpayers. When defaults on loans are likely it creates uncertainty in the economy, loss of credibility of the government, and potential volatility in the currency. These factors make a country look less attractive as a place for FDI and the associated benefits that this could bring.

Question 6

FDI evaluation

Answer 6

Evaluation: Increased investment can also exhibit negative externalities so it is important not to overplay the loss of FDI in this situation. The benefits that FDI exhibits are also often exaggerated. For example, the impact on the foreign currency gap might not be a significant as first thought as profits generated are moved overseas.

Question 7

Currency gap point

Answer 7

Foreign Currency Gap: Large payments made by the governments of the developing world to foreign governments represent a large flow of currency out of the country. This creates a significant foreign currency gap. This means that a country has insufficient foreign currency to be able to import foreign capital, which is likely to inhibit potential growth and development. This limits efficiency improvements and reduces an potential gain in international competitiveness.

Question 8

Currency gap evaluation

Answer 8

Evaluation: Is third world debt now less of a problem? Under the Jubilee 2000 banner, a diverse coalition of groups joined together to demand debt cancellation. As a result, finance ministers of the world’s wealthiest nations agreed to debt relief on loans owed by the poorest nations. A 2004 World Bank/IMF study found that in countries receiving debt relief, poverty reduction initiatives doubled between 1999 and 2004. Tanzania used savings to eliminate school fees, hire more teachers, and build more schools. Burkina Faso drastically reduced the cost of life-saving drugs and increased access to clean water. Uganda more than doubled school enrolment.