The debt burden

1. Lenders include foreign governments, international institutions such as the IMF and World Bank, and private banks.
2. Borrowing abroad can fund investment, but the debt must be serviced in foreign currency, so repayment depends on earning that currency through exports.

Causes of external debt

1. A savings gap leaves too little domestic saving, so governments borrow abroad to fund investment.
2. Persistent current account deficits must be financed by borrowing from abroad.
3. Borrowing to cover large fiscal deficits adds to external debt when the government sells bonds to foreign investors.
4. External shocks, such as falling commodity prices or a rising import bill, can force emergency borrowing.
5. Higher world interest rates raise the cost of servicing debt already taken on.
6. A depreciation of the domestic currency raises the local-currency cost of foreign-currency debt.
7. Poor debt management, corruption or borrowing for unproductive projects can also build up debt.

Consequences of external debt

1. Debt servicing, interest plus repayment, diverts government income away from health, education and investment.
2. Repaying in foreign currency drains foreign exchange reserves and worsens the current account.
3. A large debt burden can force austerity and higher taxes, lowering living standards.
4. High debt can trigger a loss of confidence, capital flight and, in the worst case, default and a debt crisis, as Sri Lanka suffered in 2022 when its reserves ran out.
5. Countries may then need debt rescheduling or relief and support from the IMF or World Bank, often tied to conditionality that requires painful reforms.
6. However, borrowing that funds productive investment can raise growth fast enough to remain affordable.

Weighing external debt

1. Borrowing is beneficial when it funds productive investment that generates returns to repay it.
2. It is damaging when funds are wasted or when shocks make repayments unaffordable.
3. On balance, external debt is a tool rather than a trap: it aids development where it funds investment whose returns exceed the interest cost and where servicing stays affordable, often judged sustainable when the debt service ratio sits well below roughly 20 to 25% of export earnings, but it becomes damaging where funds are wasted or a shock pushes servicing above what exports can cover. At that point rescheduling or relief, through schemes such as the Heavily Indebted Poor Countries initiative, can restore breathing space, but relief lasts only if the underlying deficits and governance weaknesses that built the debt are corrected too.