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Role of international debt - introduction

Syllabus: Foreign debt and its consequences

Syllabus: Outline the meaning of foreign debt and explain why countries borrow from foreign creditors

Foreign debt - historical context

S:\triplea_resources\DP_topic_packs\economics\student_topic_packs\media_development\images\debt_burden.jpgAs well as receiving aid, most developing countries have borrowed on the international markets, especially after independendence and quite large amounts mainly from International commercial banks.

The oil price shocks of 1973-74 and 1978-79, the expansion of the Eurodollar, a rise in public expenditure by African governments following rising commodity prices in the early 1970s, the recession in industrial countries and the subsequent commodity price fall, and a rise in real world interest rate are usually identified as major factors underpinning the African debt crisis, although some observers believe that the causes were more entrenched in the history of Africa and its trading relationships with the rest of the world.

Clearly external shocks were a catalyst for the debt problems suffered by developing countries. Following the first oil-crisis in 1973-74, developing countries that were non-oil producers experienced a substantial increase in their debts levels. However, those developing countries that had oil reserves received large inflows of revenues a result of spiralling prices on world markets.

They found that they could not spend the huge sums of money they were receiving and looked for opportunities to lend these newly acquired funds. As a consequence, many of the petro-dollars that appeared in the world banking system came from new, oil rich countries.

Banks could find few takers for loans among developed economies, as they were trying to deflate to reduce inflationary pressures, so they turned to the developing world and offered them very competitive (some would argue unwisely competitive) terms to borrow money. These loans were often made with little regard to the ability of the developing countries to make the required repayments.

Then came the 1980s, and a new era of economics in the USA. Taxes were cut, but government spending was kept at previous levels or even higher as war expenditure rocketed. The shortfall was financed by a large increase in US government deficits and borrowing. Interest rates moved significantly upwards and the poorer nations found that their debt had risen in real value and many were unable to pay the interest on their loans, let alone the capital repayments.

Some developing countries were forced to reduce public spending, which further exacerbated the poverty problems they were experiencing.

In the new Millennium following pressure from developing countries, and from domestic political pressure groups, developed countries and multilateral agencies made some attempts to reduce the debt burden of the developing countries. However, despite some action on debt and some good intentions, the burden of foreign debt is still a very real problem for many developing countries (and developed see Eurozone currently).

Syllabus: Explain that in some cases countries have become heavily indebted, requiring rescheduling of the debt payments and/or conditional assistance from international organizations, including the IMF and the World Bank.

Greece today is a great example of this.