1. RESEARCH PAPER
EXTERNAL DEBT IMPACT
BY: MOEZZA MIR
12/5/2011

2. 1 Introduction:
External Debt is usually considered as a main source of income for developing countries. Two
forms of Debt are internal or external aid or loan for long and short time. Foreign or external
debts are those loans which are taken from the international agencies or organizations and
developed countries. Agencies like International Monitoring Fund and World Bank are major
lenders. Countries like France, Germany, and United States of America are the major lenders for
the underdeveloped countries. Pakistan is also a major borrower of loan from these countries.
Foreign or the external debts are considered as significant source for the economy but also it is
hard to repay those debts in future. External debts have also a dark side for underdeveloped
countries with some of its benefits regarding investment and economic growth. The
relationship between external debt, economic growth and capital inflows can become
complicated for several reasons. Firstly, there is a relationship between external debt servicing
and economic growth. According to Awan, Asghar & Rehaman (a, 2011)” Other than external
debt major problem is shortening of funds due to external debt servicing which also affects
other affairs of economy and BOP. Past statistical results regarding external debt servicing are
showing excess of external debt load”.
Secondly, government policies designed to influence the balance of payments, domestic
interest rates and employment may affect the stock of foreign debt and hence, debt servicing
and economic growth both directly and indirectly through their effects on exports, domestic
savings and foreign capital inflows. “The major reason for external debt accumulation is due to
useless expenditure of government, to finance existing spending, improper investments in low
ranked projects and inefficient utilization on projects of foreign aid”(Hameed, Ashraf &
Chaudhary 2008).
Thirdly, there may be a two way relationship between debt stock and debt servicing. Finally,
long term capital inflows, depending on its characteristics may also affect economic growth,
investment and debt stock. According to Malik, Hayat , Hayat (2010) “From all over era Pakistan
is experiencing swear problems of debt regarding economic growth and investment which is
leading to greater frequency of scarcity.”
Country like Pakistan is majorly affected by long-term and short-term debts. Due to the
insufficient infrastructure, government policies and poor developmental projects these debts
were not used efficiently in the past and still in present. The debts also cause low growth in
GDP and over all GNP.
Foreign aid and external debt was considered a significant source of income for developing
countries. According to Awan, Asghar & Rehaman (b, 2011) “ To raise growth rate of LDC like

3. Pakistan external debts are taken but it has an after effect which are difficult to maintain, but if
country can sustain its competence than they become helpful for any country.” From the late
1950’s current account deficit was considered normal. The countries facing current account
deficit were encouraged to borrow from international community to boost their economic
growth. During the last fifty years the external debt problem is one of the main challenges
faced by the developing countries like Pakistan. External debt and its repayments act as a
hindrance to the economic growth and development of developing countries. In the past three
decades it has been observed that external debt has been the main cause of decline in
investment and the growth performance of many nations. This external debt is like an
unfavorable tax on future generations, which they have to pay for nothing.”Heavy external debt
does not necessarily imply a slow economic growth. It is a country’s inability to meet its debt
obligations compounded by the lack of information on the nature, structure and magnitude of
the external debt.” (Were 2001). Countries may have heavy external debt along with relatively
higher level of exports that can help them to sustain their level of external debt. “To maintain
high external debt countries should maintain their level of exports but if it has not been able to
maintain than it will lead the wealth of economy down and deficit will come to happen due to
high debt servicing and it will extend country’s debt beyond its limit.” (Shabbir)
But external debt, if not sustainable, imposes higher risk to the economic prosperity, as its
servicing which is also an indicator of higher current account deficit, may lead to debt overhang
in a country. For any economy, debt either public or publically guaranteed, which also includes
the contingent liabilities, plays a crucial role towards overall economic progress. Developing
economies typically have limited sources to fetch revenues. If they fail to utilize their debt
productively, mobilize investment and create new employment opportunities; they will
eventually get stuck up with the dilemma of lower revenue base which will affect their spending
capacity, thereby leading to higher debt servicing. Inability to service debt on time not only
makes it harder for the developing countries to get aid at concessional rates with less
conditionality’s from the donor agencies but it also increases the country risk. That not only
reduces the overall level of foreign direct investment but forces a country to rely on domestic
borrowing. This higher domestic borrowing increase the domestic interest rate which leads to
crowding out that further slows down the economic growth.
Traditionally, while assessing the external debt vulnerabilities and risk factors that can hamper
economic growth, economists’ give emphasis on two types of indicators, namely external debt
indicators and macroeconomic indicators1. External debt indicators include the assessment of

4. external debt to GDP ratio, external debt to exports ratio that helps in analyzing the burden of
debt services, and short-term debt to total debt ratio, that gauges the liquidity problems
associated with external debt. In case of macroeconomic indicators, focus lies on a number of
variables mainly comprising the level of net international reserves, real effective exchange rate,
level of inflation, GDP, openness of trade, lending and borrowing rates, domestic credit, level of
investment and fiscal deficit.