External Debt and Economic Reforms

External debts by third world countries have been an important aspect or their economies. In the wake of economic reforms, these external debts have assumed greater significance. External debts have accrued to third world countries due to their borrowings from the developed nations, International Financial Institutions like IMF, World Bank etc., regional (specific to a continent) development institutions like Asian Development Bank and African Development Fund, and other non-domestic sources mostly belonging to the developed nations.
Although different third world countries categorize external debts differently, however external debts can broadly be categorized in to four units –

  • Loans taken from International Financial Institutions – IMF, World Bank.
  • Public guaranteed debts.
  • Private debts.
  • Central Bank Deposits.

It has been observed, that developing countries with high external debts have been late to adopt economic reforms.

Even though the need to implement intensive economic reforms could be felt in these economies, the governments kept delaying the inevitable. The costs of delaying economic reforms are too high in such economies.
However, the easy availability of foreign loans has helped these countries to offset temporarily the costs of delaying economic reforms. In the absence of proper reforms, the responsibility of high government spending had to be shouldered by these countries.

This was done from the foreign loans that were easily available since the de-colonization times. However these economies faced immense difficulties in repaying these loans causing the economies to plunge into greater external debts. This also explains the fact that countries with high external debts have had slower growth rates compared to those with less external debts. This can lead to a vicious circle leading to a debt trap wherein a country continues external borrowings to offset fiscal deficits without resorting to economic policy reforms.

The International Financial Institutions have played an important role in this regard. High borrowing countries were encouraged to adopt economic reforms while providing them with the loans to sustain their economy. Many countries adopting economic reforms have registered high growth rates and lower external debts as a result of the reforms. However in some cases especially in the African continent, sustainability of external debts has been a cause of concern.

The G7 in 1996 founded an initiative titled the HPIC (Heavily Indebted Poor Countries).The objective of this initiative was to make the tax burden sustainable for these countries with enormous external debts. The HPIC initiative was given further momentum in 1999. The option of external debt buy-backs between developing economies was also floated. In 2005 the G8 meeting in London took this initiative a step further. Eighteen Heavily Indebted Poor Countries was given a debt relief of forty billion US dollars. However a precondition to writing off the external debts was that the countries would ensure economic growth through proper implementation of economic reforms. The meeting also declared that another 20 countries could be considered for relief of external debts if they met the targets for proper economic reforms.

The areas in which these countries would need to focus with respect to their economic reforms include –
Privatizing of public sector units.
Liberalizing trade.
Elimination of subsidies.
Reduction of budgetary expenses.


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Last Updated on : 26th June 2013

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