Foreign Debt

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FOREIGN DEBT FOREIGN INVESTMENT
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FOREIGN DEBT

• Foreign debt may be defined as the amount of
  money that a countrys residents, both public and
  private, owe to the rest of the world.
• It is important to distinguish between gross and
  net foreign debt. Gross foreign debt is the total
  amount borrowed from non-residents. Net foreign
  debt is gross foreign debt minus residents
  lending to overseas.

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FOREIGN DEBT

• Many people view foreign debt as a disadvantage
  for a country, although most countries do have a
  foreign debt.
• However, foreign debt can be an advantage since
  it can provide an increase in a nations
  productive capacity, output, employment and
  living standards.

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DEBT SERVICING

• Repaying foreign debt requires payment of the
  original sum borrowed, plus interest on that
  debt. The interest that is paid is known as debt
  servicing.
• The debt servicing ratio is the foreign debt
  interest payments as a proportion of export
  income. It gives an indication of the capacity of
  an economy to pay the costs associated with its
  level of foreign debt and thus the cost of debt
  to the economy.

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VIEWING FOREGN DEBT

• Foreign debt is the accumulation of a countrys
  current account deficits over time. Hence foreign
  debt can be seen as
• (i) a nations imports and income paid to
  overseas residents is greater than the value of
  exports and income received.
• (ii) national expenditure exceeding national
  income, i.e. a nation spending more than it
  earns.

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VIEWING FOREIGN DEBT

• (iii) the difference between national
  investment and national savings. If a country
  does not have sufficient domestic savings, it
  must borrow to finance its investment which
  must come from overseas.

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CONSEQUENCES OF FOREIGN DEBT

• Foreign debt has several consequences for a
  country
• (i) falling credit ratings this will increase
  the interest rate that the country will have to
  pay on future borrowings since lenders perceive
  a greater lending risk
• (ii) the increased interest payments lower the
  countrys standard of living as more income is
  diverted from consumption

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CONSEQUENCES OF FOREIGN DEBT

• High debt levels also increase the vulnerability
  of an economy to deteriorating world economic
  conditions e.g. if the countrys currency
  depreciated, this will immediately increase the
  size of the foreign currency denominated debt
  further increasing interest payments.

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REDUCING FOREIGN DEBT

• There are several ways to reduce a countrys
  foreign debt
• (i) Increasing international competitiveness
  (microeconomic reform). Growth in exports will
  reduce the CAD and hence foreign debt.
• (ii) Increasing the savings pool - this will
  reduce the borrowings required to fund
  investment

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REDUCING FOREIGN DEBT

• (iii) Monetary policy to maintain low inflation
  rates will improve export competitiveness and
  our CAD this will also preserve the real
  purchasing power of savings and will act to
  improve the level of domestic savings.
• (iv) Use of fiscal and monetary policy to
  reduce aggregate demand this will discourage
  import demand which contributes to foreign
  debt.

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FOREIGN INVESTMENT

• Foreign investment may be defined as the stock of
  financial assets in a country owned by foreign
  residents, and financial transactions in the
  balance of payments which increase or decrease
  this stock of financial assets.

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FOREIGN INVESTMENT

• Foreign investment can be categorised into two
  main groups direct investment and portfolio
  investment.

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DIRECT INVESTMENT

• Direct investment represents funds invested in an
  enterprise involving at least 10 ownership and
  enabling influence over the key policies of the
  enterprise. It is usually stable and long term
  and generally adds to the countrys productive
  capacity.

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PORTFOLIO INVESTMENT

• Portfolio investments do not result in ownership
  or control of enterprises, i.e. less than 10
  ownership. These include financial assets like
  shares on the stock market (less than 10 of
  total shares) and bonds. Portfolio investment is
  generally unstable and speculative.

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DEBT vs. EQUITY

• Foreign investment can be in two forms
• Debt investments are where enterprises borrow
  funds from overseas to finance investment
  (foreigners do not own domestic assets)
  portfolio investment usually takes this form.
• Equity investments are where foreigners invest in
  the ownership of domestic assets direct
  investment usually takes this form.

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BENEFITS OF FOREIGN INVESTMENT

• There are many benefits of foreign investment
• Creates employment
• Technological development through technology
  transfer
• Provision of capital
• Introduction of superior research and development
  (RD) and managerial and technical expertise
• Improvements in productivity, growth and
  competitiveness in export and import competing
  industries

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COSTS OF FOREIGN INVESTMENT

• There are two major arguments against foreign
  investment
• Loss of control over economic decision making
  this may conflict with Government policy or
  public wishes. National sentiment may oppose
  foreign ownership for emotional or nationalistic
  reasons
• Debt servicing costs payments to investors add
  to the incomes section of the CAD. This may
  require more borrowings increasing foreign debt
  further

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