External debt is the portion of a country's debt that was borrowed from foreign lenders, including commercial banks, governments, or international financial institutions. These loans, including interest, must usually be paid in the currency in which the loan was made. To earn the needed currency, the borrowing country may sell and export goods to the lender's country.

Breaking Down an External Debt

A debt crisis can occur if a country with a weak economy is not able to repay the external debt due to the inability to produce and sell goods and make a profitable return. The International Monetary Fund (IMF) is one of the agencies that keep track of the country's external debt. The World Bank publishes a quarterly report on external debt statistics.

If a nation is unable or refuses to repay its external debt, it is said to be in a sovereign default. This can lead to the lenders withholding future releases of assets that might be needed by the borrowing nation. Such instances can have a rolling effect, wherein the borrower’s currency collapses and that nation’s overall economic growth is stalled.

The conditions of default can make it challenging for a country to repay what it owes, plus any penalties the lender has brought against the delinquent nation. The way defaults and bankruptcies are handled for countries differs from what the consumer market experience, allowing the possibility for countries that have defaulted on external debt to potentially avoid having to repay it.

How External Debt Is Used by the Borrower

Sometimes referred to as foreign debt, corporations, as well as governments, can procure external debt. In many instances, external debt takes the form of a tied loan, which means the funds secured through the financing through must be spent back into the nation that is providing the financing. For instance, the loan might allow one nation to buy resources it needs from the country that provided the loan.

External debt, particularly tied loans, might be set for specific purposes that are defined by the borrower and lender. Such financial aid could be used to address humanitarian or disaster needs. For example, if a nation faces severe famine and cannot secure emergency food through its own resources, it might use external debt to procure food from the nation it received the tied loan from. If a country needs to build up its energy infrastructure, it might leverage external debt as part of an agreement to buy resources such as the material to construct power plants in underserved areas.