External Debt: A Vicious Cycle With No Right Answers


Undertaking external debt—debt that is owed to foreign entities—is a common, effective, and sometimes dangerous strategy. Many countries use foreign lenders as a means of acquiring capital at a cheaper rate than they could find within their own borders. Every country on earth, whether taken out by its government, corporations, or citizens, has external debt, showing just how prominent this economic strategy is. Via foreign loans, nations are able to begin projects, such as developing infrastructure, while mitigating the effects of runaway inflation. Simply put, nations need money to enact policy, and sometimes money can be borrowed or bought from a foreign entity at a lower price than national banks, lenders, or even by printing more capital. 

The dangers of debt

Although many countries employ it, this sort of debt carries a number of concerns, chief among them the possibility that, if managed improperly, it might push the nation into a debt crisis. A “debt crisis” is when a country simply owes too much to foreign lenders, a quantity it cannot and often would not be able to repay. When debt levels are too high and a country enters a debt crisis, there is a high risk it will default on what they owe and be unable to repay the loan or the interest that comes with it. When countries default on their debt, it hurts their credit nationally, making it difficult for them to borrow money in the future, thus affecting their financial stability and forcing governments to obtain funds by cutting government expenditures in social programs and implementing higher taxes, all of which drastically impact citizens.

Additionally, owing money to other nations is inherently dangerous due to power dynamics. Sometimes struggling or developing nations need to take out foreign loans to simply “stay afloat,” as Investopedia phrases it. These loans of desperation often come with harsh terms, including high-interest rates and other market restrictions. This interest that the country may not be able to repay in the future often leads to a vicious cycle of continuous debt, putting the debtor nation at the will of their lender, or, as Investopedia phrases it, “in their pocket.”

In short, the largest issue of external debt arises when it is taken on out of desperation and not as a legitimate economic strategy. When done strategically and by choice, countries can use external loans to save money and fuel their economies; however, when done out of desperation, a debtor nation is at the will of the terms the lenders put forward, often leading to impossible conditions that cause bankruptcy and an ensuing cycle of taking on more and more debt to stay above water.

The case of Latin America: loans to pay loans

External debt is becoming a globally prominent issue, particularly in Latin America, where the negative effects are plainly seen. During the harsh economic situation of the COVID pandemic, many Latin American companies were forced to take out loans to carry out their pandemic policies. According to data from the Economic Commission for Latin America and the Caribbean (ECLAC), the average gross debt of governments in the region is 77.7%. Essentially, Latin American countries owe more than three-quarters of what they earn each year to foreign bodies. Furthermore, the cost of servicing these debts, such as paying the agreed-upon interest, accounts for 59% of the region’s exports. What is able to be earned by the nation via exports is, unfortunately, largely owed as debt to lenders. These statistics make Latin America the most indebted region in the world.

This information is given and commented on heavily in a 2021 article from El Pais, “Latin America, in the Hands of Wall Street.” It is explained here that Latin America is being reviewed negatively by creditors, leading to an increasing difficulty in acquiring loans at a reasonable price. As countries struggle to repay their previous loans, one of the most common ways to obtain the funds needed to pay off debts is, ironically, to take out more loans. Loans that have increasingly high-interest rates and, in the future, will be ever more difficult to pay. This is a prime example of the aforementioned vicious debt cycle that can swallow economies.

Future perspectives for Latin America

So what can be done to combat this debt crisis? In the long run, Latin America must find a new way to pay off their previous debts, effectively breaking them out of the cycle and ending their economic “captivity” by their Wall Street lenders. This, however, is easier said than done.

A real-world example of measures that can be and have been taken to combat this cycle is the pandemic actions of Argentinian Finance Minister Martín Guzman. According to El País’ “Argentina’s Perpetual Crisis” publication, Argentina is one of the world’s largest debtors, owing around 44 billion US dollars to lenders. Fortunately for Argentina, bankrupt countries have far more ground to negotiate than bankrupt companies. Lenders cannot simply foreclose on a country as they would on a company that defaulted on a loan. Guzman took this advantage as an opportunity to renegotiate the terms of Argentina’s debts, bringing down the interest rates that lenders accepted, knowing Argentina has a higher chance of repaying them if the interest is manageable. Lenders know that something is better than nothing, a fact that debtor nations can use to their advantage.

However, by this point, Argentina’s credit image is so weakened due to previous defaults on loans and renegotiating their terms that the country has been largely excluded from the lending market in the future, at least from the market with reasonable and affordable terms of borrowing. This puts them in a complicated situation, because, like most Latin American nations, Argentina needed foreign loans to overcome the economic recession derived from the COVID-19 pandemic. With no option left, Guzman chose to simply create the money needed, printing cash in place of borrowing money at a ridiculously high rate of interest. Although this led to high inflation, Guzman deemed it justified in its effort to slow Argentina’s debt cycle to foreign nations before it was too late, based on the calculation that inflation would cost the nation less than interest on future loans.

Argentina is just one of many examples in Latin America alone. As exemplified by Argentina, nations need to begin acting now, as external debt is a compounding issue that will only grow worse. Unfortunately, the countries of this region have few options for getting out of debt without repercussions, forcing decisions between the lesser of two evils: higher inflation and lower debt, or continuing to borrow and risking future market exclusion, which could lead to a new socioeconomic crisis. The growing sentiment among the leadership and populace alike in this region is a strong will to rid the nations of their cyclical debt to foreign powers, regardless of the cost. This sentiment could provide the impetus needed to end, or at least weaken, Wall Street’s and other lenders’ stranglehold on the Latin American world. 

Featured cover image by: iStock

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