Why international borrowing

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In addition to the suffering that results from economic stagnation, the United Nations has also linked high levels of foreign debt and a government's dependency on foreign assistance to human rights abuses. Economic distress causes governments to cut social spending, and reduces the resources it has to enforce labor standards and human rights, the U. Monetary Policy. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.

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Key Takeaways Foreign debt is money borrowed by a government, corporation or private household from another country's government or private lenders. Foreign debt has been rising steadily in recent decades, with unwelcome side-effects in some borrowing countries, especially developing economies.

Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Not surprisingly, the countries whose exposure to currency risk is the highest are the first of the remaining non-euro area EU member states to take concrete steps towards the introduction of the euro.

Specifically, following the implementation of a number of pre-entry policy commitments, in July , Bulgaria and Croatia joined the Exchange Rate Mechanism ERM II , which is the final stage of the euro adoption process. The Romanian authorities have announced that they will initiate the same process in the coming years. Meanwhile, other EU member states outside the euro area have not yet expressed interest in adopting the euro. This can be partly explained by their relatively low exposure to currency risk.

In particular, given that currency mismatches are contained, the benefits of adopting the euro and eliminating currency risk do not seem very large from their perspective, making the euro adoption less attractive as a policy anchor.

The ability of the central bank to intervene is much greater in countries whose government debt is mostly denominated in local currency. Even if investors choose not to finance such a country any longer, its central bank can print more money — by lending to commercial banks or by purchasing bonds in the secondary market — in order to help the government refinance its liabilities. This is exactly what the European Central Bank did during the European sovereign debt crisis and what it has been doing following the outbreak of the COVID pandemic in early There is little doubt that these two crises would have been much worse had the ECB not intervened in such a way.

The historical episodes documented in this paper clearly show that debt and currency crises are likely when the government is borrowing too much on short maturities, when reserves are insufficient, the real exchange rate is overvalued and credit growth is excessive.

In contrast, the probability of a crisis is likely to be low if the authorities implement a prudent policy mix; if the government maintains a balanced budget, the debt-to-GDP ratio is relatively low and the average maturity of debt is long, it is unlikely that the country will have difficulty refinancing the debt, regardless of its unfavourable currency composition.

The maintenance of ample foreign currency reserves is also important, for it signals to investors that the government will be able to meet its obligations even if it temporary loses access to international financial markets.

It is also vital to carry out vigorous supervision and regulation of the financial sector, as failures of large banks can impose a heavy burden on public finances and thus undermine debt sustainability.

Public finances of non-euro area EU member states do not appear to be heavily exposed to currency risk. In the event of a sharp depreciation of their currencies, the resulting increase in the debt-to-GDP ratio would be mild in most cases. Even countries with a relatively high share of foreign currency debt in total government debt, such as Bulgaria and Croatia, are unlikely to have trouble with debt refinancing in the near future owing to their generally robust fiscal and overall macroeconomic performance.

Their resilience was demonstrated after the outbreak of the COVID pandemic when both countries were able to implement significant fiscal stimulus programs to support the economy while keeping their currencies and public finances stable.

However, from a long-term perspective, these two countries have every reason to adopt the euro. Apart from the fact that their government debt consists mainly of euro-denominated liabilities, the two countries stand out with persistently high levels of loan and deposit euroization, which is an additional major source of vulnerability. The introduction of the euro would bring substantial benefits to Bulgaria and Croatia in terms of lower risk exposure and higher resilience to financial crises.

It is therefore not surprising that Bulgaria and Croatia are the first among the remaining non-euro area EU member states to express interest in joining the ERM II and introducing the euro. For all other member states, except Romania, the net economic benefit of adopting the euro appears to be smaller, which partly explains why their authorities do not have the ambition to launch the euro adoption process any time soon. Abiad, A. Banking, Debt, and Currency Crises. Early Warning Indicators for Developed Countries.

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Accept cookie More information. In this article Abstract 1 Introduction 2 Costs and benefits of government borrowing in foreign currency 2. Abstract This paper discusses the costs and benefits of government borrowing in foreign currency. While discussing the main costs, such as increased exposure to currency and rollover risks, and limited capacity to respond to financial crises, this paper also identifies two benefits of foreign currency borrowing.

The paper also explores to what extent governments of non-euro area EU member states rely on foreign currency borrowing and whether they have sufficient capacity to preserve currency stability in the event of adverse shocks. The analysis suggests that the public finances of these countries are not heavily exposed to currency risk.

Exceptions to this are Bulgaria and Croatia, whose government debt is mainly denominated in euros, and who also suffer from high loan and deposit euroization.