- 10 Marks
Question
External debt does not constitute a burden when contracted loans are optimally deployed and the return on investment is sufficient to meet maturing obligations, as and when due, while servicing of the domestic economy is not undermined. The magnitude and severity of debt burden cannot be determined on the basis of debt volume only, rather, the debt volume should be viewed in combination with certain debt ratios for better appreciation of the debt problem.
Required:
Discuss THREE ratios commonly used to analyze the degree of indebtedness of a country and explain TWO sources of external debts.
Answer
Ratios Used to Analyze Indebtedness:
- External Debt Service to Export Ratio: Reflects the proportion of export earnings allocated to servicing external debt. Since external debts are typically paid in foreign currency, export earnings become critical for debt servicing.
- External Debt Stock to Export Ratio: Measures the total external debt in relation to export earnings, indicating the extent to which foreign exchange from exports could liquidate outstanding debt.
- External Debt Stock to Nominal GDP Ratio: Shows the extent to which a country’s domestic output can cover its external debt, where a high ratio indicates a significant debt burden.
Sources of External Debt:
- Paris Club of Creditors: An association of creditor countries formed in 1956, which includes major economies such as the USA, UK, and Germany. It negotiates debt repayments with debtor nations.
- London Club of Creditors: Consists primarily of commercial banks from industrialized countries. Established in 1976, the club assists in restructuring unguaranteed debts owed by private sector borrowers in debtor nations
- Tags: Debt Analysis, Debt Ratios, External Debt, Fiscal Responsibility, Public Finance
- Level: Level 2
- Topic: Fiscal Policy and Public Finance
- Series: MAY 2021
- Uploader: Kwame Aikins