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FOREIGN DEBT &FOREIGN INVESTMENT

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• Foreign debt may be defined as the amount of money that a country’s 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 resident’s lending to overseas.

FOREIGN DEBT

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• 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 nation’s productive capacity, output, employment and living standards.

FOREIGN DEBT

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• 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.

DEBT SERVICING

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• Foreign debt is the accumulation of a country’s current account deficits over time. Hence foreign debt can be seen as:

(i) a nation’s 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.

VIEWING FOREGN DEBT

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

VIEWING FOREIGN DEBT

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• 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 country’s standard of living as more income is diverted from consumption

CONSEQUENCES OF CONSEQUENCES OF FOREIGN DEBTFOREIGN DEBT

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

CONSEQUENCES OF FOREIGN DEBT

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• There are several ways to reduce a country’s 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

REDUCING FOREIGN DEBT

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(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.

REDUCING FOREIGN DEBT

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• 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.

FOREIGN INVESTMENT

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

FOREIGN INVESTMENT

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• 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 country’s productive capacity.

DIRECT INVESTMENT

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• 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.

PORTFOLIO INVESTMENT

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• 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.

DEBT vs. EQUITY

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• There are many benefits of foreign investment:– Creates employment– Technological development through technology

transfer– Provision of capital– Introduction of superior research and development

(R&D) and managerial and technical expertise– Improvements in productivity, growth and

competitiveness in export and import competing industries

BENEFITS OF FOREIGN INVESTMENT

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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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