Lesson 4 of 6 · 13 min
External stability and foreign-currency debt
A sovereign without a reserve currency can only service its foreign-currency debt if it holds or earns enough foreign currency, so analysts compare external debt with GDP and with FX reserves, and look hard at where the foreign currency comes from.
In short
- External stability depends on whether foreigners are able and willing to hold assets in the country's currency. Reserve-currency and actively traded currencies give the most stability.
- Debt in the domestic currency is backed by the government's own tax base; external (foreign-currency) debt must be paid with foreign currency the country holds or earns.
- For a non-reserve currency sovereign, the key is external liquidity and solvency: the short- and long-term ability to generate sufficient, stable foreign-currency inflows.
- Ratios: FX reserves / GDP, reserve ratio (FX reserves / external debt), long-term external debt / GDP, external debt due in 12 months / GDP. More reserves = stronger; more external debt = weaker.
- Sources of FX: current account surpluses, capital inflows, remittances, commodity exports. Declining or volatile inflows weaken the ability to service foreign-currency debt.
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