Data Response 4.7

$4.3 billion debt hurdle in face of 2011/12 budget

1. Distinguish between ‘internal’ and ‘external’ debt.

External debt exists when the debt is contracted in a foreign currency, and when a country borrows from bankers abroad. On the other hand, internal debt is debt owed to locally owned banks in the local currency – generally, it is immune to changes in international or other foreign rates.

2. Using examples from the article and from your own knowledge, examine the problems associated with a developing country having a significant amount of external debt.

Having a significant amount of external debt may cause some problems, as “debt have pushed domestic interest rates to a higher end and the cost of debt servicing is going up by the day, leaving insufficient funds for basic services provision including fro education, healthcare, safe drinking water and infrastructural and energy projects.” If interest rates are increased, that means that there is a higher demand in money, which would imply that countries with a debt burden would have their budget consumed since they try to service this debt. Therefore, the money to be spent to increase domestic product or investments will be out of use.

3. Explain how inflation affects the external debt of a country such as Uganda.

If there is inflation, that would mean that there is also an increase in external debt. This is because as inflation would increase interest rates, and so the servicing of Uganda’s debt would take over their budget. This may potentially lead to Uganda to borrow money to service its debt, and furthermore Uganda’s debt would become unsustainable because they need to pay more in servicing their debt. In addition, inflation will create a decrease in demand for Uganda’s currency. So therefore inflation will make Uganda to not be able to gain increases in national debt to cover its debt, and the economy will be unable to grow.

4. Evaluate the policies that a developing country, such as Zambia, can use to counter the effects of inflation.

To counter the effects of inflation, Zambia can simply use fiscal policies such as decreasing consumption and government expenditure to increase the aggregate demand curve to the right; however, that will not be an effective policy in pushing the country to further develop. This is because a decrease in government spending, let’s say, in the area of health care and/or education will limit the people’s abilities. Therefore, Zambia should deal with their debt instead of considering how to reduce inflation. There are many ways that Zambia can tackle their debt crisis. Zambia can reschedule their debt to create a longer period in repaying loans, they can swap debts, where a creditor country cancels a debt at its nominal value. Also, Zambia can ask developed countries to write-off debts, which would support developing countries to increase imports and hence increase world trade. Such policies dealing with the debt will be effective, in that the stabilization would lead to reducing the inflation.

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