An economy’s development may be restricted by an unsustainable amount of foreign debt because:
1) Opportunity Cost.
A large foreign debt in terms of GDP means the country must pay a high rate of interest (debt service), so funds are diverted away from spending on the domestic economy. Between 19801990, Sub-Saharan Africa’s external debt rose by 163%. This resulted in the ‘lost decade of growth’ as domestic spending was diverted towards debt service. GDP per capita fell by 2.5%, consumption per capita fell by 40% and investment fell by 29.7%.
2) Loss of Credit Rating.
Maybe debt is so high that the country has a low credit rating and cannot borrow more money, then it may need to divert even more spending away from the domestic economy. Advanced economies may even lose their AAA credit rating if they run up large unsustainable foreign debts for example the US economy in 2011.
3) Repelled MNCs.
MNCs will be discouraged from entering an LDC with a large foreign debt because MNCs will expect the LDC government to spend on debt service rather than the infrastructure and tax breaks.
However, foreign debt may not be a major constraint on development because: – Most countries have foreign debt, debt is only a problem when it becomes unsustainable. – It may be necessary for an LDC to get into debt first to raise funds for development. After investment has come to fruition the debt can be repaid. – An LDC could get into debt and seek debt cancellation. – Maybe other factors are more important development constraints.