This paper analyzes the issue of external debt from a macroeconomic perspective. According to the paper, in India, the external debt situation does not pose a serious threat to the debt sustainability of the nation. With an improvement in the current account balance and increase in the foreign exchange reserves of the economy, there is a decline in external debt as a percentage of GDP thus implying a sound external financial management in the country. The worsening fiscal situation in recent years has not spilled into the vulnerable external sector. This implies a better resilience and readiness of the economy compared to early 1990s, to adjust and avoid any advent of financial instability arising, due to the changing internal and external economic environment.

It is conventionally argued that given limited domestic resources, external financing helps to moderate the domestic resources constraint by ugmenting the domestic capital stock. It helps the economy to grow through expansionary economic activities resulting from the productive use of the existing and the borrowed resources. External borrowing helps the private sector to undertake its production ventures in the domestic economy and abroad. It helps in importing new technologies (advanced modes of production) for augmenting the capacity and enhancing the productivity of industries. It also helps the government to mobilize resources for financing its socio-economic activities.

However, there is an optimal level or sustainable limit to the external debt financing, which has become a subject of great debate and discussion among the economists especially in the context of heavily indebted economies. Economists gauge sustainability of external borrowing from different indicators/measures such as external debt to GDP ratio, debt to export ratio, short-term debt to total debt, total debt to foreign exchange reserve ratios and comparison between the contractual interest rate on foreign loans and growth of exports etc.

It may be noted that although debt is useful if it is channeled for productive purpose, excessive reliance on external sources of borrowing might become counterproductive as it may have adverse impact on the domestic economy. More external debt implies excessive demand on the foreign currency. It leads to weakening of domestic currency (or appreciation of foreign currency). Appreciation of foreign currency aggravates the existing debt burden in the future. This also leads to the current account imbalance, as it requires more exports for clearing the debt (Easterly and Schmidt-Hebbel, 1994). Further, given a higher demand for foreign currency, if it leads to a rise in the supply of domestic currency, it may result in expansion of aggregate money supply. Expansion of money supply reduces the interest rates. As a consequence, it would lead to the outflow of capital from the domestic economy.

Applied Finance Journal, Financial Management, Domestic Economy, Macroeconomic Variables, Financial Institutions, Entrepreneurial Activities, Indian Economy, Public Sector Banks, Domestic Markets, Asian Economic Crisis, Gross Domestic Product, GDP, Financial Markets, Trade Liberalization, Financial Development, Macroeconomic Factors.