The Impact of Public Debt on Exchange Rates

Debt is integral to both businesses and economies, but must be closely managed to prevent it having the disastrous consequences we have recently experienced. By borrow large sums of money, countries can afford to invest in massive public projects, which normally has a positive impact on their national economy. However, the greater a country’s debt, the faster inflation is likely to rise and hence the repayment of the debt will be in a currency of lower value. For this reason, foreigners are less likely to invest in the currency of a country with high debt, therefore the exchange rate of that currency will fall.

Just like a personal credit rating, the impact that debt has on a country’s exchange rate is largely due to just how trustworthy that country has proved itself in making past repayments. If a country regularly borrows and repays money, foreign investors won’t be put off by further debts that are likely to be repaid. If, however, investors are worried that the country won’t repay the debt, leading to the devaluation of its currency, they are less likely to invest – further lowering the exchange rate.

As with all aspects of life, the key is balance; borrowing money that can be repaid and investing it in schemes that will be beneficial to the country as a whole. Simply borrowing and wasting large amounts of money will cripple the exchange rate – as we have seen.