How Do Nations Borrow Money?

Just like individuals, nations borrow money and just like individuals, they also have to repay their debt along with interest! And why some nations can't borrow money? For the same reasons as individuals their expenses are greater than their income. To meet the gap, the country can print currency, raise debt and cut expenditure. Often a country combines the three to tackle its financial hurdles.

There are primarily three ways that a nation can borrow money; 1. is by issuing bonds internally to its own citizens,

2.is taking a loan from international bodies like the World Bank or the Asian Development Bank etc. and

3.third is by taking loans from other countries.

Most Governments issue Treasury Bonds and other Debt Instruments which essentially means that governments are borrowing on behalf of the country from their citizens. While most of these bonds are issued to cover the expenses of the government in some cases they are issued with some specific purpose like building infrastructure etc. Normally the bonds issued by governments are considered to be the safest way to invest money and so the interest rate given by them is also the lowest. These bonds are bought and sold in the open market and their yields also keep varying.

Then the second source of borrowing for countries is from institutions like the International Monetary Fund or the Asian Development Bank. Here the countries have to specify what the purpose of the funds are going to be and the inspectors from these institutions then visit the country to appraise the project. For example if a particular country wants to borrow money for building a Dam they will approach the international fund. The fund will then send their inspectors to appraise the project, see the viability and the benefits that are going to accrue to the people as a result of the project. They then determine the amount of the loan, tenure and the interest rate. Normally such loans are subsidized as they are normally for good causes.

These types of loans are not given out in lump sums and money is released at different stages of the project and the repayment also normally starts at the end of an alotted time period - say 5 years or so. This provision is kept because the country is seeking the loan precisely because they do not have funds at hand and the project being undertaken is for the benefit of the people. However, this does not mean that interest does not accrue on that amount for that time period. Interest keeps on accruing which has to be paid later.

The third way in which nations borrow money is by borrowing it from other nations. Normally this is also done with some specific purpose in mind and is quite subsidized which means that the interest rates are lower than normal. Nations do this to develop strategic ties with other nations generally to gain some form of economic or military advantage. For instance the US may decide to lend to Pakistan to fight terrorism or India may lend to Bangladesh to tackle floods because it's a neighbor. More than financial aid, when nations lend to each other it's a signal of goodwill and political diplomacy. In political diplomacy there is always give and take and unlike the case of individuals where if one borrows money it is expected to be repaid, here the beneficiary country can repay in other ways as well. While all this is never clearly stated the cases of many debts being written off after a period of time without relationships getting strained is enough evidence to show that the lending country did not really expect to get it back. Other favors can be given in international forums like the WTO for economic reasons or for military reasons by providing a country's airspace and land for having a military base.

These are the three main ways in which nations borrow and lend money to each other or from their own citizens or international agencies. While in some cases they have to borrow to maintain their expenditures at other times, it is to take care of some special needs like an emergency or some other project. You will notice that most of the above behavior is quite similar to individuals and if you think about it, you will be able to find similarities even in your own life. Taken in context, it may help you become a little more creative in you personal dealings.