INTRODUCTION TO EXTERNAL DEBT MANAGEMENT
table of contents
S.R.nocontent
1Introduction to External Debt Management
2External Debt and Macroeconomic Considerations
3Important Aspects Related To External debt Management
4External Debt Sustainability
5External Debt Development and Management Some Reflections on
India
6External Debt Management Policy
7CONCLUSION
Introduction to External Debt Management
External debt (or foreign debt) is that part of the total debt
in a country that is owed to creditors outside the country. The
debtors can be the government, corporations or private households.
The debt includes money owed to private commercial banks, other
governments, or international financial institutions such as the
IMF and World Bank.
Definition
IMF defines it as "Gross external debt, at any given time, is
the outstanding amount of those actual current, and not contingent,
liabilities that require payment(s) of principal and/or interest by
the debtor at some point(s) in the future and that are owed to
nonresidents by residents of an economy."
In this definition, IMF defines the key elements as follows:(a)
Outstanding and Actual Current Liabilities: For this purpose, the
decisive consideration is whether a creditor owns a claim on the
debtor. Here debt liabilities include arrears of both principal and
interest.
(b) Principal and Interest: When this cost is paid periodically,
as commonly occurs, it is known as an interest payment. All other
payments of economic value by the debtor to the creditor that
reduce the principal amount outstanding are known as principal
payments. However, the definition of external debt does not
distinguish between whether the payments that are required are
principal or interest, or both. Also, the definition does not
specify that the timing of the future payments of principal and/or
interest need be known for a liability to be classified as
debt.
(c) Residence: To qualify as external debt, the debt liabilities
must be owed by a resident to a nonresident. Residence is
determined by where the debtor and creditor have their centers of
economic interest - typically, where they are ordinarily located -
and not by their nationality.
d) Current and Not Contingent: Contingent liabilities are not
included in the definition of external debt. These are defined as
arrangements under which one or more conditions must be fulfilled
before a financial transaction takes place. However, from the
viewpoint of understanding vulnerability, there is analytical
interest in the potential impact of contingent liabilities on an
economy and on particular institutional sectors, such as
government.
Generally external debt is classified into four heads i.e. (1)
public and publicly guaranteed debt, (2) private non-guaranteed
credits, (3) central bank deposits, and (4) loans due to the IMF.
However the exact treatment varies from country to country. For
example, while Egypt maintains this four head classification, in
India it is classified in seven heads i.e. (a) multilateral, (b)
bilateral, (c) IMF loans, (d) Trade Credit, (e) Commercial
Borrowings, (f) NRI Deposits, and (g) Rupee Debt.
External Debt and Macroeconomic Considerations
How foreign borrowing affects macroeconomic stability can be
best understood in the context of production, consumption, savings,
and investment. In a closed economy (no foreign trade), production
comprises goods and services for personal consumption (consumer
goods), capital goods (buildings, plant and equipment, inventories
used by enterprises), and goods and services used by the
government, which can be both for consumption (for current use) and
for investment. Where there is foreign trade, production also
includes goods for export; imports are a supplement to domestic
consumption, for investment, for government use or for exports.
There is a relationship between production and income. Put
simply production creates incomes equal to the value of output. The
government in taxes takes some income; some is taxed; some is saved
by the private sector; the balance is spent on consumption. Foreign
borrowing is the excess of imports of goods and services over
exports and net borrowing creates debt, which can be repaid if
exports exceed imports. In the absence of foreign borrowing
(exports and imports are equal), private sector investment plus
government spending is limited by the level of private sector
savings and taxation.
Economic growth, of course, could be accelerated with foreign
borrowing, permitting imports to exceed exports and at the same
time, investment plus government expenditures to exceed savings
plus taxes. There are standard indicators for measuring the burden
of external debt: the ratios of the stock of debt to exports and to
gross national product, and the ratios of debt service to exports
and to government revenue. Although there is widespread acceptance
of these ratios as measures of creditworthiness, there are no firm
critical levels, which, if exceeded, constitute a danger for the
indebted country.
However, the World Bank Staff has proposed a set of parameters,
which it uses to demarcate moderately and severely indebted
countries. Countries with a rapid export growth can support higher
debt relative to exports and output. Heavily indebted, however, are
vulnerable to severe macroeconomics shocks-sharply higher interest
rates in the lending countries, for instance, or simply lenders
cutting back on their commitments. Faced with these pressures,
countries must then adjust by cutting private investment,
decreasing government expenditures and or increasing government
revenues.
Important Aspects Related To External debt Management
A) Financing Techniques
Countries have a limited ability to support external borrowing.
At the same time, the supply of finance is also limited.
Consequently, borrowers must choose the best combination from the
available sources of external finance to suit the needs of
individual projects-and of the economy as a whole. The country
wishes to minimize the problems in servicing new debt, while making
maximum use of grants and foreign loans on concessional terms.
These are clearly the cheapest from of financing, but their
availability is generally restricted to the poorest developing
countries; and even for those countries, they are inadequate to
meet needs. A maximum leverage can be obtained from concessional
financing by combining it with other types of financing. Other
sources of credits are export financing and loans from
international commercial banks.
Authorities should ensure that credits from financial markets
are part of a package that provides the best possible external
financing mix for the economy, as well for an individual project.
For projects the best mix could mean one with: (1) maximum
concessional loans or maximum market finance (2) the maximum
capital that can be rolled over easily, or (3) the minimum debt
service due in the years before returns materialize. Authorities
must also ensure that the aggregate financing package meets
national financing priorities, This involves an assessment of such
aspects as: the sources of finance ,including the amounts that can
be borrowed and the prospects for future supply; the currency
composition of foreign borrowing that would minimize exposure to
exchange rate fluctuations; the exposure to interest rate
fluctuations over the life of the loan; and the impact of new
borrowing on the structure of debt service obligations.B) How much
to Borrow
The amount that any country ought to borrow is governed by two
factors: how much foreign capital the economy can absorb
efficiently, and how much debt it can service without risking
external payment problems. Each factor will depend on the quality
of economic management. Borrowings can be on different terms and in
different currencies, which complicates the policy decision. There
may be uncertainty too about evolving debt-servicing capacity.
Interaction between debt servicing capacities, the type of finance,
and the borrowing decision increases in complexity as the number of
loans increases.
C) Managing Risk
Countries are sometimes exposed to BOP shocks arising from
unfavorable changes in the relative prices of exports and imports,
suppose that a countrys exports earnings are in dollars and its
foreign debts are repayable in yen deterioration in the exchange
rate of the dollar vis-a-vis the yen will add to the debt servicing
obligation of the borrowing country. Fluctuations in commodity
prices, foreign exchange rates and world interest rates are largely
beyond the control of countries. It is possible to hedge against
this risk. Managing risk is an important part of public debt
management.D) Knowing The Debt
Information on external debt and debt service payments is
essential for the day-to-day management of foreign exchange
transactions as well as managing debt and for planning foreign
borrowing strategies, At the most detailed level, the information
enables central authorities to ensure that individual creditors are
paid promptly; at more aggregated levels; debt data are needed for
assessing current foreign exchange needs, projecting future debt
service obligations, evaluating the consequences of further future
borrowing and the management of external risk The component of
external debt statistics include details of each loan contract and
its schedule of future service payments, figures on loan
utilization, and the payments of debt service obligations. From
these data elements summary figure on foreign borrowing,
outstanding debt, and projected debt are assembled. The resulting
statistics provide inputs for budget and BOP projections.
After this lets have a look at external debt sustainability in
detail in Chapter 2.External Debt Sustainability
Sustainable debt is the level of debt which allows a debtor
country to meet its current and future debt service obligations in
full, without recourse to further debt relief or rescheduling,
avoiding accumulation of arrears, while allowing an acceptable
level of economic growth. (UNCTAD/UNDP, 1996)
External-debt-sustainability analysis is generally conducted in
the context of medium-term scenarios. These scenarios are numerical
evaluations that take account of expectations of the behavior of
economic variables and other factors to determine the conditions
under which debt and other indicators would stabilize at reasonable
levels, the major risks to the economy, and the need and scope for
policy adjustment.
In these analysis, macroeconomic uncertainties, such as the
outlook for the current account, and policy uncertainties, such as
for fiscal policy, tend to dominate the medium-term outlook.
World Bank and IMF hold that a country can be said to achieve
external debt sustainability if it can meet its current and future
external debt service obligations in full, without recourse to debt
rescheduling or the accumulation of arrears and without
compromising growth. According to these two institutions, external
debt sustainability can be obtained by a country by bringing the
net present value (NPV) of external public debt down to about 150
percent of a countrys exports or 250 percent of a countrys
revenues.
Indicators of External Debt Sustainability
There are various indicators for determining a sustainable level
of external debt. While each has its own advantage and peculiarity
to deal with particular situations, there is no unanimous opinion
amongst economists as to one sole indicator. These indicators are
primarily in the nature of ratios i.e. comparison between two heads
and the relation thereon and thus facilitate the policy makers in
their external debt management exercise.
These indicators can be thought of as measures of the countrys
solvency in that they consider the stock of debt at certain time in
relation to the countrys ability to generate resources to repay the
outstanding balance.
Examples of debt burden indicators include the (a) debt to GDP
ratio, (b) foreign debt to exports ratio, (c) government debt to
current fiscal revenue ratio etc. This set of indicators also
covers the structure of the outstanding debt including the (d)
share of foreign debt, (e) short-term debt, and (f) concessional
debt in the total debt stock.
A second set of indicators focuses on the short-term liquidity
requirements of the country with respect to its debt service
obligations. These indicators are not only useful early-warning
signs of debt service problems, but also highlight the impact of
the inter-temporal trade-offs arising from past borrowing
decisions. The final indicators are more forward looking as they
point out how the debt burden will evolve over time, given the
current stock of data and average interest rate. The dynamic ratios
show how the debt burden ratios would change in the absence of
repayments or new disbursements, indicating the stability of the
debt burden. An example of a dynamic ratio is the ratio of the
average interest rate on outstanding debt to the growth rate of
nominal GDP.
These were certain aspects of external debt in the next chapter
we will see how the external debt was managed by various countries
of the world at the time of economic crisis.
Debt management strategy-a global overviewThe design of an
adequate strategy for public debt management should include proper
consideration of a number of questions. Among them, several come to
mind: (a) how much public debt should be issued in domestic markets
and how much in foreign capital markets? (b) What should be the
currency denomination of new public debt issues? (c) What is the
optimal maturity structure of public debt? (d) Should governments
consider redeeming in advance some issues and refinance them on
different terms? (e) Should public debt be issued at fixed or
variable rates and (f) should public debt issues be directed to a
particular segment of the market (financial institutions, other
institutional investors, corporate sector, etc).Most of these
choices entail a trade-off between the level and the variance of
debt costs and are highly dependent on both the domestic
macroeconomic context and conditions in international markets.
Nonetheless, the debt management strategy has important
implications for the economy as a whole. Good liability management
should result in lower borrowing costs and unobstructed access to
international capital markets, while minimizing any crowding-out
effects on private sector borrowing. The choice of the specific
characteristics of the debt portfolio involves difficult decisions.
While on a pure cost-based analysis it is tempting to choose
short-term over long-term debt, the latter might Brady bond spreads
for different emerging market economies have behaved similarly,
though at different levels, in the midst of financial crises or
increased uncertainty. Thus, the liquidity of emerging markets
securities and the collective behavior of institutional investors
make the financial authorities tasks more difficult, particularly
since systemic risk may rise swiftly. Over the past decade, capital
mobility has increased many times over and its main features have
also changed, especially those related to the allocation between
foreign investment and traditional lending. Mexico, as a recipient
economy, has witnessed those events.
Total capital inflows to Mexico grew from a yearly average of
US$ 2 billion in 198788 to $36 billion in 1993. In the latter year,
foreign investment amounted to 920/0 of capital inflow.
The 1994 crisis caused an important reduction of these flows, to
$23 billion in 1995. Given that foreign investment for that year
turned out to be negative, loans from abroad represented more than
1000/0 of total capital inflows. For 199697 capital inflows were on
average $10 billion per year. However, it should be emphasized that
total foreign investment represented more than 2000/0 of that
amount. That is, foreign investment more than compensated for the
decline in indebtedness. For 199899 capital inflows are estimated
to have averaged $16 billion per year, with total foreign
investment amounting to 770/0 of the inflows. Foreign direct
investment grew from $4 billion in 1993 to $11 billion in 1994 and
has kept a stable level of around $10 billion per year since then.
On the other hand, portfolio investment has shown more erratic
behavior. Having reached a peak of $29 billion in 1993, it turned
negative in 1995 ($10 billion) and for 199699 has averaged under $1
billion per year. The important reduction in the flows of foreign
portfolio investment to Mexico since the crisis of 199495 is
primarily explained by the adoption of a floating exchange rate
regime.
This regime has proved to be extremely helpful in inhibiting
short-term foreign investments by reducing their expected return,
once adjustment is made for exchange rate risk. Without the
implicit guarantee to portfolio investment provided by the
semi-fixed exchange rate regime, foreign direct investment started
to play a more dominant role in financing
Mexicos current account deficit blurred. The Exchange
Stabilization Fund prevented the liquidity crisis from turning into
a solvency crisis, whose repercussions would have been far more
devastating.
Prior to 1994, both debtors and the banking system in general
were in a fragile situation. Past due loans had increased
substantially, and the lack of proper provisioning started to erode
banks capital.
In addition, some commercial banks faced severe problems that
were not revealed in their financial statements, and, in some
instances, banks disregarded existing regulations and proper
banking practices (Mancera (1997)). In this environment, the effect
of the currency depreciation, rising inflation and higher interest
rates on the credit service burden seriously jeopardized the
Mexican financial system. At that time, the materialization of
systemic risk and its impact on the economy were major
concerns.
Faced with this situation, the government and the central bank
implemented a comprehensive programme to deal with the banking
sector crisis, without derailing monetary policy from its main task
of procuring the reduction of inflation. The successful mix of
policies ensured the consistency of Mexicos macroeconomic framework
and allowed the economy to recover and rapidly return to
international markets. An important element of the overall strategy
was to provide liquidity to commercial banks to comply with their
external obligations. To this end, a dollar facility was made
available to them by the central bank. Thus, Banco de Mxico played
the role of lender of last resort for commercial banks at a time of
distress, making foreign exchange available to banks through a
specially designed credit window. These dollar-denominated loans
were channeled through the Fund for the Protection of Savings
(FOBAPROA).At the beginning of April 1995, the dollar-denominated
credits granted through FOBAPROA reached a maximum of US$ 3.8
billion. However, the high level of interest rates purposely
charged on such credits induced a rapid amortization, as banks
sought other sources of financing. By 6 September 1995, the 17
commercial banks that had participated in this scheme had already
repaid their credits.
In this sense, the programme achieved its stated purpose, namely
that of providing temporary assistance. Once international markets
were reopened to Mexican agents (July 1995), the main objectives
for the immediate future included the refinancing of the Exchange
Stabilization Fund in the market, have a smaller refunding risk and
thus be preferable in the end.
That is, a better schedule of amortizations lowers country risk
and finance costs over the medium term, both for the government and
for the private sector. Likewise, borrowing domestically may turn
out to be more expensive than in external markets. Yet borrowing in
domestic markets could trigger a rapid development of these markets
and pave the way for a solid corporate domestic market in the
future. In sum, a good liability management strategy is one that
helps minimize the cost of borrowing over the medium and long term.
The objective is certainly not to save the last basis point in each
transaction, but rather to bring down the overall borrowing cost.
Thus, a smooth debt amortization profile is crucial. There is no
doubt that emerging economies have to work hard to ensure desirable
characteristics in the debt profile, even if initially costly. At
the end of 1994, Mexico faced a liquidity crisis accompanied by a
very high refinancing risk.
This forced the country to seek support from the international
community to confront the heavy short-term debt burden. Economic
policy was oriented towards rapidly re-establishing macroeconomic
stability. This was the only way to stop capital flight and
gradually restore Mexicos access to international financial
markets. To deal with the scenario just described, a comprehensive
package of policy measures was put together. The stabilization
programme was built upon restrictive fiscal and monetary policies
and was reinforced by the financial package (Exchange Stabilization
Fund) assembled by the US financial authorities and multilateral
organizations. The rescue package amounted to more than US$ 52
billion: $17.8 billion committed by the IMF, $20 billion by the
United States government, $10 billion by the Bank for International
Settlements, $3 billion by commercial banks and $1.5 billion by the
Bank of Canada. It is worth mentioning, however, that in 1995
Mexicos drawings amounted to only $24.9 billion. A solvent
government might still face liquidity problems that limit its
ability to service its debt. For instance, an overly pessimistic
view about the future of the economy might lead lenders to curtail
the amount of financing temporarily even if the country is in fact
solvent. Eventually, liquidity problems might escalate, negatively
affecting the governments access to international capital markets.
At this particular stage, the distinction between liquidity and
solvency problems for a country is.
At the same time; the private pension fund system has continued
to grow, making long-term resources more widely available. Today,
Mexicos foreign debt amortization schedule is light and well
distributed over time. The overall debt burden, including domestic
and external debt, diminished from levels above 450/0 of GDP in
1990 to approximately 280/0 in 1998. This trend is thought to have
continued in 1999.The countrys solvency and liquidity indicators
compare favorably to those of other countries: external debt as a
share of GDP amounted to 170/0 in early 1999, while the ratio of
total exports to external debt was 1.7. An example of Mexicos
strategy to ensure external financing when conditions in
international capital markets turn adverse is the credit line
secured with international financial institutions in November
1997.
After having a look at the global scenario of external debt lets
understand the debt management in India .External Debt Development
and Management
Some Reflections on IndiaIntroduction
In 1990-91 when India got into a severe foreign exchange crisis
her outstanding level of external debt was $ 83. 8 billion. The
level of debt was about 40 per cent of Gross Domestic Product and
the debt service payment was about 30 per cent of exports of goods
and services. Several destabilizing forces acting on the Indian
foreign exchange markets were a downgrade of Indias sovereign
credit ratings to non-investment grade, reversal of capital flows,
exacerbated the foreign exchange crisis and withdrawal of the
foreign currency deposits held by non-resident Indians. One can
best describe the severity of the situation by quoting from the
then Finance Minister of India Dr Manmohan Singhs Budget 1992-93
speech to the Parliament:
"When the new Government assumed office (June 1991) we inherited
an economy on the verge of collapse. Inflation was accelerating
rapidly. The balance of payments was in serious trouble. The
foreign exchange reserves were barely enough for two weeks of
imports. Foreign commercial banks had stopped lending to India.
Non-resident Indians were withdrawing their deposits. Shortages of
foreign exchange had forced a massive import squeeze, which had
halted the rapid industrial growth of earlier years and had
produced negative growth rates from May 1991 onwards".With this
background a study on Indias external debt would obviously raise
certain questions such as: how did India manage historically with a
very low volume of external capital inflows; how is that the third
world debt crisis of early 80s had a little impact; how is it then
that India got into a massive foreign exchange crisis in 1990-91;
how was India spared from the contagious currency crisis of 1997;
and how did India managed to improve her rank from what was third
debtor after Brazil and Mexico in 1991 to eighth in 2002 in the
list of the top fifteen debtor countries(as per the Global
Development Finance report 2004 published by the World Bank). Still
more notable is the fact that India never defaulted to
international lenders in her entire credit history (except one or
two instances of corporate rescheduling).
Although the level of debt has increased to $ 112.1 billion by
end-December 2003, the magnitude of debt is no longer an issue at
present. The economic reforms and debt management policies pursued
since 1991 have helped to bring down the share of external debt in
GDP to 20.2 per cent and the debt service ratio to 15.8 percent by
end-December 2003. The reforms involving trade and capital account
liberalization have changed the nature and composition of capital
flows into Indian economy. The gradual opening of the capital
account and improved credit standing internationally, supported by
the prudent macroeconomic policies, have established investors
confidence.
The above scenario although presupposes several accomplishments
underlying the countrys external debt management history, the
Indian economy nevertheless displayed several episodes of
imbalances in her debt, capital flows and external sector. Indias
external debt management in the light of the development in her
overall macroeconomic policies and draws lessons for countries in
the region. It needs to be mentioned here that the trends in debt
need to be reviewed along with the developments in external sector
and capital flows, because the overall trade regime, involving
trade restrictions, export subsidisation and exchange controls
would govern to a large extent the behaviour of external debt.
Burden of External Debt In India
It is a source of some comfort that India's external debt
continues to be at a stable level. According to the status paper
prepared by the Union Finance Ministry, the stock of foreign debt
stood at $98.4 billion at the end of December 2001. After a
substantial increase of $16 billion between 1991 and 1995, partly
on account of fresh loans and partly on account of exchange rate
movements, the total debt has fluctuated between $93 billion and
$99 billion since 1995. Going by a number of indicators, India's
external debt situation is far better today than it was during the
balance of payments (Bop) crisis of 1991.
While the absolute size of foreign debt is important, more
relevant is the weight this debt imposes on the economy. And, on
that count, the burden has become lighter and lighter, even as the
stock of outstanding has remained more or less constant. Annual
repayments of loans and interest as a percentage of current
receipts the debt service ratio, which was as high as 35 per cent
in 1990-91, has fallen to 13 per cent today. Debt as a percentage
of the gross domestic product has nearly halved since the early
1990s. And the short-term debt to GDP ratio, which crossed 10 per
cent in 1990-91 and precipitated the Bop crisis of that year, has
been held under 3 per cent. Overall, India is now classified by the
World Bank as a "less" indebted country, which is two rungs below
the extreme category of "severely" indebted countries, which is
where Brazil, Argentina and Indonesia now belong. In absolute terms
as well, India's position has improved globally. In the mid-1990s,
India was the third largest debtor in the world; today it is ranked
ninth. All this has taken place in spite of the fact that new loans
are increasingly being raised on commercial rather than
concessional terms, as was the practice for decades.
External Debt Management Policy
Indias Debt-GDP ratio which shows the magnitude of external debt
to domestic output had declined from 38.7 % at the end of March
1992 to 22.3% at end March 2001.Similarly the debt service ratio
that measures the ability to serve debt obligations has declined
from 35.3% of current receipts in 1990-91 to 16.3% in 2000-01.
This improvement in external debt should be attributed both to a
cautious policy on foreign borrowings (which includes annual caps
on commercial loans which would not have been possible if the rupee
was fully convertible) and to the steady growth in current receipts
in the Bop. There are, however, enough areas of concern, which
should prevent complacency and persuade the Government to go slow
on capital account convertibility. The first is that while the
short-term debt to GDP ratio was only 2.8 per cent at the end of
2001, the more accurate measure of immediate repayments total debt
of a residual maturity of one year was 9 per cent of GDP in
December 2001. This is still not a very heavy burden, but it is not
something to be taken lightly.
The second concern should be that the estimate of debt servicing
in the years ahead (based on past borrowings) shows that there are
going to be two major humps round the corner. In 2003-04 and
2005-06, repayments of the expensive Resurgent India Bonds and
India Millennium Deposits fall due. Debt service in both years will
then cross $12 billion. This will be the largest since 1995-96,
though the Government hopes that not all the repayments will be
repatriated. The third concern should be the impact of the
Government's decision to make even the existing non-repatriable
bank deposits by non-resident Indians fully payable in foreign
exchange. As a consequence, two such schemes were discontinued last
April and outstandings transferred to repatriable accounts where
they will be held till maturity. The stock of deposits in one of
these schemes was itself over $7 billion. This means that if these
deposits are taken out of the country when they mature they will
add to India's debt service burden. And if they are renewed they
will add substantially to India's external debt burden. Either way,
the Government's decision is going to have a negative impact on the
Bop.
Problems Of External Debt Management In India
Borrowing costs are not limited to interest costs. First, there
is the dependency syndrome, which leads to the development of
constituencies at the various levels of government to keep the
borrowing momentum in full swing, actively supported by the
multilateral development agencies. Second, there is an element of
uncertainty in regard to whether the loans will be available when
most needed, with the uncertainty increasing in the event of any
demonstration of national self-reliance in area unacceptable to the
stockholders of the lending agencies. Third, neither the civil
servants negotiating the loans nor their political bosses have a
direct responsibility for loan repayment, with the result that
there is bound to be a relatively high degree of laxity in ensuring
the best and most productive use of the borrowed funds. Fourth,
there is hardly any evidence to indicate that countries with heavy
indebtedness really can ever develop to such an extent that they
will be free from such indebtedness.
1997 Asian Crisis and Its Impact
The Southeast Asian crises had several common elements:
speculative attack on the currencies (with sharp depreciation); the
authorities being forced to defend the plummeting currency by
depleting large volumes of international reserves; banking crisis
compelling the governments to extend massive financial assistance
to banks through budgetary support to prevent a collapse.
Another distinguishing feature of the crisis was the effect of
contagion; crisis in one country spreading into several others in
the region. The contagion impact depended on the degree of
financial markets integration as well as the existing state of the
economy.
The speculative attacks were on those countries currencies that
were competing in the same world markets for goods and capital.
The Asian crisis had only a marginal impact on India, with
negligible impact on her foreign exchange markets, the level of
reserves and the banking system. It has been observed that the
macroeconomic fundamentals prevailing at the time coupled with the
flexible exchange rate management and control on short-term capital
flows helped India to withstand the currency crisis.
The crises demonstrated that the major objective of sound debt
management policy could be to achieve or maintain debt
sustainability, while meeting key economic macroeconomic goals.
At the time of currency crisis Indias balance of payments
situation had become sustainable due both to a reduction in the
current account deficit and to a substantial increase in net
capital inflows. The current account deficit had fallen from its
peak level of $ 9.8 billion in 1990- 91 to US $3.7 billion in
1997-98; the later was estimated at 1.5% of the GDP.
The 1997 level of current account deficit as per cent of GDP was
7.9% in Thailand, 4.9% in Korea and Malaysia, 3.3% in Indonesia and
4.7% in Philippines. Indias external debt at the end of 1997-98 was
$92.9 billion or 23.8 per cent of GDP. The debt-GDP ratio was very
high for the affected Southeast Asian countries: Thailand (56.8%),
Indonesia (67%), Philippines (54%) and Malaysia (49%).
Table 2: Selected Indicators of Indias External Sector (% growth
unless noted)
Item/Year
91-9292-9393-9494-9595-9696-9797-98
1. Growth of Exports -1.13.320.218.420.34.52.6
2. Growth of Imports -24.515.410.034.321.610.15.8
3. Exports/Imports 86.777.684.874.874.070.283.3
4. Reserves to Imports 5.34.98.68.46.06.67.0
5. Short-term debt/Reserves76.764.518.816.923.225.519.8
6. Debt service Ratio 30.227.525.626.224.321.418.3
7. Current account balance* -0.4-1.8-0.4-1.1-1.8-1.0-1.5
8. External Debt*
41.039.835.832.328.225.923.8
9. Debt service payments* 3.33.33.33.63.63.32.8
* As % of GDP Source: Economic Surve
The level of international reserves, which was just $ 5.5
billion in 1991-92, increased to $29.4 billion 1997-98, providing
about 7 months of imports cover. Nevertheless, exports continued to
finance over 80% of India imports, thus making the trade account
near self-sustaining. By the end of March 1998, the combined level
of portfolio flows and short-term debt constituted about 75 per
cent of the countrys foreign exchange reserves.
Indeed, the entire volatile inflows were said to have been added
to reserves that had given sufficient leeway for stabilizing
speculations in the foreign exchange markets.The net capital
inflows into India increased from $4.7 billion in 1991-92 to $9.5
billion in 1996-97, which came down marginally to $8.2 billion in
1997-98, because of the uncertain domestic and international
environment (mainly arising out of sanctions from the US). In the
aggregate, there was already a shift towards non-debt creating
flows, by way of foreign institutional investors (FII) into Indias
debt and equity markets, euro equity issues by Indian companies,
which had reached at $5.5 billion in 1997-98.
Debt flows (to cover aid, commercial borrowings, NRI deposits,
drawings from IMF) in contrast was actually coming down
significantly, reaching about $3.0 billion in 1997-98.
Short-term debt was repeatedly considered as an important risk
factor in the precipitation of foreign exchange crisis, especially
when coupled with high or unsustainable current account deficits.
The share of short-term debt in the total debt was just 6% in India
at the time of crisis, which compares with 41% in Thailand, 25% in
Indonesia, 28% in Malaysia and 19% in Philippines. By the end of
March 1998, the combined level of portfolio flows and short-term
debt constituted about 75 per cent of the countrys foreign exchange
reserves. Indeed, the entire volatile inflows was said to have been
added to reserves that had given sufficient leeway for stabilizing
speculations in the foreign exchange markets.
It needs to be recognized that the short term flows also have
provided the necessarily liquidity to an otherwise thin currency
market in India.
The Asian crisis had therefore important policy lessons, and
particularly in the context of external debt management and capital
flows. It is by now abundantly clear that the crisis was not just
because of the high current account deficit but much to do with the
way the current account deficit was financed, the nature of capital
flows (such as debt vs non-debt creating flows), and finally the
way external capital being used for (such as financing investment
as opposed to consumption or non tradable). The relative immunity
to the crisis had also much to do with the structure of capital
flows.
Although the Indian rupee was fully convertible on the current
account, convertibility on the capital account front was rather
asymmetric, with somewhat more restrictions on capital outflows
than on inflows. With controls on trade, foreign exchange
transactions and short-term capital flows, it was therefore
possible to insulate the Indian economy from external shocks.
Exchange rate was considered the most important variable
affecting the currency crisis. After a devaluation of about 22% in
July 1991 India shifted to a system flexible exchange rate
management based on partial convertibility in March 1992 and
finally to market determined exchange rate system in March 1993.
The market driven exchange rate also had obliged the policy makers
to have lower inflation, disciplined fiscal and monetary policies,
and stable real exchange rate for attaining sustainable balance of
payments.
Under the circumstances the Reserve Bank retained the necessary
flexibility in managing the currency, by quoting its own reference
rate and actively intervening at that rate from time to time. In
addition the market driven exchange rate also prevented excessive
risk-taking by agents that would have occurred a fixed or a pegged
exchange rate regime.In fact, the existence of exchange risks have
discouraged some of the more speculative short-term capital flows
in to India, thereby reducing the need for policy
interventions.
The conduct of exchange rate policy had also stabilizing impact
on the currency and capital flows pursued with appropriate
mechanisms of intervention and sterilization. Looking from the
experience, one noticed some kind of self-balancing mechanisms to
have worked in the Indian foreign exchange markets. At a time of
exchange market pressure, the policy seemed to have been not to
defend the currency fully by spending reserves and, thereby,
offering the speculators an easy target. In addition the market
driven exchange rate also prevented excessive risk-taking by agents
that would have occurred a fixed or a pegged exchange rate regime.
In fact, the existence of exchange risks have discouraged some of
the more speculative short-term capital flows into India, thereby
reducing the need for policy interventions.
Evolving Debt and Capital Flows Scenario Towards 2003
Indias external $ 112.1 billion stood at the end of December
2003, which increased from $ 83.8 billion in March 1991(Table 3).
The growth rate during the period was at an annual average rate of
2 per cent per annum. Some of the increase has been due to
valuation changes, resulting from the weakening of US dollar vis
-a- vis other currencies (for example, $ 5.7 billion out of $6.8
billion increase in external debt during 2002-03 was due to such
valuation changes).
In terms of the level of outstanding debt India ranked as eighth
in 2002 from among the top fifteen debtor countries in the world,
coming after Brazil, China, Russian Federation, Mexico, Argentina,
Indonesia and Turkey. This implied a marked improvement in her
debtor position since 1991 foreign exchange crisis, when her rank
was third from among the top fifteen debtor countries, i.e. coming
after the two most heavily indebted countries such as Brazil and
Mexico.
Table 3: India's External DebtEnd-March 1991(US $ mn.)Share in
total External DebtEnd-March 1996(US $ mn.)Share in total External
DebtEnd-March 2001(US $ mn.)Share in total External DebtEnd-Dec
2003(US $ mn.)Share in total External Debt
Multilateral2090025286163131898323055827
Bilateral1416817192132015323161794216
IMF26233237430000
Export Credit43015537665368547734
Commercial Borrowing1020912138731523227242058218
NRI Deposits*1020912110111217154172986727
Rupee Debt1284715823393042326352
Short-term Debt854410503452745357735
Total External debt838011009373010098757100112130100
Share of Concessional Debt to Total Debt44.842.336.036.4
Source: Indias External Debt: A Status Report, Government of
India, 2003.
An important aspect of Indias external debt has been its
concessionality. As of December 2003 about 36. 4 per cent of the
overall debt portfolio was characterized by concessional debt,
contracted mainly from multilateral and bilateral institutions. Due
to the concessional nature of indebtedness the present value
concept becomes the appropriate measure, obtained by discounting
the future debt service payments for individual loans by
appropriate discount rates and aggregating such present values.The
present values Indias external debt stood at $ 82.9 billion in the
year 2002 which is 80 per cent of the total outstanding debt.
According to Global development Finance, the present value of
external debt in the year 2002 was 17 per cent of GNP, lowest
within the top fifteen debtor countries except China (with 14 per
cent in 2002).
The effectiveness of debt management policy should be judged in
terms of the debt serving capacity, which can be gauged by
indicators measuring solvency as well as liquidity. In Table 4 we
analyze the most commonly used indicators debt sustainability: debt
service ratio, interest service ratio, debt to gross domestic
product ratio, short-term debt to total debt and short term debt to
foreign exchange reserves. As seen from Table there is remarkable
improvement in all the ratios during 1990-2003. The stock of
external debt to GDP ratio declined from its peak of 38.7 per cent
in 1991-91 to 20 percent in 2002-03. The debt service ratio which
reached a record level of over 35 per cent in 1990-91, declined
steadily to 14.7 per cent in 2002-03.
The most notable outcome of external debt management during
1990s has been the control over short-term debt. The level of
short-term debt amounted to only US $5.0 billion by December 2003.
The share of short term debt to total debt declined significantly
from over 10 per cent in 1990-91 to 4.4 per cent in 2002-03, which
actually was the lowest for India from among the top 15 debtor
countries.
The volume of short-term debt, which was 146 per cent of foreign
exchange reserves in 1990-91, declined to just 6 per cent in
2002-03. By taking into account the residual/remaining maturity
within the component of short-term debt, it still remains modest at
$ 12. 7 billion or 11.7 per cent of total external debt by
end-December 2003(Table 5).
Special Purpose External Commercial Borrowing
The Indian Government had obtained external borrowing using
special provisions three times since 1991: India Development Bonds
(IDBs), 1991; Resurgent India Bonds (RIBs), 1998; and, India
Millennium Deposits (IMDs), 2000. These borrowings were used only
to meet the unfavorable external circumstances, and served as
alternative to sovereign borrowings. The maturity of these
issuances were about five years, mostly subscribed by non-resident
Indians, with redemption only at maturity and offering reasonable
spread over comparable government bond yields. These instruments
were considered as substitutes for foreign currency deposits, which
extended the duration of the countrys debt profile.
Table 11: Special Borrowings by India since 1991
Type of BorrowingsAmount(US $ Million)Interest Rate (%)5-Year
Government Bond YieldSpread
(Col 3-4)
India Millennium Deposits, 20005,520
Mobilization in US Dollar5,1828.505.572.93
Mobilization in Pound Sterling2587.854.633.22
Mobilization in Euro806.85
Resurgent India Bonds, 19984,230
Mobilization in US Dollar3,9877.755.262.49
Mobilization in Pound Sterling1808.005.452.55
Mobilization in Euro636.25
India Development Bonds, 19911,627
Mobilization in US Dollar1,3079.507.861.64
Mobilization in Pound Sterling32013.259.923.33
Source: Indias External Debt: A Status Report, Government of
India, October 2001.
Foreign Currency Deposits
Many countries allow foreign currency deposits from expatriates
as a source for balance of payments financing. Such schemes were
introduced in India in 1970 allowing non-Resident Indians/Overseas
Corporate Bodies to place deposits denominated in foreign currency
as well as local currency with the Indian banks, with interest rate
fixed and exchange rate guaranteed by the Reserve Bank of India.
The two oil shocks of 1970s brought substantial amount of US dollar
deposits from the gulf countries. By the end of March 1990, the
total NRI deposits were to the extent of $ 12 billion. However
these short-term deposits have proved to be very volatile,
responding to macroeconomic instability as well as political risks.
The external payments difficulties of 1990-91 demonstrated the
vulnerability associated with these deposits.
Considering the huge fiscal costs of exchange guarantee and
higher interest rates offered on such deposits as compared to
international rates, the policy later years withdrew the exchange
rate guarantee and reduced considerably the interest rate spread. A
scheme called Non-resident Non-repatriable Rupee Deposit (NRNRRD)
was also introduced in order to avoid the reversibility character
of the deposits, but was later withdrawn in April 2002.
12: Outstanding Balances NRI Deposit Schemes (US $ million)
End-MarchNR(E)RAFCNR(A)*FCNR(B)NR(NR)RD**FC(O)NTotal
19754040
19808561881,044
19852,3047703,074
19903,7778,63812,415
19954,5567,0513,0632,4861017,166
19963,9164,2555,7203,5421317,446
19974,9832,3067,4965,604420,393
19985,63718,4676,262220,369
19996,0457,8356,61820,498
20006,7588,1726,75421,684
20017,1479,0766,84923,072
20028,4499,6737,05225,174
200314,92310,1993,40728,529
*:Withdrawn effective August 1994.
**:Withdrawn effective April 2002.
Source: Reserve Bank of India.
Let us view the financial highlights of the fiscal 2005-06 in
form of charts and tables in the next chapter. Indias External Debt
as at the end of March 2006
CURRENT SCENARIO
Indias total external debt is placed at US $ 125.2 billion at
the end of March 2006. At this level, the external debt stock
increased by about US $ 2 billion over the end-March 2005 level
(Chart 1).
The valuation effect, on account of appreciation of the US
dollar against other major international currencies, has had a
moderating impact on the stock of external debt.
Among the various components of debt, NRI deposit, trade credit
and multilateral debt have risen during the year (Table 2).
External commercial borrowings (ECBs), bilateral and rupee debt
declined during the year. External commercial borrowings recorded
net outflows due to one-off effect of principal repayment of India
Millennium Deposits (IMDs) (US $ 5.5 billion) (Table 2) (Chart 2).
Table 2: Variation in External Debt by Components
Item At the end-of Variation during 2005-06 March 06 March 05
Amount Amount Absolute variation Percentage variation (US $
million) (US $ million) (US $ million) (Per cent) (1)
(2)
(3)
(4)
(5)
1. Multilateral 32,558(26.0)
31,702(25.7)
856
2.7
2. Bilateral 15,784(12.6)
16,930(13.7)
-1,146
-6.8
3. IMF 0(0.0)
0(0.0)
0
0.0
4. Trade Credit
a. Above 1 year 5,326(4.3)
4,980(4.1)
346
6.9
b. Upto 1 year* 8,788(7.0)
7,524(6.1)
1,264
16.8
5. Commercial Borrowings 25,560(20.4)
27,024(21.9)
-1,464
-5.4
6. NRI Deposits (long-term) 35,134(28.1)
32,743(26.6)
2,391
7.3
7. Rupee Debt 2,031(1.6)
2,301(1.9)
-270
-11.7
8.Total Debt 1,25,181(100.0)
1,23,204(100.0)
1,977
1.6
Memo Items A. Long-Term Debt 1,16,393(93.0)
1,15,680(93.9)
713
0.6
B. Short-Term Debt 8,788(7.0)
7,524(6.1)
1,264
16.8
The US dollar was the most important currency in the currency
composition of Indias external debt at end-March 2006, accounting
for 45.1 per cent of total external debt stock (Chart 3).
Indicators of Debt Sustainability
There has been a perceptible improvement in external debt
indicators over the years reflecting the growing sustainability of
external debt of India.
External debt to GDP has dropped to 15.8 per cent at end-March
2006 from 17.3 per cent at end-March 2005 and 30.8 per cent at
end-March 1995.
The debt service ratio has risen to 10.2 per cent during 2005-06
from 6.1 per cent during 2004-05 largely due to IMD repayments. It
may be indicated that debt service ratio was 17.1 per cent in
1999-2000.
Reflecting the rise in short term debt during 2005-06, the ratio
of short-term to total debt and short term debt to reserves rose to
7.0 per cent and 5.8 per cent, respectively (Table 3).Table 3:
Indicators of Debt Sustainability (in per cent)Indicators
End-March 06
End-March 05
(1)
(2)
(3)
Total debt /GDP
15.8
17.3
Short-term/Total debt
7.0
6.1
Short-term debt/Reserves
5.8
5.3
Concessional debt/Total debt
31.5
33.3
Reserves/ Total debt
121.1
114.9
Debt Service Ratio*
10.2
6.1
* relates to fiscal year 2005-06 and 2004-05
The share of concessional debt in total external debt declined
to 31.5 per cent at end-March 2006 from 33.3 per cent at end-March
2005 (Table 3). It may be recalled that this ratio was around 45.9
per cent at end-March 1991. This development indicates a gradual
increase in non-concessional private debt in India's external debt
stock. At this level, however, concessional debt continues to be a
significant proportion of the total external debt, especially by
international comparison.
Indias foreign exchange reserves exceeded the external debt by
US $ 26.4 billion providing a cover of 121.1 per cent to the
external debt stock at the end of March 2006 (Chart 4).
CONCLUSIONManagement of external debt is closely related to
themanagement of domestic debt, which in turn depends on the
management of overall fiscal deficit. Debtmanagement strategy
isanintegralpartofthe wider macroeconomicpolicies that act as the
first line of defense against any external financial shocks. For an
emerging economy, it is better to adopt a policy of cautious and
gradual movement towards capital accountconvertibility. At the
initial stage, it may be prudent to encourage non-debt creating
financialflows (Foreign Direct Investment and Equity Portfolio)
followed by liberalizationof long-term and medium-term external
debt. Big bullet loans are bad for small economies, as these can
create refinancing riskthat many countries would be well advisedto
avoid. It is not enough to manage the government balance sheet
well; it is also necessary to monitor and make an integrated
assessment of national balance sheet and to put more attentionon
surveillance ofoveralldebt- internaland external, private
andpublic.Ineachofthemajor Asiancrisis economies-Indonesia,Koreaand
Thailand- weakness in the government balance sheet was not the
source ofvulnerability, rather vulnerability stemmed from the
un-hedged sort-term foreign currency debt of banks, finance
companies and corporate sector. It is not sufficient to manage the
balance sheet exposures, it is equally important manage off balance
sheet and contingent liabilities. Emerging as well as
advancedeconomieshaveexperiencedhowbadbankscanleadtolargecoststotheeconomyandanunexpectedweakeningofthegovernmentsbalancesheet.Government
guarantees of private debt canalso have similar adverse impact. It
is necessary to adopt suitable policies for enhancing exports and
other current account receipts that provide the meansfor financing
imports and debt services
EMBED Excel.Chart.8 \s
EMBED Excel.Chart.8 \s
_1250856308.xlsChart2
28.7
38.7
37.5
33.8
30.8
27
24.5
24.3
23.6
22.1
22.6
21.1
20.2
Percent
External Debt - GDP Ratio*
Chart1
0.051
0.273
0.16
0.043
0.184
0.266
0.023
Composition of External Debt as at End Dec 2003 (Share in %)
Sheet1
Composition of External Debt as at End Dec 2003 (Share in
Percent)
Short term Debt5.1%
Multilateral27.3%
Bilateral16.0%
Export Credit4.3%
Commercial Debt18.4%
NRI Deposit26.6%
Rupee Debt2.3%
Sheet2
External Debt - GDP Ratio
Mar-9128.7
Mar-9238.7
Mar-9337.5
Mar-9433.8
Mar-9530.8
Mar-9627
Mar-9724.5
Mar-9824.3
Mar-9923.6
Mar-0022.1
Mar-0122.6
Mar-0221.1
Mar-0320.2
Chart3
83.82.2
85.35.6
906.4
92.715.1
9920.8
93.717
93.522.4
93.526
96.929.5
98.335.1
101.139.6
98.851
105.367
104.971.9
112.197.6
Total External Debt
Foreign Currency Assets
US $ Billion
Total External Debt and Foreign Currency Assets
Sheet3
Total External Debt and Foreign Currency Assets (US $
Billion)
Total External DebtForeign Currency Assets
End Mar-9183.82.2
End Mar-9285.35.6
End Mar-93906.4
End Mar-9492.715.1
End Mar-959920.8
End Mar 9693.717
End Mar 9793.522.4
End Mar 9893.526
End Mar 9996.929.5
End Mar 0098.335.1
End Mar 01101.139.6
End Mar 0298.851
End Dec 02105.367
End Mar 03104.971.9
End Dec 03112.197.6
Chart4
4.4
7
9
9.4
10.3
11.1
11.2
11.2
11.5
12.8
16.2
17.2
17.6
20.1
28.5
Countries
Percent
International Comparison-Proportion of Short Term Debt to Total
External Debt, 2002
Sheet4
International Comparison - Proportion of Short term Debt to
Total External Debt
India4.4
Mexico7.0
Chile9.0
Phillipines9.4
Brazil10.3
Russian Fed11.1
Columbia11.2
Argentina11.2
Turkey11.5
Poland12.8
Hungary16.2
Malaysia17.2
Indonesia17.6
Thailand20.1
China28.5
Chart5
141.4
72.8
51.8
54.6
53.6
35
34.4
33.8
30.6
29.8
24.5
24.2
19.5
16.1
6.4
Countries
Percent
International Comparison-Proportion of Short Term External Debt
to Total Foreign Exchange Reserves, 2002
Sheet5
International Comparison-Proportion of Short Term External Debt
to Total Foreign Exchange Reserves, 2002
Argentina141.4
Indonesia72.8
Brazil51.8
Hungary54.6
Turkey53.6
Columbia35
Philipines34.4
Russian Fed33.8
Thailand30.6
Poland29.8
Chile24.5
Malaysia24.2
Mexico19.5
China16.1
India6.4
Chart6
0.3
0.4
0.7
0.9
0.9
1.4
2.7
3.5
6.6
9.5
16.6
17.8
21.1
24
38.4
Percent
Countries
International Comparison-Proportion of Concessional Debt to
Total External Debt 2002
Sheet6
International Comparison-Proportion of Concessional Debt to
Total External Debt 2002
Hungary0.3
Russian Fed.0.4
Chile0.7
Argentina0.9
Mexico0.9
Brazil1.4
Columbia2.7
Turkey3.5
Malaysia6.6
Poland9.5
Thailand16.6
China17.8
Philipines21.1
Indonesia24
India38.4
Chart7
0.416
0.156
0.214
0.113
0.064
0.031
0.006
Currency Composition of External Debt as at End-December
2003
Sheet7
Currency Composition of External Debt as at End-December
2003
U S Dollar41.6%
SDR15.6%
Indian Rupee21.4%
Japanese Yen11.3%
Euro6.4%
Pound Sterling3.1%
Others0.6%
Chart8
7.3
8.2
11.3
14.9
18.3
20.2
22.5
23.1
23.2
25
32.8
33.9
40.2
40.8
68.9
Countries
Percentage
International Comparison of Debt Service Ratio, 2002
Sheet8
International Comparison of Debt Service Ratio, 2002
Malaysia7.3
China8.2
Russian Fed.11.3
India14.9
Argentina18.3
Philipines20.2
Poland22.5
Thailand23.1
Mexico23.2
Indonesia25
Chile32.8
Hungary33.9
Columbia40.2
Turkey40.8
Brazil68.9
Chart9
10.57
10.73
8.17
7.27
7.17
6.98
6.32
7.02
6.46
6.53
6.85
US $ Billion
Government Guaranteed External Debt
Sheet9
Government Guaranteed External Debt
End Mar 9410.57
End Mar 9510.73
End Mar 978.17
End Mar 987.27
End Mar 997.17
End Mar 006.98
End Mar 016.32
End Mar 027.02
End Mar 036.46
Dec 31, 026.53
Dec 31, 036.85
_1250858299.xlsChart1
100100
9288.5
85.581.8
82.176.9
77.672.1
74.568.3
64.5555.08
60.5347.2
57.8643.3
61.8242.88
60.7839.78
59.4537.72
63.4539.05
63.4436.34
63.2935.46
66.5335.52
68.4335.75
72.8237.05
REER
NEER
Figure 4 : NEER & REER of the rupee
Sheet1
1986100100
19879288.5
198885.581.8
198982.176.9
199077.672.1
199174.568.3
199264.5555.08
199360.5347.2
199457.8643.3
199561.8242.88
199660.7839.78
199759.4537.72
199863.4539.05
199963.4436.34
200063.2935.46
200166.5335.52
200268.4335.75
200372.8237.05