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TYBMS External Debt Management

Introduction to External Debt ManagementIntroduction to External Debt Management

EXTERNAL DEBT (or foreign debt) is that part of the total debt in a country that isowed 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 andActual 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.

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IMPORTANT ASPECTS RELATED TO EXTERNALDEBT MANAGEMENT

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 anindividual 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.

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HOWMUCHTO 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.

MANAGINGRISK

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.

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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.

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EXTERNAL DEBTAND 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.

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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. Heavilyindebted, 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.

After this lets have a look at external debt sustainability in detail in Chapter 2.

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External Debt SustainabilityExternal 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.

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INDICATORSOF 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

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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 economiccrisis.

Debt Management Strategy - A Global OverviewDebt Management Strategy - A Global Overview

The 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 foreigncapital 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

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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 1987

88 to $36 billion in 1993. The 1994 crisis caused an important reduction of these

flows, to $23 billion in 1995. For 199697 capital inflows were on average $10 billion

per year.. 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. 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

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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 6September 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

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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 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,

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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 ManagementExternal Debt Development and Management

SOME REFLECTIONSON INDIA

INTRODUCTION

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".

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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 littleimpact; 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 thirddebtor 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.

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BURDENOF 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

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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.

CAUSES FOR INCREASE IN EXTERNAL DEBT

The important causes for the sharp increase in Indias external debt were the

following:

Increase in Trade Deficit

The enormous increase in trade deficit has been a very important reason for the sharp

increase in Indias external debt. the poor export performance of India has also been

responsible for the large trade deficit. The impact of oil price hike has already been

pointed out earlier.

Decline in the Net Invisibles

During the 1980s, there was a gradual decline in invisibles surplus. Invisibles

surpluses had traditionally financed a large part of Indias deficit. There was a steep

fall in this since the beginning of the eighties. Net invisibles financed nearly 73% of

the trade deficit in 1980-81. During the sixth plan (1980-85), on an average it

financed more than 60% of the trade deficit. By 1990-91 it dropped to 13%,

compelling the nation to take increasing recourse to external source for meeting the

payment obligation. This falling trend in the net invisibles had been caused by the

adverse trends in invisible payments on the one hand and invisibles receipts on the

other.

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Change in the Composition of the Debt

One important source of the BOP problem in the 1980s and afterwards is the change

in the source of financing the large current account deficit. In the earlier period, i.e.

until the beginning of the 1980s, almost the entire deficit was financed through

inflows of concessional assistance, which kept the debt-service burden low. As

against this, the eighties were marked by a reduction in flows of concessional

assistance to India, particularly from the World Bank Group. The credits from the

IDA on soft terms declined, while loans from the World Bank on market terms

increased sharply. As a result, the average interest rate on Indias official debt

increased from 2.4% in 1980 to 6.1% in 1982. The debt service payments on

multilateral loans tripled from $371 million in 1984 to $1106 million in 1989. Further,

the average maturity of loans declined from 40.8 years in 1980 to 24.4 years in 1989.

Between 1980 and 1989, the debt to private creditors, including commercial banks

and non-residents increased almost ten-fold, from $2.3 billion to $22.8 billion. The

debt service as a percentage of export earnings nearly tripled during this period, from

9.1% to 26.3%.

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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.

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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 IndiaProblems 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 forloan 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.

EXTERNAL DEBT DEVELOPMENT UNTIL 1970S

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Looking at historically one observes that external capital played a very insignificant

role in Indias development process. The industrialisation strategy adopted since the

1950s emulated an import substituting trade regime, with both imports and exports

being strictly regulated through quota and duties. The level of current account deficit

was as low as 1.2 per cent in 1970, matching the availability of external finance, most

of which were contracted from the official creditors and at concessional interest rates.

Private commercial borrowings from the international capital markets were nil. The

total external debt outstanding at $ 8.4 billion was just about 13.3 per cent of GDP for

the year 1970.

India responded very well to the first oil shock of 1973, with prudent macroeconomic

management. The deflationary stance of macroeconomic policies coupled with

massive inflows of inward remittances from Gulf led to even a surplus on current

account in 1976-77, which helped to build up the reserve level.

Imports were virtually restricted to the level of exports, and thus the entire inflows of

worker's remittances and net aid inflows (after adjusting the gross flows for debt

service) were ploughed back to build up the reserves.

It was no surprise, therefore, to find that during this period gross aid inflows were

sharply reduced by the donors, as these were only going to swell further the reserves.

By 1978-79, the reserve level reached about 9 months of import requirements. There

was strong opinion in some quarters as to whether India could take advantage of this

comfortable foreign exchange situation to relax the severity of the import control

regime. To some extent imports were liberalised in 1976-77 and 1977-78 through the

introduction of Open General License (OGL), but the persistence of almost total

protection of the Indian industrial sector prevented any significant loosening of

import.

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The second oil shock had a major impact on Indias balance of payments, however,

with the prices of POL more than doubling during the course of 1979. The oil imports

accounted for almost 58 percent of total imports and 46 percent in terms of export

earnings. The primary focus of balance of payment management after the second

shock was to finance the deficit, rather to control it through deflationary stance of the

first oil shock-type.

DEVELOPMENTSIN EXTERNAL SECTOR DURING 1980S

India remained unaffected by the debt crisis of early eighties facing many developing

countries, due to her insignificant level of private debt. The foreign exchange

constraints in the aftermath of second oil shock could be relieved by drawing

substantial amount of loans from the International Monetary Fund: SDR 266 million

under Compensatory Financing Facility (CFF) in 1980, SDR 529.01 million under

Trust Fund Loan (TFL) in 1980-81 and SDR 5 billion under Extended Fund Facility

(EFF) during 1981-84 (of which India used only SDR 3.9 billion). The foreign

exchange situation also improved dramatically due to the inflow of remittances from

the Gulf.

A substantial amount of import savings could be made due to large-scale import

substitution in the areas of food, petroleum (after the discovery of Bombay High) and

fertilizer. Thus, an improved foreign exchange scenario, which along with the

available multilateral concessional assistance helped India to retain her credit-

worthiness and avoid a possible liquidity crisis of the Latin American type in early

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1980s. In fact taking the advantage of the improved foreign exchange scenario Indian

policy makers attempted to relax the severity of the controlled trade regime in the 80s.

The liberalization of the import control regime, particularly the category of Open

General License (OGL) and export-related licenses, opened up a variety of importsthat were required by a wider range of emerging consumer goods industries. Export

growth remained sluggish during the eighties, due to the slowdown in the growth of

world trade, decline in primary commodity prices in the global market, and the

expansionary policy at home, as the later might have reduced the exportable surplus to

some extent. Indeed the trade deficits went up from $ 5.9 billion in 1984-85 to $ 7.9

billion in 1990-91 (with $ 9.1 billion in 1988-89) and the current account deficits from

$ 2.4 billion to $ 8.9 billion during the same period (based on RBI data).

With the near stability in the inflows of concessional assistance, financing of deficits

were made by raising commercial loans from the Eurocurrency markets in the form of

syndicated loans and Eurobonds as well as accepting short term foreign currency

deposits from the non-resident Indians.

Table 1: Indicators of Current Account Sustainability for India (Per cent)

Indicator 1971

-

1975

197

6-

198

0

198

1-

198

5

198

6-

199

0

199

1-

199

5

199

6-

200

0

200

1-

200

3

Trade Deficit/ GDP -0.9 -1.4 -2.5 -2.1 -1.2 -2.5 -2.2

Current Account

Deficit/GDP

-0.4 0.2 -1.5 -2.2 -1.3 -1.3 0.2

Gross Fiscal

Deficit/GDP

-3.3 -5.0 -6.8 -8.1 -5.7 -5.1 -5.9

Private Sector: SI

Gap

2.7 4.7 3.8 4.8 7.3 6.6 9.9

External Debt/GDP 15.3* 12.8* 13.2* 15.8* 33.9 24.3 21.2

Short-term

Debt/Total Debt

.. .. .. 10.0 6.7 5.3 3.6

Non-Debt Capital

Flows/Total Capital

Flows

.. .. .. 6.0 27.1 49.3 94.8

Debt Servicing .. .. .. 30.2 28.9 19.7 15.3

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Changes in REER .. -2.1 0.8 -4.9 -2.9 -0.8 4.8

Import Cover

(Months)

4.3 7.4 4.2 3.3 5.9 7.2 11.2

* Comprising of external assistance, commercial borrowings and IMF loans only. Thus, the external

debt-GDP ratio for these periods is not comparable with the subsequent period.

SI Gap: Saving Investment Gap

Source: Reserve Bank of India.

The imbalances in the external sector coincided with the macroeconomic imbalances

in the economy, particularly in the form of increasing domestic money supply and

budget deficits (see Table 1). The expansionary monetary and fiscal policies did not

take into account the likely repercussion in the form of spill over effects on balance of

payments. In fact, the generation of the excess liquidity that accompanied the

liberalised import structure swelled the level of current account deficit.

The principal mode of balance of payment adjustments in India during the second half

of the eighties was the managed depreciation of the rupee. Between 1985-90, the

NEER of the rupee depreciated by almost 50 per cent and the REER by 30 per cent.

It is clear that in a situation where the balance of payment problem was basically due

to the macroeconomic imbalances, which arose primarily from the expansionary

macroeconomic policies and the liberalised import structure, the expenditure

switching effects of devaluation did not work.

The debt management policies in 1970s and 1980s was not helping India develop

and there arised a need to make changes in the policies.

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DEBT POSITION DURING 1990s

Indias external debt at end-September 1999 stood at US $98.87 billion as against US

$97.68 billion at end-March 1999. Despite the increase in debt stock, there has been

considerable improvement in major debt indicators, which reflects an over all

improvement in the external debt scenario of the country. In this regard, it is

noteworthy that the Debt-GDP ratio improved from 41.0 per cent in 1991-92 to 23.5

per cent in 1998-99 (Table 6.12). The debt service payments as ratio of current

receipts continued to improve steadily from 30.2 per cent in 1991-92 to 18 per cent in

1998-99. Short-term debt (i.e., debt with an original maturity of up to one-year)declined from US $ 8.54 billion at end-March 1991 to US $ 4.61 billion at end

September 1999. The share of short term to total debt fell from 10.2 per cent at end

March 1991 to 4.7 per cent at end- September 1999 (Figure 6.5).

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Simultaneously, the ratio of short term debt to foreign currency assets has continued

to improve from the high of 382.1 per cent at the end March 1991 to 15.1 per cent at

end September 1999. (Table 6.12). The share of concessional debt to total external

debt was 38.7 per cent at the end September 1999 as against around 45 per cent during

first half of the decade. The share has been declining gradually since the mid-nineties

showing signs of structural change in the composition of external debt.

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India has been among the top ten developing country debtors. However, its

comparative indebtedness position has improved over the years. India ranked as the

third largest debtor country after Brazil and Mexico in 1991 while in 1997 it ranked

eighth after Brazil, Mexico, China, Korea, Indonesia, the Russian Federation and

Argentina.Table 6.13 gives comparative indebtedness position for the top 15 debtor

countries. India has the most favorable short term to total debt ratio. Since India has a

high proportion of concessional debt, its Present Value (PV) of debt is low, and it

ranks tenth on this count (as against eighth position in terms of total indebtedness).

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External debt management continues as an area of high priority. To consolidate the

gains already made, the focus of external debt management policy would be continuedstress on high growth rate of exports, keeping the maturity structure as well as the

total amount of commercial debt under manageable limits and encouraging non-debt

creating flows of foreign investment

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CCRISISRISISANDAND RREFORMEFORMININ THETHE 19901990SS

The foreign exchange crisis opened up several internal conflicts of an inward looking

economy. The policy makers considered the unsustainable balance of payment

situation as the symptom and the disease was inherent in the trade and industrial

policy that protected the Indian economy from both internal and external competition.

The shrinking share of India's exports in the global trade was considered as the

reflection of the receding exports competitiveness and the absence of a right kind of

commodity mix in India's export basket. The inefficiency of the trade regime had

much to do with the prohibitive tariffs and a pervasive system of import controls.

The entire regime of discretionary management of foreign exchange had constrained

growth, proliferated black markets in foreign exchange and created avenues for

considerable rent-seeking activities.

Indias approach to the 1990-91 crises was not to default on her external obligations,

rather to pursue macroeconomic reforms, and remain current on debt servicing by

borrowing from multilateral sources. As part of the overall macroeconomic reforms,

sweeping changes were introduced in the areas of trade and exchange rate policies.

The Congress led government, which assumed office at the Centre in June 1991,

accepted the medium term structural adjustment programme of the IMF. An

immediate fall out of this programme was the sharp devaluation of the rupee. In July

1991 the rupee was devalued at two stages, from 1 Rs.34.36 to Rs.41.59.

This was followed by a plethora of trade policy reform measures, beginning August

1991, by slashing cash subsidies for the export sector and relieving the economy from

the QR and tariff regimes adopted since fifties.

Indias reform efforts since 1990s had led to a resumption of growth, decline in

inflation, improved fiscal deficit, and a sustainable balance of payments. As we shall

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see later this had remarkably reduced the external debt burden and brought several

beneficial changes in the composition of capital flows in years to come.

DEVELOPMENTSTO 1991 FOREIGN EXCHANGE CRISIS

By 1990, there was a marked deterioration in India's balance of payments. Although

there was satisfactory growth in exports, it was overshadowed by growth in imports,

stagnant flows in invisibles such as tourism and private transfers, and mounting debt

service burden. The current account deficits which were sustained mainly by

borrowing from commercial sources and NRI deposits, with short maturities and

variable interest rates, resulted in a ballooning of repayment burden towards 1990.

The size of external debt reached $ 83 billion in March 1991, 45 percent of which was

contracted from private creditors and at variable interest rates.

The debt service payments had reached 30 percent of export earnings by March 1991,

which was close to some of the heavily indebted countries such as Indonesia (31 per

cent), Mexico (28 per cent), and Turkey (28 per cent).

Interest components alone were about $ 4 billion, comprising some 50 per cent of the

total current account deficits and 21 per cent of the total merchandise exports. The

growth of exports in US dollar terms was not sufficient even to pay for the interests

for each of the three years to 1990-91 and India had to make for amortization

payments by resorting to fresh borrowing.

The foreign exchange crisis was exacerbated by the Gulf war that began in August

1990, causing shortfall in exports to West Asia, loss of remittances from Kuwait and

Iraq, huge foreign exchange costs of emergency repatriation from the region and,

most importantly, additional cost of oil imports due to the oil price increase.

The Gulf crisis coincided with recessionary trends in the West that had depressed the

demand for Indias exports.

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Furthermore, the economic decline in Eastern Europe led to a contraction of exports

to these markets.

The uncertain political climate at home along with the precarious balance of paymentssituation led to the erosion of India's credit ratings abroad. The Moody's downgraded

India's status to BB in 1990, which was the highest speculative grade for long-term

debt.

There were indications that the net resource transfer on account of official and private

credit had become negative in 1990-91 i.e. the fresh inflows were not even adequate

to meet the obligations on account of amortization and interest payments. The levelof foreign exchange reserves fell to just $ 1 billion in 1990-91. This desperate

situation led the Reserve Bank of India to sell 20 tonnes of gold in May 1991 and

pledge another 46.91 tonnes in July 1991, for meeting the urgent foreign exchange

needs and financing current account deficits. An imminent foreign exchange crisis

loomed large before the Indian economy, with unsustainable external debt burden.

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RESPONSETO 1991 CRISISANDITSEFFECTS

Ten years ago India was in the midst of a full-blown balance of payments crisis. We

have come a long way since those dark days of collapsing confidence, thanks mainly

to sound economic policy and partly to good luck. Its a story of successful economic

reform.

To begin with, its worth recalling just how bad our external economic position hadhad become in 1991. By March the current account deficit in the BoP had cumulated

to a record level of nearly 10 billion dollars or over 3 per cent of GDP. Exports were

falling. The foreign borrowing spree had taken the ratio of short-term external debt to

foreign currency reserves to an astronomical 380 per cent. Foreign currency reserves

skated close to a pitiful billion dollars throughout the spring and summer of the year.

NRI deposits were bleeding away. Access to commercial external credit was

becoming extremely costly and difficult. Even the normally sober government

Economic Survey for the year admitted A default on payments, for the first time in

out history had become a serious possibility in June 1991.

Faced with this prospect, the new Government (with Manmohan Singh as finance

minister) undertook emergency measures to restore external and domestic confidence

in the economy and its management. The rupee was devalued, the fiscal deficit was

cut and special balance of payments financing mobilized from the IMF and World

Bank. The government also launched an array of long overdue and wide-rangingeconomic reforms. Aside from various measures of domestic liberalization, the

strategy for restoring external sector health embraced six key planks.

First, and most importantly, the exchange rate was made market-dominated after a

two year transition. It improved greatly the incentives to exporters and to NRIs

remitting funds to India through official channels. Correspondingly the rupee cost of

importing became higher. Most important, the price of foreign exchange stopped

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good recovery in 2000/01. Foreign investment has actually fallen since the peak of

1996/97 and totaled only $3.4 billion in 2000/01. External debt indicators have

continued to improve but not decisively.

Remittance inflows have plateaued after 1996/97.True, the current account deficit has

remained low but this mainly reflects the stagnation of non-oil imports because of a

sluggish industrial economy. Only software exports have bucked the lackluster trend

of recent years. Whats amiss and what should we do?

First, we should draw the right lessons from our earlier success. The most important

and most encouraging lesson is that when we pursue good economic policies we

quickly get the rewards in the form of strong economic performance. Second, the

strength our external sector depends crucially on the productivity and competitiveness

of our producers in agriculture, industry and services. Rigid labour laws and

reservation of products of small scale industry handicap our competitiveness. The

sooner the budget speech promises on these are implemented, the better. Our

infrastructure sectors of power, roads, ports and railways are notoriously inefficient

compared to our international competitors. The sooner we reform them, the more

competitive our producers will become. Our customs tariffs are usually high and have

changed a little after the sizable reductions between 1991 and 1997. protection

reduces efficiency and productivity. Here too, budget speech intentions await

fulfillment. Third, foreign direct investments (FDI) could play a big role in boosting

output, exports and employment, as it has in China which is host to almost 20 times

the amount of FDI each year than we are. The same factors of poor infrastructure,

rigid labour laws, high government borrowings and weak export orientation that deter

domestic investment also inhibit FDI.

Over the past year the world economy has slowed and India (like everyone else) faces

a tougher external economic environment. The disastrously wrong response to this

would be to turn more inward. Our painfully slow economic progress in the three

decades up to 1980 provides ample testimony to bankruptcy of inward-looking

development strategies. The correct response is to improve productivity and complete

harder. That means implementing the policy priorities, noted above, with even greater

vigour and consistency. Only good economic policies will yield more growth, less

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poverty and a stronger external sector. We have seen that before and we must ensure

it in our future.

1997 A1997 ASIANSIAN CCRISISRISISANDAND IITSTS IIMPACTMPACT

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.

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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 91-92 92-93 93-94 94-95 95-96 96-97 97-98

1. Growth of Exports -1.1 3.3 20.2 18.4 20.3 4.5 2.6

2. Growth of Imports -24.5 15.4 10.0 34.3 21.6 10.1 5.8

3. Exports/Imports 86.7 77.6 84.8 74.8 74.0 70.2 83.3

4. Reserves to Imports 5.3 4.9 8.6 8.4 6.0 6.6 7.0

5. Short-term debt/Reserves 76.7 64.5 18.8 16.9 23.2 25.5 19.8

6. Debt service Ratio 30.2 27.5 25.6 26.2 24.3 21.4 18.3

7. Current account balance* -0.4 -1.8 -0.4 -1.1 -1.8 -1.0 -1.5

8. External Debt* 41.0 39.8 35.8 32.3 28.2 25.9 23.8

9. Debt service payments* 3.3 3.3 3.3 3.6 3.6 3.3 2.8

* 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

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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 hadgiven 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

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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 has 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 marketP a g e | 3 8


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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.

EEVOLVINGVOLVING DDEBTEBTANDAND CCAPITALAPITAL FFLOWSLOWS SSCENARIOCENARIO TTOWARDSOWARDS 20032003

Indias external $ 112.1 billion stood at the end of December 2003, which increasedfrom $ 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 amongthe 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 thirdfrom 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 Debt

End-March19

91

(US$mn.) S

hareintotalExternalDebt

End-March19

96

(US$mn.) S


End-March20

01

(US$mn.) S


End-Dec20

03

(US$mn.)

ShareintotalExternalDebt

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Multilateral 20900 25 28616 31 31898 32 30558 27

Bilateral 14168 17 19213 20 15323 16 17942 16

IMF 2623 3 2374 3 0 0 0 0

Export Credit 4301 5 5376 6 5368 5 4773 4

Commercial

Borrowing

10209 12 13873 15 23227 24 20582 18

NRI Deposits* 10209 12 11011 12 17154 17 29867 27

Rupee Debt 12847 15 8233 9 3042 3 2635 2

Short-term Debt 8544 10 5034 5 2745 3 5773 5

Total External debt 83801 100 93730 100 98757 100 112130 100

Share of

Concessional Debt

to Total Debt

44.8 42.3 36.0 36.4

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).

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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

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28.7

38.737.5

33.8

30.8

27

24.5 24.3 23.622.1 22.6

21.120.2

0

5

1 0

1 5

2 0

2 5

3 0

3 5

4 0

4 5

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Percent

External Debt- GDP Ratio*


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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).

Table 4: Indicators of Debt Sustainability for India

Year Solvency Indicators Liquidity Indicators

DSR ISR DGDP STD/TD STD/FER

1990-91 35.3 15.5 28.7 10.2 146.5

1991-92 30.2 13.0 38.7 8.3 76.7

1992-93 27.5 12.5 37.5 7.0 64.5

1993-94 25.4 10.5 33.8 3.9 18.8

1994-95 26.2 9.7 30.8 4.3 16.9

1995-96 24.3 8.8 27.0 5.4 23.2

s1996-97 21.2 7.3 24.5 7.2 25.5

1997-98 19.0 7.5 24.3 5.4 17.2

1998-99 17.8 7.8 23.6 4.4 13.2

1999-00 16.2 7.3 22.1 4.0 10.3

2000-01 17.2 6.6 22.4 3.6 8.6

2001-02 13.9 5.4 21.0 2.8 5.1

2002-03 14.7 4.1 20.3 4.4 6.1

DSR = Debt Service Ratio; ISR = Interest Service Ratio; DGDP = Debt to Gross Domestic Product

Ratio; STD = Short-Term Debt; TD = Total Debt; FER = Foreign Exchange Reserves.

Source: Reserve Bank of India

Table 5: Indias Short Term External Debt by Residual Maturity (US $ million)

199

8

199

9

200

0

200

1

2002

Short-term debt by original

maturity

5,046 4,274 3,936 3,628 2,745

(5.4) (4.4) (4.0) (3.6) (2.8)

Long-term debt maturing within

one yr

6,723 7,059 8,359 6,767 11,465

(7.2) (7.3) (8.5) (6.7) (11.6)

Total Short-term debt by

residual maturity

11,76

9

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(12.6) (11.7) (12.5) (10.3) (14.4)

Note: Figures in the bracket represent per cent to total external debt.

Source: Indias External Debt: A Status Report, June 2003.

Table 5: Reserve Indicators for India

Year Import Coverof Reserves

(months)

Reservesto

ExternalDebt

Reserves toShort Term

debt

1990-91 2.5 7.0 68.3

1991-92 5.3 10.8 130.4

1992-93 4.9 10.9 155.1

1993-94 8.6 20.8 530.9

1994-95 8.4 25.4 590.0

1995-96 6.0 23.1 430.8

1996-97 6.5 28.3 392.8

1997-98 6.9 31.4 582.0

1998-99 8.2 33.5 760.2

1999-00 8.2 38.7 966.4

P a g e | 4 3

0

20

40

60

80

100

120

En dMar 91

EndMar 92

EndMar 93

EndMar 94

EndMar 95

EndMar 96

EndMar 97

EndMar 98

EndMar 99

EndMar 00

EndMar 01

EndMar 02

EndDec 02

EndMar 03

EndDec 0

US$B

illion

Total External Debt and Foreign Currency Ass

Total External Deb Foreign Currency Asse


44/81


2000-01 8.6 41.8 1,165.4

2001-02 11.3 54.8 1,971.1

2002-03 13.8 72.0 1,650.9


The level of foreign exchange reserves went up from just 2.5 months of import cover

during 1990-91 is currently sufficient for over a year imports. The buildup reserves

were an outcome of the capital account opening in India as well as official policy

keeping in view the factors such as the level of current account deficit; the size of

short-term liabilities, debt servicing, the possible variability in portfolio investments

and other types of capital flows; unanticipated pressures on the balance of payments

arising out of external shocks such as oil price hikes. Looking at the sectoralcomposition of external debt one finds that the share of government and government

guaranteed debt account for about 48 per cent of total external debt in December

2003. Debt contracted by the corporate sector, which also include government owned

public sector undertakings, are showing an increasing trend.

Table 6: Government Guaranteed External Debt ($ Millions)

1994 1996 1998 1999 2001 2002 2003

1 Govt. Debt 5594

3

5309

5

4652

0

4613

7

44027 4361

9

45647

2 Non-Got Debt 3675

2

4063

5

4701

1

5074

9

57105 5513

8

66483

4 Total External Debt(1+2) 9269

5

9373

0

9353

1

9688

6

10113

2

9875

7

11213

0

3 of which with Govt. Guarantee*:

( a+b+c )

1056

8

8545 7269 7174 6315 7022 6851

a. Financial Sector 1709 1098 2323 2496 1429 1761 1807

b. Public Sector 8533 7070 4605 4363 4639 5070 4985

c.Private Sector 326 377 341 315 247 191 59

5 Govt. Debt and Guaranteed

Debt(1+3)

6651

1

6164

0

5378

9

5331

1

50342 5064

1

52498

6 Percent of Govt. Debt and

Guaranteed Debt to Total External

71.8 65.8 57.5 55.0 49.8 51.3 46.8

P a g e | 4 4


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Debt(5/4)

7 Percent of Govt. Guaranteed Debt

to Non- Govt Debt(3/2)

28.8 21.0 15.5 14.1 11.1 12.7 11.0

Comparing the external debt indicators of the top 15 debtor countries for the years

1990 and 2001 one observes very comfortable situation for India (Table 7). Indias

debt had grown at 18 per cent as compared to over 300 percent rise in Korea, China,

Malaysia and Russian Federation and over 200 per cent rise in Argentina, Brazil,

Chile, Colombia, Indonesia and Turkey. Most of the solvency indicators for India

have shown perceptible improvement during the decade and fare well from among the

top fifteen indebted countries: level of external debt to exports of goods and services,

external debt to GNP, debt service ratio and interest service ratio, etc all show

considerable improvement during the decade. The adjustments in the debt indicators

are far better for India as compared to all other debt countries, particularly in the post

Asian crisis years.

COMPOSITIONOF CAPITAL FLOWS

The pattern of capital flows into India reveals a shift in its composition, from debt to

non-debt creating flows with decreasing importance of short-term flows such as

foreign currency deposits and short term debt, and an increasing share of foreigndirect and portfolio investment flows(Table 8). The share of non-debt flows in total

capital flows have increased to 46.6 per cent during 2002-03. Portfolio investments

flows from FIIs are allowed since 1993, the cumulative investment of which was $ 19

billion in 2003 with about 10 per cent of the total market capitalization of the Indian

stock market.

P a g e | 4 5


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Table 7: Comparison of External Debt Indicators of Top Fifteen Debtor Countries

P a g e | 4 6


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Table 9: Composition of Capital Inflows to India

Types of Flows 1990-

91

1995-

96

1997-

98

1999-

00

2000-

01

2001-

02

2002-

03

Total Net Capital

Inflows($ bn)

7.1 4.1 9.8 10.4 10.0 10.6 12.1

PERCENT

Non-debt Creating

Inflows

1.5 117.5 54.8 49.7 67.8 77.1 46.6

a) FDI 1.4 52.4 36.2 20.7 40.2 58.0 38.5

b) Portfolio

Investment

0.1 65.1 18.6 29.0 27.6 19.1 8.1

Debt Creating

Inflows

83.3 57.7 52.4 23.1 59.4 9.2 -10.6

a) External

Assistance

31.3 21.6 9.2 8.6 4.3 11.4 -20.0

P a g e | 4 7

Country Debt

Outstanding

($ billion)

Concessional

Debt to Total

Debt (%)

PPG to Total

Debt

External Debt to

Current receipts

External debt

to national

Income

Debt Service

Ratio

Interest Service

Ratio

Short Term

Debt to Total

Debt

Short Term

Debt to

Reserves

Years 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001

Argentina 62.2 136.7 0.8 1.0 75.3 75.1 373.7 373.7 46.0 52.5 37.0 66.3 16.3 29.9 16.8 14.6 228.1 137.4

Brazil 120.0 226.4 2.5 1.2 73.2 41.3 325.5 314.4 26.5 46.9 22.2 75.4 6.1 23.6 19.8 12.5 318.7 79.1

Chile 19.2 38.4 1.9 0.9 54.2 14.5 179.6 162.6 67.3 60.0 25.9 28.1 16.7 8.3 17.6 6.7 55.7 17.8

China 55.3 170.1 17.6 15.4 82.3 53.9 91.4 54.9 15.2 15.0 11.7 7.8 5.4 2.5 16.8 25.8 31.5 20.4

Colombia 17.2 36.7 5.7 2.4 85.2 59.3 181.0 210.6 45.1 46.2 40.9 36.1 17.9 15.3 8.4 10.2 31.1 36.8

India 83.8 98.8 45.9 36.0 84.9 85.0 328.9 121.6 28.7 21.0 35.3 13.9 15.5 5.4 10.2 2.8 365.4 5.4

Indonesia 69.9 135.7 26.4 20.7 68.7 50.4 233.9 205.9 64.0 97.2 33.3 23.6 13.3 8.9 15.9 16.1 149.3 80.0

Korea, Rep. 35.0 110.1 12.6 0.3 53.7 30.6 45.6 58.5 13.8 26.1 10.8 13.8 3.4 2.8 30.9 31.9 73.0 34.2

Malaysia 15.3 43.4 14.6 7.3 75.6 55.5 44.4 41.6 36.4 54.4 12.6 6.0 3.4 2.1 12.4 11.8 19.5 16.7

Mexico 104.4 158.3 0.8 0.7 72.7 54.5 191.4 85.5 41.1 26.2 20.7 26.1 13.4 6.9 15.4 11.4 163.1 40.2

Philippines 30.6 52.4 20.0 21.3 78.6 65.3 230.1 125.1 69.4 69.2 27.0 18.6 13.3 6.7 14.5 11.6 479.1 45.0

Poland 49.4 62.4 7.7 9.9 79.5 39.8 251.3 113.5 88.8 35.7 4.9 28.0 1.7 5.0 19.4 11.2 213.6 27.2

Russian Fed 59.3 152.6 0.0 0.0 80.1 66.8 .. 128.0 10.3 50.9 .. 14.5 .. 6.6 19.9 13.7 .. 64.4

Thailand 28.1 67.4 15.2 12.6 44.4 39.2 89.8 84.2 33.3 60.4 16.9 25.1 6.5 4.1 29.6 19.6 62.6 40.9

Turkey 49.4 115.1 15.1 3.5 78.6 48.6 196.1 205.7 32.5 78.8 29.4 40.0 13.5 11.1 19.2 14.2 157.0 86.6


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b) ECB # 31.9 31.2 40.6 3.0 37.2 -14.9 -19.4

c) Short- term

Credits

15.2 1.2 -1.0 3.6 1.0 -8.4 8.1

d) NRI Deposits 21.8 27.0 11.4 14.7 23.1 26.0 24.6

e) Rupee Debt

Service

-16.9 -23.3 -7.8 -6.8 -6.2 -4.9 -3.9

Other Capital @ 15.2 -75.2 -7.2 27.2 -27.2 13.7 64.0

Total (1 to 3) 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Memo: Excluding

b & c*

84.7 33.7 82.4 67.4 71.4 89.3 83.8

# refers to medium and long-term borrowings


Table 10: Portfolio

Investment in India

(US $ Million)

P a g e | 4 8

GDRs/ADR

s#

FIIs

*

Offshore

funds

Tot

al

1992-

93

240 1 3 244

1993-

94

1,520 1,66

5

382 3,567

1994-

95

2,082 1,50

3

239 3,824

1995-

96

683 2,00

9

56 2,748

1996-

97

1,366 1,92

6

20 3,312

1997-

98

645 979 204 1,828

1998-

99

270 -390 59 -61

1999-

00

768 2,13

5

123 3,026

2000-

01

831 1,84

7

82 2,760

2001-

02

477 1,50

5

39 2,021

2002-

03

600 377 2 979


49/81


#: Represents the amount raised by Indian corporates through Global Depository Receipts (GDRs)

and American Depository Receipts (ADRs).

*: Represents fresh inflow of funds by Foreign Institutional Investors.


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,

P a g e | 4 9


50/81


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

Source: Indias External Debt: A Status Report, Government of India, October 2001.

FOREIGN CURRENCY DEPOSITS

P a g e | 5 0

Type of

Borrowings

Amount(US $

Million)

Interest

Rate (%)

5-Year

Government

Bond Yield

Sprea

d

(Col

3-4)

India Millennium

Deposits, 2000

5,520

Mobilization in US Dollar 5,182 8.50 5.57 2.93

Mobilization in Pound

Sterling

258 7.85 4.63 3.22

Mobilization in Euro 80 6.85

Resurgent India Bonds,

1998

4,230



Sterling

180 8.00 5.45 2.55

Mobilization in Euro 63 6.25

India Development Bonds,

1991

1,627



Sterling

320 13.25 9.92 3.33


51/81


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.

P a g e | 5 1

Short term Debt5%

Multilateral27%

Bilateral16%Export Credit

4%

Commercial Debt19%

NRI Deposit27%

Rupee Debt2%

Composition of External Debt as at End Dec 2003(Share in %)

Short term Debt5%

Multilateral27%

Bilateral16%Export Credit

4%

Comm ercial Debt19%

NRI Deposit27%

Rupee Debt2%


52/81


12: Outstanding Balances NRI Deposit Schemes (US $ million)

P a g e | 5 2

End-

March

NR(E)

RA

FCNR(

A)*

FCNR(

B)

NR(NR)R

D**

FC(O)

N

Tot

al

1975 40 40

1980 856 188 1,044

1985 2,304 770 3,074

1990 3,777 8,638 12,415

1995 4,556 7,051 3,063 2,486 10 17,166

1996 3,916 4,255 5,720 3,542 13 17,446

1997 4,983 2,306 7,496 5,604 4 20,393

1998 5,637 1 8,467 6,262 2 20,369

1999 6,045 7,835 6,618 20,498

2000 6,758 8,172 6,754 21,684

2001 7,147 9,076 6,849 23,072

2002 8,449 9,673 7,052 25,174

2003 14,923 10,199 3,407 28,529


53/81


* :Withdrawn effective August 1994.

** :Withdrawn effective April 2002.


Let us view the financial highlights of the fiscal 2007-08 in form of charts and tables in the next

chapter.

Indias External Debt as at the end of March 2008Indias External Debt as at the end of March 2008

The exter

Documents

Final Project Comp