External Debt Indian Case Study By Tarun Das

Management of External Debt in India And Lessons for Developing Countries Dr. Tarun Das1, Economic Adviser, Ministry of Finance, India And Resource Person, UN-ESCAP, Bangkok. 1. India - External Debt Indicators External debt indicators of India showed steady improvement over time. Despite severe balance of payments difficulties due to the impact of the gulf crisis in early 1990s and hardening of international oil prices in recent years, India never defaulted on its obligations of external payments. On the contrary, India pre-paid $7 billion worth of external debt to multilateral and bilateral lenders during 2003-2004. In terms of total external debt stock, India’s position improved from the first rant in 1980 to third rank after Brazil and Mexico in 1990 and further to the eighth rank after Brazil, China, Argentina, Russian Federation, Mexico, Turkey and Indonesia in 2003. The debt-to-GDP ratio declined continuously from 38 % in 1991 to 20 % in 2003 and further to 18 % in 2004. The debt-service ratio (i.e. the ratio of total debt services to gross receipts on the current account of the external sector) also declined continuously from 35 % in 1990 to 16 % in 2003-2004 and further to 6 % in 2005. The World Bank now classifies India as a “low indebted country”. External debt is predominantly long-term. The share of shortterm debt in total debt declined from 10.2 per cent in 1990-91 to 5.7 per cent in 2004-05. Eighty per cent of government debt comes from multilateral and bilateral sources. Table-1-A: Trends of external debt of India Year End 1990-91 1995-96 2000-01 2001-02 2002-03 2003-04 2004-05

Total Ext Debt (US$ Bln) 83.8 93.7 101.3 98.4 105.0 111.7 123.3

As % of GDP

Short term Per cent

Official Creditors Per cent

Official Debtors Per cent

Concessional Per cent

Per cent 28.7 27.0 22.6 21.2 20.3 17.8 16.7

10.2 5.4 3.6 2.8 4.4 4.0 5.7

64 64 51 52 48 45 43

60 57 43 44 42 40 39

46 45 35 36 37 36 34

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This report expresses personal views of the author and should not be attributed to the views of the Ministry of Finance, Government of India or the UN-ESCAP, Bangkok. The author would like to express his gratitude to the UN-ESCAP, particularly to the Poverty and Development Division, for providing an opportunity to prepare this report and the Ministry of Finance, Government of India for granting necessary permission for that.

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Table-1-B Debt sustainability indicators for India during 1990-2005 (per cent) Year

Debt service ratio

1990-91 1991-92 1995-96 2000-01 2003-04 2004-05

35.3 30.2 26.2 16.2 16.2 6.1

Debt/ Current Receipts ratio 329 312 189 110 99 95

Short Term debt to Forex reserves 382 126 30 9 4 5

Short term debt to GDP ratio 3.0 3.2 1.4 0.8 0.7 0.6

Int. to current receipts ratio 16 13 9 6 4 2

Official creditors and official borrowers Shares of official debtors, official creditors and concessional loans in total external debt declined substantially during 1990 to 2005 (Table-2) implying inflows of more private and commercial debt. This must have enhanced the cost of external borrowing. Table-2 Creditors and Debtors Composition of External debt of India (per cent) Creditor Composition (per cent) Debtor composition (per cent) Creditors Multilateral Bilateral Non-resident Indians Others

Total

March 1991 28 36 17 23

March 2005 26 17 26 34

100

100

Debtors Government Non-government -- Financial Sec -- Public sector -- Private sector -- Short-term Total

March 1998 50 50 22 10 13 5 100

March 2005 39 61 34 17 4 6 100

Currency composition US dollar is the most important currency in the currency composition of India’s external debt (Table-3). Other important currencies are SDR, Indian rupees, Japanese Yen, Pound sterling and Euro which together accounted for 55 per cent of the outstanding external debt at the end of March 2005. Contingent Liabilities- Government guaranteed external debt Government of India raises external loans on its own account under external assistance program and also provides guarantees to external borrowings by the public sector enterprises, developmental financial institutions and a few private sector companies under the BOT schemes for infrastructure development. All loans taken by the nongovernment sectors from multilateral and bilateral creditors involve guarantees by the government. Such guarantees given by the government form part of sovereign liability as the guarantees could be invoked in the case of default by the borrower. Thus, guarantees tantamount to contingent liability of the government. However, share of guaranteed loans in total external debt has declined continuously over the years and now accounts for only 5.5% of total external debt.

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Table-3 Currency composition of India’s external debt Currency March 1996 March 2005 US dollar 41 45 SDR 15 16 Indian Rupees 15 19 Japanese Yen 14 11 Euro 9* 5 Pound sterling 3 3 Others 3 1 Total 100 100 * DM, French Franc, Netherlands Guild

Table-4 Total contingent liabilities (i.e. government guaranteed debt) Year 1994 1995 2000 2002 2003 2004 2005

As per cent to GDP 4.3 3.7 1.3 1.5 1.3 1.0 1.0

As per cent to total external debt 13.1 12.5 7.3 7.1 6.2 5.8 5.5

2 External Debt Management- Policies and Organisational Set-up India has been able to manage its external debt situation despite serious balance of payments problems at the beginning of 1990s on account of gulf war leading to disruptions of Indian exports and remittances by non-resident Indians living in the gulf. Policy emphasis has been on resorting to concessional and less expensive fund sources, preference for longer maturity profiles, monitoring short-term debt, pre-payment of high cost debt and encouraging exports and non-debt creating financial flows. Careful management of external debt allowed India to retain policy-making sovereignty and not to be wholly influenced by the conditionalities imposed by the multilateral funding agencies. In fact, in recent years India prepaid a part of more expensive debt from the World Bank, the Asian Development Bank and some bilateral countries. They insisted for substantial reduction of food and fertilizer subsidies and overall fiscal deficit, which were not politically feasible for a coalition government. Effective public debt management also helped government to adopt a step-by-step approach to liberalization and to adopt effective safety nets for the weaker and vulnerable sections of the society by expanding and strengthening various anti-poverty and poverty alleviation programs. India adopted a cautious, gradual and step-by-step approach towards capital account convertibility. Initially non-debt creating financial flows (such as FDI and portfolio equity) were liberalized followed by liberalization of long-term debt flows and partial

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liberalization of medium term external commercial borrowing. There was tight control on short-term external debt and close watch on the size of the current account deficit. Capital account restrictions for residents and short-term debt helped India to insulate from the East Asian economic crisis during 1997-2000. There was high share (80% at the end of March 2000) of concessional debt in government accounting and there was no government borrowing from external commercial sources and no short-term external debt on government account. Maturity of government debt concentrated towards long-end for the debt portfolio (GOI-MOF 2005). The organisational structure for sovereign external debt management consists of the following offices: (a)

(b) (c)

(d)

Front offices, which are responsible for negotiating new loans. Various divisions in the Ministry of Finance (MOF) such as Fund-Bank, ADB, EEC, Japan, America, ECB divisions, and the Reserve Bank of India (for IMF loans) act as front offices. Office of Controller of Aid, Accounts and Audit in the MOF acts as the Back Office, which is responsible for auditing, accounting, data consolidation and the dealing office functions for debt servicing. External Debt Management Unit (EDMU) in the MOF acts as the Middle Office, which is responsible for identification, measurement and monitoring of debt and risk, dissemination of data and policy formulation for both short and medium term. The Finance Minister acts as the Head Office and accords final approval for both internal and external debt.

Under the Indian constitutional provisions, States cannot borrow directly from external sources and the Central government has to intermediate external borrowings and bear exchange rate risk for the states. Currently, external assistance is passed on to the states on the same terms and conditions as for normal central assistance for state plans i.e. in 90:10 mix of grant and loan to the hilly and backward states (the so-called special category states) and 30:70 mix of grant and loan to other states. Loans carry an interest rate of 11.5% with maturity of 20 years including moratorium of 5 years. The system involves certain amount of concession provided to the states. Recently, on considering the high transactions cost of large number of low value projects, tied assistance, and strict conditionalities, government has taken a policy decision to prune the number of bilateral creditors from over 18 to only six namely Japan, United Kingdom, Germany, USA, European Commission and Russian Federation. Government has also decided to pre-pay outstanding bilateral debt except to Japan, Germany, USA and France. The decision was also partly influenced by the substantial build up of foreign exchange reserves and low interest rates in the domestic countries. Those bilateral countries, from which it has been decided not to receive development assistance on government account, have been advised to provide their development assistance to non-governmental organisations and the Universities etc. Accordingly,

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countries like Australia, Belgium, Canada, Denmark, France, Italy, Netherlands, Norway, Sweden, Switzerland and others are now providing assistance directly to the NGOs for primary education, urban water supply and sanitation, HIV/AIDS prevention and care, strengthening environment institutions and poverty alleviation program. India provides technical assistance under the Technical and Economic Cooperation (ITEC) Program and the Special Commonwealth African Assistance plan (SCAAP) to 141 developing countries in Asia, Africa, Latin America, Eastern Europe and the Pacific. India is also participating actively in the international initiative for economic development of HIPC (Heavily Indebted Poor Countries) and other developing countries. Under the HIPC, India is providing credit lines to seven eligible HIPC countries viz. Mozambique, Tanzania, Zambia, Ghana, Guyana, Nicaragua and Uganda. The government has waived the outstanding dues from these countries. In addition, India provides credit lines to a number of developing countries. An effective system is in place to measure and monitor the level and indicators of debt. Some of the important sustainability and liquidity indicators include external debt to GDP ratio, debt service ratio, maturity and present value of debt, short-term debt by original and residual maturity, ratios of debt to other indicators such as exports of goods and services, and foreign exchange reserves. Statistical improvement and technological upgradation have been done to monitor these parameters on real time basis. 3 Fiscal Responsibility and Budget Management (FRBM) Act 2003 Indian government enacted a Fiscal Responsibility and Budget Management Act in 2003. The Act came into force in April 2004. The Act mandates the Central government to eliminate revenue deficit by March 2009 and to reduce fiscal deficit to 3% of GDP by March 2008. Under section 7 of the Act, the central government is required to lay before both houses of Parliament Medium Term Fiscal Policy Statement, Fiscal Policy Strategy Statement and Macro Economic Framework Statement along with the Annual Financial Statement. Four fiscal indicators to be projected for the medium term. These include revenue deficit, fiscal deficit, tax revenue and total debt as % of GDP. The Act stipulates the following targets for the Central government: • Reduction of revenue deficit by 0.5% of GDP or more every year. • Reduction of gross fiscal deficit by 0.3% of GDP or more every year. • No assumption of additional debt exceeding 9% of GDP for 2004-05 and reduction of this limit by at least one percentage point of GDP in each year. • No government guarantee in excess of 0.5% of GDP in any financial year. • Greater transparency in the budgetary process, rules, accounting standards and policies having bearing on fiscal indicators. • Quarterly review of the fiscal situation.

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4 Monitoring, Dissemination and Capacity Building 100% government debt data and 80% of total external debt data are computerized on the basis of Commonwealth Secretariat DRMS. The Ministry of Finance has undertaken projects to computerise fully NRI deposits and short-term debt, which account for the residual 22% of total external debt. Time lag for data update is 8 weeks, which is well below the IMF benchmark set under the Special Data Dissemination Standard (SDDS). A Status Report on External Debt is presented by the Finance Minister to the Parliament every year. The report is also posted on the MOF homepage. Historical trends and future projections of debt stock and debt services are available for analysis, scenario building and as MIS inputs. Debt Data are updated quarterly for March, June, September, December. June 2005 debt data are now under compilation. Data by both Creditors and Debtors classification and by currency, maturity and interest mix are available. Data cross-classified by institutions and instruments are also available. World Bank provided a Grant under the Institutional Development Fund (IDF) for strengthening capacity building and policymaking process for management of Indian external debt. The Grant yielded rich dividends and involved all stakeholders in the policy of policymaking and helped in bridging research and policy. The IDF Grant helped to computerise the database and disbursements and payments system for external public debt on real time basis and reduced transactions cost significantly. Under the IDF grant the Ministry of Finance organized three international seminars and one workshop with active participation by the World Bank, RBI, academicians and all stakeholders concerned with external debt and non-debt creating financial flows. The executive agencies published three Books on papers and proceedings (CRISIL 1999 and 2001 and RBI 1999). These seminars recommended various reforms for external sectors. Most of the policy recommendations were accepted by the government. Ministry of Finance also set up various working groups comprising members from the government, RBI, financial institutions, private and public corporate bodies and professionals having expertise and the experience on the selected subjects. Members visited foreign countries to understand international best practices for management of external debt. These countries included Australia, Ireland, New Zealand, UK and USA. 1

Lessons from external debt management in India

Management of external debt in India leads to the following broad conclusions: (a) Management of external debt is closely related to the management of domestic debt, which in turn depends on the management of overall fiscal deficit. (b) Debt management strategy is an integral part of the wider macro economic policies that act as the first line of defense against any external financial shocks. (c) For an emerging economy, it is better to adopt a policy of cautious and gradual movement towards capital account convertibility.

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(d) At the initial stage, it may encourage non-debt creating financial flows followed by liberalization of long-term and medium-term external debt. (e) Big bullets are bad for small economies, as these can create refinancing risk that many countries would be well advised to avoid. (f) 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 attention on surveillance of overall debt- internal and external, private and public. In each of the major Asian crisis economies- Indonesia, Korea and Thailand- weakness in the government balance sheet was not the source of vulnerability, rather vulnerability stemmed from the un-hedged sort-term foreign currency debt of banks, finance companies and corporate sector. (g) 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 advanced economies have experienced how bad banks can lead to large costs to the economy and an unexpected weakening of the government’s balance sheet. Government guarantees of private debt can also have similar adverse impact. (h) It is necessary to adopt suitable policies for enhancing exports and other current account receipts that provide the means for financing imports and debt services. (i) Detailed data recording and dissemination are pre-requisites for an effective management and monitoring of external debt and formulation of appropriate debt management policies. (j) There is a need to set up a Public Debt Office with the following functions:

• • • •

To deal with both domestic & external debt To set bench marks on interest rate, maturity mix, currency mix, sources of debt Identification and measurement of contingent liabilities  Policy formulation for debt management  Monitoring risk exposures Building Models in ALM framework

(k) It is vital that external contingent liabilities and short-term debt are kept within prudential limits.

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(l)

It is important to strengthen public and corporate governance and enhance transparency and accountability.

(m)It is also necessary to strengthen the legal, regulatory and institutional set up for management of both internal and external debt. (n) (o) A sound financial system with well developed debt and capital market is an integral part of a country’s debt management strategy. 6 External Debt Management Strategy In all the East Asian crisis economies, weaknesses in financial systems as a result of weak regulation and supervision and a long tradition of a heavy government role in credit allocation led to misallocation of credits and inflated asset prices. Another vital weakness of all countries was associated with large unhedged private short-term foreign currency debt in a setting where the private corporate sector was highly leveraged. Short-term foreign currency denominated debt created two kinds of vulnerabilities in these economies. First, if some creditors pulled out their money, each individual creditor had an incentive to join the queue. As a result, even a debtor that had been fully solvent before the crisis could be plunged into insolvency. Second, such debts also created vulnerabilities associated with the exchange rate depreciation. Exchange risk was either borne directly by the financial institutions or passed on to the corporations as the funds was on lent (thereby converting exchange risk into credit risk). These factors were further complicated by the interaction of exchange rate and credit risks. Currency depreciation led to wide spread insolvency and created additional counter-party risk, which in turn added momentum to the exit of foreign capital. The management of debt crisis faced by the East Asian countries was not without precedence. Following the inception of the Latin American debt crisis in 1982, and on the presumption that the debt problem was one of liquidity and not solvency, the initial debt management strategy aimed at normalising the relationship between the debtors and creditors through a combination of economic adjustment by debtor countries and negotiations on financial relief. The financing modalities provided debtor countries with some financial relief through interest rate spreads, reduced fees, and extension of maturities and provision of some new finances. The negotiations conducted on a case-bycase approach for debtor countries were co-ordinated by the private bank steering committees in consultation with the IMF, World Bank and governments of the creditor banks’ home countries (Islam 1998). In the case of Asian crisis, countries succeeded in striking a reasonably comprehensive debt-rescheduling strategy with creditor banks. The implementation of the deal was voluntary and all creditors did not join the scheme. So long as free movement of international capital is allowed, there is no guarantee that the debt crisis will not recur in

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future. Whenever such a financial crisis occurs in future, it is necessary to formulate an international debt management strategy on the basis of negotiations among international private lenders, investors and borrowers for sharing the responsibility for debt relief, for rescheduling or for delaying claims on repayment. More effective structures for orderly debt workouts, including better bankruptcy laws at the national level and better ways at the international level of associating private sector creditors and investors with official efforts are needed to help resolve sovereign and private debt problems. In the case of East Asian crisis, considerable thought was given to mechanisms that involve private sector to forestall and resolve crisis in a more timely and systematic way. A range of options are available in this respect, viz. (a) to contract credit and swap facilities with groups of foreign banks, to be activised in the event of liquidity pressures, such as those contracted by Argentina and Mexico; (b) embedding call options in certain short-term credit instruments to provide for an automatic extension of maturities in times of crises; (c) feasible modifications of terms of sovereign bond contracts to include sharing clauses; and (d) a possible role for creditor councils for discussion between debtors and creditors. However, these are complex issues and need to be designed carefully so that there are no perverse incentives, which may encourage private creditors to bail themselves out at the first sight of difficulty, rather than providing net new financing in the event of a crisis. Developing countries need to strengthen their debt management strategy by developing comprehensive debt sustainability models, which will integrate external sector, particularly the flows of external debt, with broad macro-economic variables and provide early warning regarding any possible debt trap. In this respect, separate debt models may be developed with respect to sovereign external debt and private debt. All countries need to monitor very carefully short-term debt, long-term debt by residual maturity, all guarantees and all contractual contingent liabilities arising out of both debt and non-debt creating financial flows. A more comprehensive approach is needed when trying to deal with excessive private borrowing and risk taking in the presence of large capital inflows and weak financial systems. This often means applying more flexible exchange rates, tighter fiscal policy and improved financial system. Domestic financial sector liberalisation should also proceed carefully and in step with tighter financial regulation and supervision, and internationally recognised prudential norms for capital adequacy and provisioning for non-performing assets by commercial banks and financial institutions. Contents

1. Introduction

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2. Scope and objectives of Report 3. Methodology 4. Cambodia 4.1 Cambodia’s Macroeconomic Developments in 2005 4.2 External debt situation in Cambodia 4.3 Institutional arrangement for external debt management 4.4 Evaluation by international organizations 4.5 Major areas of concern and recommendations 5. Lao PDR 5.1 Macro-economic developments in Lao PDR 5.2 External debt situation in Lao PDR 5.3 Major areas of concern and recommendations 6. Concluding observations Selected References

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Report on “National Workshops on Capacity Building on External Debt Management in the Era of Globalisation” in Cambodia and Lao PDR During 20-24 February 2006 2

Tarun Das, Resource Person, UN-ESCAP, Bangkok

1.

Introduction

A wider project on management of external debt in heavily indebted Asian countries for poverty reduction and achievement of the United Nations Millennium Development Goals (UN-MDG) is being executed by the Poverty and Development Division (PDD), UN-ESCAP, Bangkok. As a part of this project, two consecutive “National Workshops on Capacity Building for External Debt Management in the Era of Rapid Globalisation” were held in Cambodia and Lao PDR during 20-24 February 2006. The first was held jointly by the UN-ESCAP and the Ministry of Economy and Finance, Government of Cambodia at the Economics and Finance Institute, Phnom Penh during 20-21 February 2006, followed by the second held jointly by the UN-ESCAP and the Ministry of Finance, Government of Lao PDR at the Lao Plaza Hotel, Vientiane during 23-24 February 2006. . Both these workshops were participated by government departments and other organizations concerned with the management of external debt in the respective countries. The workshops were highly interactive in nature with presentations made by both the UN-ESCAP officials and consultant, country experts and multilateral organizations. This Report by the resource person contains major conclusions and recommendations with respect to the management of external debt in Cambodia and Lao PDR following the presentation and wide ranging discussions in the workshops and is now submitted to the Poverty and Development Division of UN-ESCAP. 2.

Scope and Objectives of the Report

The aim of the workshops in Phnom Penh, Cambodia and Vientiane, Lao PDR was to assist the respective governments and in particular the Ministry of Finance to improve capacity building in external debt management in the light of international best practices. At the outset, it must be noted that the report deals primarily with the management of external debt and does not deal with all aspects of public debt consisting both domestic and external debt. Much of the international best practices dealing with sovereign debt (such as the IMF Guidelines for Public Debt Management1- the “IMF Guidelines”) is concerned with the management of public debt in total, not just external debt. Likewise, most of the country laws deal with the totality of sovereign debt. This is evidenced by the titles of such laws in many countries (common titles 2 include Fiscal Responsibility Law 1 2

Prepared by the Staffs of the International Monetary Fund and the World Bank, and dated 21 March 2001. http://www1.worldbank.org/publicsector/pe/countrybudgetlaws.cfm.

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2000 of Brazil, Fiscal Responsibility and Budget Management Act 2003 of India, National Treasury Management Agency Act 1990 of Ireland, Fiscal Responsibility Act 1994 and Public Finance Act 1989 of New Zealand, Public Finance Act 1998 of Poland, and Finance Act 1998 of the United Kingdom). 3.

Methodology

As stated above, main methodology consisted of organizing interactive workshops with presentation made by the UN-ESCAP officials and resource persons and local experts. There were participants representing the Ministry of Finance, the Central Bank and a number of other government ministries and agencies and multilateral organizations. The workshop was led by Dr. Amarakoon Bandra of the Poverty and Development Division of the UN-ESCAP and was supported by Dr Tarun Das, UN-ESCAP resource person. In addition, other experts from the government in both the countries and the World Bank in Cambodia assisted in the workshop and made valuable presentations. The Workshops were inaugurated by the senior level officers for management of external debt in both the countries. There were presentations on the state of the economy, future economic outlook and debt scenario, legal and institutional set up and policies for debt management. The presentation of these persons, together with the active involvement of the participants, helped to ensure that the results of the workshop were relevant in the context of, and indeed driven by, the respective country situations and experiences. 4. Cambodia 4.1 Cambodia’s Macroeconomic Developments in 2005 Cambodia has made significant economic progress since the establishment of the Royal Government of Cambodia in 1993 and the resumption of long denied external assistance. There had been a steady improvement in economic environment with higher growth, better fiscal discipline and management, and accelerated integration with the region and the rest of the world. Measurable improvements in various social indicators include sharp reduction in poverty levels; expansion of primary education; reduction in mortality rates for both infants and under-five year olds; reduction in communicable diseases and incidence of HIV/AIDS; improved urban access to safe water, and rural access to sanitation; and, reduction in gender disparity in many fields. A sound macroeconomic policy framework helped Cambodia to achieve impressive growth during the last 10 years. Annual GDP growth rate averaged around 5.6 percent since 1993 and 7 per cent since 1999 with growth in per capita income around 4½ percent per annum. Economic

growth in 2005 is estimated to be 7 percent, reflecting stronger agricultural growth, continued expansion of exports, tourism and construction activities. However, the economy still suffers from a number of weaknesses. Reforms in governance have not progressed at the required pace. Economic growth has been uneven over sectors and regions, leaving it vulnerable to external shocks and unsustainable over time. Growth has been largely urban based, underlining need for 12

more rural focus in the future. Despite significant reduction of poverty

ratio at the macro level from 47 per cent in 1994 to 35 per cent in 2004, there is high incidence of poverty in rural areas. In 2004, about 91 per cent

of the poor lived in rural areas and, among the poor, a larger share was closer to the poverty line. Poor households in rural areas have higher dependency burden and lack human capital: they tend to be uneducated, unskilled and unhealthy, while urban poor are subject to insecurity of housing rights and lack of opportunities for gainful income generation. Fiscal Policy Basic objectives of fiscal policy are to maintain a sustainable fiscal balance with gradual increase in budget allocation for social and economic sectors through curtailing and rationalizing public expenditure and by broadening tax base, preventing tax evasion and leakage in expenditure, and strengthening tax administration for higher revenue realization. Furthermore, prudent fiscal policy has been recognized as key to ensuring price stability in Cambodia's highly polarized economy. Fiscal performance in 2005 was good, with improved revenue mobilization and expenditure restraint. The 2005 Budget was implemented with extreme prudence and caution to make room for additional expenditure for financing important reform programs, such as the civil service reform, improvements in physical infrastructure, especially roads and bridges, while trying to avoid high inflation. Domestic revenue increased from 11.3 percent of GDP in 2004.to 11.7 percent of GDP in 2005. The tax revenue increased from 8.4 percent of GDP in 2004 to 8.7 percent of GDP in 2005. However, the non-tax revenue is expected to be at around 2.5 percent of GDP. Monetary Policy and Performance Broad money recorded a robust growth of 20 percent in 2005, due to the increase in foreign currency deposits and credit to the private sector. Foreign currency deposits, the largest component of broad money, recorded an increase of 20 percent, witnessing a firm confidence in the banking sector and in the economic policy of the Royal Government of Cambodia. Credit to private sector rose by 40%, driven by the construction of hotels and houses. Capital and reserves of the banking system continued to rise, up by 9.6% in 2005, reflecting the banks' efforts to strengthen their capital base in compliance with the recent requirements of the law. Gross official reserves rose by 12 percent reflecting continued strong export performance, sustained tourist arrivals, and other forms of capital flows, including FDI. Despite high oil prices, the government was successful in maintaining inflation under check and ensuring a stable exchange rate. Inflation rate reached 5.8 percent at the end of 2005, higher than the last 5 years due to the impacts of higher oil prices. The Cambodian riel-US dollar exchange rate depreciated by 2.48 percent, up from 4,035 riels per US

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dollar at the end of 2004 to 4,135 riels per US dollar at the end of 2005. There was increased inflow of foreign investment in oil refinery, hotels, ports and cement, tobacco and cigarette industries. External sector performance The external sector performed well in 2005, despite high oil prices and higher trade deficit. Provisional BOP data for 2005 indicated that the current account deficit, excluding official transfers, increased from -9.9 percent of GDP in 2004 to -10.3 percent of GDP in 2005, reflecting the impact of higher petroleum prices and net income debits. Nearly the entire current account deficit was attributable to an increased deficit in the trade balance. While exports increased by 9.8 percent, imports increased by 17.6 percent. Exports of textile, clothing and footwear, which accounted for more than 70 percent of Cambodia’s exports, continued to expand. Non-garment exports were estimated to have increased at a faster pace than the garment sector, and produced 13 percent of Cambodia's total export earnings. This group includes traditional agricultural commodities such as rubber, wood products, fishery products, and paddy rice. In order to reduce the dependence of the economy on a single commodity and to utilize the country's agricultural potential in a more dynamic way, the government has encouraged private investment in the agricultural sector and the agro-industries. The overall balance increased from a surplus a surplus of 0.9 percent of GDP in 2004 to 1.1 percent of GDP in 2005 due to larger inflows on capital and financial accounts. On the whole, a positive overall surplus was achieved, while gross international reserves expanded further to cover more than 2.5 months of import of goods and services. 4.2 External Debt Situation in Cambodia In the latest issue of Global Development Finance (2005), the World Bank classified Cambodia as a moderately indebted low income (MILI) country. Its major problem is the low level of income. Policy prescriptions include improvement in real economic growth, continuation of sound macro-economic policies and strengthening legal and institutional set up for management of public debt including external debt. As evidenced by major external debt statistics summarized in Table-1, positive aspects of Cambodian external debt include favourable debt service ratio, low share of short-term debt and high share of concessional debt in total debt. However, there had been mixed trends of external debt sustainability indicators in Cambodia in recent years. As judged by some indicators, external indebtedness of Cambodia improved to some extent in 19992003. External debt service (to exports) ratio declined significantly from 2.1 percent in 1999 to 0.9 percent in 2003 and the external debt to exports ratio declined from 162 percent to 115 percent over the same period due to substantial growth of exports. The share of exports in GNI improved from 46 percent to 68 percent in 1999-2003, the share of multilateral debt in total debt improved from 13 percent to 26 percent, and the share of concessional loan in total external debt remained more or less stable around 89 percent

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over the same period. On the other hand, there was deterioration in some debt indicators. The external debt to GNI ratio increased from 75 percent in 1999 to 77 percent in 2003, the ratio of short-term debt to total debt increased from 6 percent to 7 percent over the same period and the country has foreign exchange reserves, equivalent to only 3.7 months imports cover. Table-1: External Debt in Cambodia (in US$ million) Items Total Debt stock (EDT) Long term debt Public & guaranteed Private non-guaranteed Use of IMF credit Short-term debt Total debt service (TDS) Interest payments (INT) Interest on long term debt Interest on IMF loan Interest on short term debt Gross national income (GNI) Exp.of goods and services (XGS) Workers remittances Imp.of goods & services (MGS) International reserves (RES) Current account balance

1990 1846 1683 1683 0 27 136 30 30 29 0 1 1115 … 0 … … …

1999 2518 2293 2293 0 73 152 32 14 12 1 1 3354 1555 106 2033 509 -188

2000 2628 2328 2328 0 73 227 32 18 12 1 5 3461 1997 121 2457 611 -135

2001 2697 2393 2393 0 80 224 22 9 5 1 4 3571 2263 133 2635 697 -86

2002 2900 2587 2587 0 96 217 21 8 6 1 1 3831 2525 140 2907 913 -55

2003 3139 2814 2814 0 104 221 25 9 8 1 0 4060 2741 138 3216 982 -125

115 102 102 0 4 9 76 68 68 0 2.5 5.7 0.8 0.3 0.2 31 3.8 7.5 89 21 66 76 -1.4

115 103 103 0 4 8 77 69 69 0 2.6 5.4 0.9 0.3 0.2 31 3.7 7.0 89 26 68 79 -3.1

Sustainability Debt indicators (in percent) EDT/ XGS Long term debt/ XGS Public & guaranteed / XGS Private non-guaranteed/ XGS Use of IMF credit/ XGS Short-term debt/ XGS EDT/ GNI Long term debt/ GNI Public & guaranteed / GNI Private non-guaranteed/ GNI Use of IMF credit/ GNI Short-term debt/ GNI TDS/ XGS INT/ XGS INT/ GNI RES/ EDT RES/ MGS (months) Short-term debt/ Total debt Concessional debt/ EDT Multilateral debt/ Total debt XGS/ GNI ratio MGS/ GNI ratio C/A Balance as % of GNI

… … … … … … 166 151 151 0 2.4 12.2 … … 2.7 … … 7.4 91 0.1 … … …

162 147 147 0 5 10 75 68 68 0 2.2 4.5 2.1 0.9 0.4 20 3.0 6.0 90 13 46 61 -5.6

132 117 117 0 4 11 76 67 67 0 2.1 6.6 1.6 0.9 0.5 23 3.0 8.6 88 14 58 71 -3.9

119 106 106 0 4 10 76 67 67 0 2.2 6.3 1.0 0.4 0.3 26 3.2 8.3 88 16 63 74 -2.4

Source: Global Development Finance 2005, World Bank

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External debt - of which about 60 percent is owed to the United States and the Russian Federation - constitutes 94 percent of Cambodia’s public debt. At end-2004, Cambodia’s total external public debt was $3.1 billion (64 percent of GDP), while domestic debt amounted to 4.1 percent of GDP, denominated entirely in local currency. Cambodia’s two largest creditors are the Russian Federation and the United States. Cambodia is not servicing its debt to either creditor and is making efforts to conclude agreements with both creditors under the framework of the Paris Club. It is trying to have a debt restructuring agreement with the US and Russia in 2006. As a consequence, Cambodia’s net present value (NPV) of external debt to GDP ratio would drop from 47.0 percent at end-2005 to 24.5 percent in 2006. At present, the Cambodia’s authorities are conducting negotiations with the Russian Federation and the United States on the rescheduling of its pre-1993 financial obligations. Technical discussions have taken place with a view to reconciling outstanding issues. The government is currently reviewing documentation from the United States to determine the exact amount of claims. The U.S. insisted that they would not write off any debts contracted by Cambodia during the war of 1970-75. The U.S. and Cambodia have disputed the total amount of principal. While the U.S. suggested that there are sufficient evidence that the total amount of US$162 million is Cambodia’s obligation. Cambodia claims that some documents are unclear and the part of the claim are not Cambodia’s obligation. The U.S. claims that, after agreeing on the total principal amount, Cambodia and the U.S. need to sign the bilateral agreement based on the 1995 Paris Club agreement (i.e., flow rescheduling on Naples terms assuming a 40-year maturity, 16-year grace period, and an interest rate of 3 percent). After signing the bilateral agreement, both need to calculate arrears up to now and, if necessary, Cambodia need to ask rescheduling those arrears through the Paris Club. Cambodia and the Russian Federation have discussed rescheduling with a stock operation. They have agreed that (1) after applying the stipulated exchange rate and the 70 percent upfront discount, the total debt is US$457 million, and (2) interest rate for the precut-off-date debt is about 0.8 percent with concessional repayment schedule. However, the countries have disagreed on (1) classification of US$40 million as either pre-cut-off-date or post-cut-off-date debt and the interest rate on the post-cut-off-date debt. The latest bilateral discussion was held in Moscow in June 2005. No agreement was reached. The assumption for the macroeconomic framework is (1) the disputed US$40 million is classified as pre-cut-off-date debt, and (2) the interest rate for the post-cut-offdate is about 3 percent, in line with the Russian claim. Cambodian authorities are making best efforts to reach a debt rescheduling agreement with the United States and the Russian Federation. Restructuring is critical for Cambodia’s debt sustainability. Agreement on debt rescheduling with the U.S. and Russia may reduce amortization payments, but it could increase interest obligations.

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Cambodia’s external debt repayment will have significant impact on budget execution and thereby on poverty reduction goals. By 2008, after rescheduling of its pre-1993 obligations, Cambodia's external debt is estimated to be about 39.4 percent of GDP, and debt service will equal 1.3 percent of exports of goods and services. However, the fiscal burden of the debt is heavy, given the low revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debt management policy and strictly avoid non-concessional financing. In the 1980s Russia granted interest-free loans for the rehabilitation of Cambodia from the scourges of war and genocide. The Russian Federation participated in the Paris Club as a creditor. Countries that have obtained, or will obtain in the future, a concessional rescheduling from Paris Club creditors receive an up-front discount of 70 percent on all pre-1992 debts to Russia before the application of Paris Club terms. The amounts remaining after the up-front discount are denominated in a mutually agreed currency and are considered commercial debt (non-concessional) for Paris Club purposes. The remaining amount after the exchange rate uncertainty reduction, Russia applied Naples Terms under the Paris Club Agreement for most of the countries, including the non-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term of loan (interest rate, grace period and payment modality). The amounts remaining after the up-front discount are denominated in a mutually agreed currency and are considered commercial debt (non-concessional) for Paris Club purposes. The remaining amount after the exchange rate uncertainty reduction, Russia applied Naples Terms under the Paris Club Agreement for most of the countries, including the non-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term of loan (interest rate, grace period and payment modality). Agreement on debt rescheduling with the U.S. and Russia may reduce amortization payments, but it could increase interest obligations. Cambodia’s external debt repayment will have significant impact on budget execution and thereby on poverty reduction goals. By 2008, after rescheduling of its pre-1993 obligations, Cambodia's external debt is estimated to be about 43 percent of GDP, and debt service will equal 2.6 percent of exports of goods and services. However, the fiscal burden of the debt is heavy, given the low revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debt management policy and strictly avoid non-concessional financing. 4.3 Institutional arrangements for external debt management Institutions engaged in the management of external debt in Cambodia include the Parliament, Treasury Bills Commission (TBC), Ministry of Economy and Finance, National Treasury (NT), Investment and Cooperation Department and the National Bank of Cambodia (NBC) with distinctive roles and responsibilities.

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Parliament is the final authority for approval of annual budget and makes laws to regulate public finance and public debt from both domestic and international sources. It also checks the proper use of resources including debt to avoid mismanagement of public debt. The Treasury Bill Commission is chaired by the Secretary of State, Ministry of Economy and Finance (MEF) with the Deputy Governor, NBC as Vice-Chairman, and Deputy. Sec. Gen, Chief of NT, and Directors, Operations Department, Finance Industry, Budget, AEF Department in the MEF as members. It takes policy decisions on issues related to public finance including domestic debt and cash management and issues appropriate instructions to NT and NBC for effective enforcement of the policies. It also prepares draft bills for parliament approval and issues terms, amount and timing for Treasury Bills. National Treasury builds and presents financial consolidated report and ensures general balance of accounts. It is in charge of settlement of expenses, payrolls, collection of revenues foreseen by finance law, balance and control revenues and expenditure. It manages cash flow, national budget, autonomous budgets and reserve accounts. It also manages the treasury accounts deposited with NBC. In conformity with the international best practices, NT is moving from cash to accrual accounting. Investment and Cooperation Department manages public investment and makes liaison with IFI, which prepare all public agreement regarding economic and financial assistance, loan contracts, guarantees and on-lending operations. It records all debt agreements and its corresponding transactions and settlement. It makes projections for external debt services and disbursement for budgetary purpose, and orders the payment for external debt services. National Bank of Cambodia participates in the management of external debt and claims. It assist in the debt management by conducting securities operation, perform open market operations in the secondary market and provides guarantees to foreign creditors for domestic borrowers 4.4 Evaluation by the International Financial Institutions Under the Multilateral Debt Relief Initiative, the IMF Executive Board approved in December 2005 debt relief for Cambodia. The IMF will provide 100 percent of debt relief on all debt incurred by Cambodia to the IMF before January 1, 2005 amounting to US$82 million. The international community has made these additional resources available to help Cambodia make progress toward the Millennium Development Goals (MDGs). Cambodia has qualified for IMF debt relief because of its satisfactory overall economic performance in recent years with progress in poverty reduction and improvements in public expenditure management. Since 1999, Cambodia enjoyed robust economic

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expansion, with annual growth rates averaging over 7 percent and inflation being kept under control. During this period, the Royal Government has shown strong commitment to implementing its National Poverty Reduction Strategy, and improving public administration, in particular public expenditure management. Performance in these areas provides assurance that resources made available under the Multilateral Debt Relief Initiative will be used effectively. 4.5 Major Areas of Concerns and Recommendations •

At present Cambodian external debt is manageable with favourable external debt service ratio, low share of short term debt and high share of concessional debt in total external debt, but its sustainability in the long term may create problems unless appropriate macro economic and financial policies are put in place to improve revenues and exports and overall economic development.

•

There are down side risks due to low revenue/GDP ratio and its pressure on the government budget.

•

There is lack of a proper mechanism to monitor and manage external debt. A fullfledged debt office with independent front, back, middle and head offices may be established in the medium term as per international best practices.

•

There is instability of economic growth over the years, as real GDP growth declined from 5.7 per cent in 2001 to 4.3 percent in 2004 although it is expected to increase to 6 per cent in 2005. In order to achieve broad based growth in the medium and long term it is desirable to improve investment climate, to diversify the economy, to reduce transactions cost for doing business, to increase productivity for private sector development, and to improve human and physical infrastructure.

•

The health of public finance remains weak. Budget deficit declined from 6.6 per cent in 2002 to 5.5 percent in 2005 but still remained high. Revenue/GDP ratio is low at 12 per cent in 2005. It is desirable to continue with sound fiscal and monetary policy for realizing sound public debt management. Tax reforms need to continue and tax administration further strengthened for enhancing revenue realizations.

•

There is high dependency on exports of garments and wood products, which makes the country vulnerable to external shocks. It is desirable to diversify exports and continue reforms for encouraging private investment and public-private partnership.

•

Trade balance is deteriorating and the current account deficit is rising (from 1.5 per cent of GDP in 2002 to 4.9 per cent in 2005). Trade balance should be improved to a significant degree in order to reduce external vulnerability.

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•

Current account balance at 10.3 per cent of GDP in 2005 is high and is a matter of concern. The deteriorating current account balance, mainly caused by poor macroeconomic performance, needs to be arrested by broad basing economic growth and removal of impediments to the private sector development.

•

Given a flexible exchange rate regime, exchange rate volatility is another area of concerns. Although a flexible exchange rate regime helps cushion the external and domestic shocks, it may create problems for financing debt services in the case of excessive depression of domestic currency. Exchange rate fluctuations may also create contingent liabilities for the government in future. It is desirable to fix benchmarks for composition, interest rates and maturity of public debt.

•

Government apparatus is weak and overloaded reflecting the negative effects of the war. Institutional mechanism is yet to be in full gear to facilitate growth and development. It is desirable to strengthen institutional and legal systems and to ensure good governance.

•

A dollarised economic system has both advantages and disadvantages. It deprives the country to make use of domestic monetary and fiscal policies for the country’s development. There is a need to have a long-term mechanism to give the local currency a larger role in the economy. For this, steps are needed to build the public confidence on the local currency as a store of value and a medium of exchange.

•

There is slow financial sector development and legal and institutional reforms remain inadequate despite reform efforts. It is desirable to achieve a sound banking and financial system by further progress made in the regulation and supervision systems and through an active use of global standards for capital adequacy requirements, accounting, auditing, and disclosure.

•

As in the most developing countries, the bond market is weak and needs to be developed for encouraging both savings and investment.

•

Debt rescheduling may reduce amortization payments, but it could increase interest obligations. As a result budgetary pressures could be high, particularly in view of the low revenue/GDP ratio. Negotiations are taking place for rescheduling the country’s pre-1993 debt obligations with Russia and the United States. If debt rescheduling goes ahead as intended, Cambodia’s medium term debt stock is sustainable, particularly in view of the high concessionality of the debt stock. Therefore, Cambodia needs to pursue a strong debt management strategy and avoid nonconcessional borrowing.

•

Even after rescheduling NPV of public debt would be still high at 230 per cent of total revenue as revenue ratios are low. Debt servicing could be under strain and could have negative implications on the country’s investor perception and the development process. Anticorruption rules and regulation and increase transparency 20

in both public and private sector. It is necessary to take measures to increase revenue thereby reducing the pressure on the budget. •

Increasing debt/GNI ratio from 75% in 1999 to 77% in 2003 is a matter of concern. It is advisable to improve public expenditure management, in particular lending to SOEs and government guarantees, thereby contain the growth in debt.

•

Most of the external debt is denominated in dollars and rubles. It is necessary to fix currency mix and interest rate mix.

•

There is no single institutional body for management of external debt in Cambodia. Operational debt management functions are scattered among different institutions. There is lack of coordination, no communication in some cases and inconsistency in actions. There is need to have a good coordination between the fiscal and monetary policy advisers and the debt management function.

•

There is also lack of qualified and sufficient staff and proper performing computer based debt management system. There is no systematic analysis of public debt.

There is need to introduce a legal framework for management of public debt, to strengthen institutional arrangement with clear rules and responsibilities, and to coordinate debt management functions among various authorities. It is necessary to strengthen capacity of staff to undertake specific debt analysis including risk. •

There is absence of a proper mechanism to monitor and manage debt, which may have adverse impact on governance and sustainability of debt in future. It is advisable to establish urgently an institutional framework (UNCTAD-DMFAS or similar arrangement) to record and manage debt and to put in place a debt management strategy and risk management framework.

In the absence of a proper framework, monitoring of external debt appears to be weak. It is advisable to put in place well articulated and clearly defined role of responsibilities for staff, clear monitoring and control policies and reporting arrangements. It is also necessary to assess debt sustainability regularly and take corrective measures in time. It is necessary to set up Middle Office for external debt to perform debt sustainability analysis and to incorporate it into debt choice for annual budget. 5. Lao PDR 5.1 Economic Development in LAO PDR

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In recent years Lao PDR has made significant economic progress. Real GDP growth rate has improved from 5.8 per cent in 2000-01 to 6.5 percent in 2004-05 and rate of inflation has decelerated from 26.9 per cent to 9 per cent over the same period. Table-2: Trends of growth rates and inflation rates in Lao PDR since 2000-01 2000-01 2001-02 2002-03 2003-04 2004-05 GDP growth rate (%) 5.8 5.9 5.9 6.2 6.5 Inflation rate (%) 26.9 8.9 11 15 9 Monetary Policy Bank of Laos (BOL) conducts its monetary policy trough open-market operation to stabilize the value of the kip. However, there are severe limitations for conducting independent monetary policy due to the existence of a highly dollarised economy and widespread use of hard currencies for domestic transactions. During 2004-05, broad money supply (M2) grew by 9.2 per cent, inflation was moderate at 6.5 per cent, exchange rate was almost stable with marginal depreciation of Kip by 0.16 per cent in terms of US $ and the foreign exchange reserve amounted to 3.5 months of imports. Fiscal Performance and Outlook The Budget outcome for FY 2003/04 was satisfactory with achievement of revenue targets, while total expenditure and net lending amounted to only 74.3 per cent of the plan due to the shortfall of capital expenditure and on-lending by 58.5% of plan. Fiscal reforms in 2004-05 includes amendments of the Tax Law for revision of the turnover tax rates, increase of the minimum threshold for payroll tax, reduction of the maximum rate of payroll tax, consolidation of the tax rate on rental income and strengthening of the tax administration. Because of these reforms, government revenue is expected to reach 15 per cent of GDP by 2010. The Customs Law was also amended to meet international standards and best practices, to provide greater clarity on the rights and roles of central and provincial custom offices and to introduce the concept of regional offices. Expenditure reforms aimed at enhancing policy consistency, transparency and accountability in public expenditure management. A Public Expenditure Management Strengthening Program (PEMSP) is operational for fiscal planning and budget preparation, execution, accounting and financial reporting, improving capacity building and strengthening the Financial Legislation and Regulatory Framework. Public Expenditure Reviews and Public Expenditure Tracking Surveys were conducted regularly as a part of. Monitoring and Evaluation System for PEMSP,

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Performance of State Owned Commercial Banks or SOCBs has been improving gradually, but many challenges remain for improving quality of assets and loan portfolio, delineation of non-performing loans and strengthening of management and supervision of Boards, recapitalization of weak banks and general improvement of audit and accounting systems as per international best practices. The government is making an attempt to adjust the balance between current and capital expenditures, move from project support to programmatic approach in PEM support area and to appoint International Banking Adviser(s). Medium Term Outlook Medium term scenario envisages the economy growing at 7.5 to 8% per annum induced by large foreign invested projects in the mining and hydropower sectors. Inflation rate is expected to remain at one digit level, provided that monetary and fiscal policies remain prudent. Strong export growth, mainly from mining sector, is expected to offset the high oil price risk. Despite an increase in the external current deficit, primarily caused by imports for big economically viable project, the underlying external position remains manageable. Current account deficit is expected to be financed by the capital inflows consisting of mainly increased inflow of FDI and continuance of concessional medium and long-term borrowings. 5.2 External debt situation in Lao PDR In the latest issue of Global Development Finance (2005), the World Bank classified Lao PDR as a severely indebted low income (SILI) country. Like Cambodia, its major problem is the low level of income. Policy prescriptions for both these countries include improvement in real economic growth, continuation of sound macro-economic policies and strengthening legal and institutional set up for management of public debt including external debt. As is evidenced by the World Bank statistics summarized in Table-3, positive aspects of Lao PDR external debt, similar to those in Cambodia, include favourable debt service ratio, low share of short-term debt and high share of concessional debt in total debt. However, there were mixed trends of external debt sustainability indicators in Lao PDR in recent years. As judged by some indicators, external indebtedness of Lao PDR improved to some extent in 1999-2003. The external debt to GNI ratio declined from 177 percent in 1999 to 142 percent in 2003, the share of multilateral debt in total debt improved from 42 percent to 50 percent and that of concessional loan in total external debt remained more or less stable around 98 percent over the same period. Level of shortterm debt remained negligible and the country had foreign exchange reserves, equivalent to 5.5 months imports cover in 2003 compared to 2.6 months import cover in 1999. On the other hand, there had been deterioration in some other debt indicators. External debt service (to exports) ratio increased significantly from 7.7 percent in 1999 to 10.4 percent

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in 2003 and the external debt to exports ratio increased from 528 percent to 592 percent over the same period due to poor performance of exports. The share of exports in GNI declined from 34 percent to 24 percent in 1999-2003.

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Table-3 External Debt in Lao PDR (in US$ million) Items Total Debt stock (EDT) Long term debt Public & guaranteed Private non-guaranteed Use of IMF credit Short-term debt Total debt service (TDS) Interest payments (INT) Interest on long term debt Interest on IMF loan Interest on short term debt Gross national income (GNI) Exp.of goods and services (XGS) Workers remittances Imp.of goods & services (MGS) International reserves (RES) Current account balance

1990 1768 1757 1757 0 8 3 9 3 3 0 0 866 105 11 215 8 -55

1999 2527 2471 2471 0 53 3 37 9 9 0 0 1428 479 1 629 135 90

2000 2502 2453 2453

2001 2495 2456 2456

2002 2665 2620 2620

0 42

0 37

0 43

7 41 10 10

2 44 10 10

2 45 11 11

0 0 1657 513 1

0 0 1715 483 1

0 0 1694 434 1

638 144 -8

599 151 -82

505 216 …

488 478 478 0 8 1 151 148 148 0 2.5 0.4 8.0 1.9 0.6 6 2.7 0.3 98 42

517 508 508 0 8 0 145 143 143 0 2.2 0.1 9.1 2.1 0.6 6 3.0 0.1 98 42

614 604 604 0 10 0 157 155 155 0 2.5 0.1 10.4 2.5 0.6 8 5.1 0.1 98 46

31 39 -0.5

28 35 -4.8

26 30 …

2003 2846 2801 2801 0 44 1 50 12 12 0 0 2004 481 1 557 257 …

Sustainability Debt indicators (in percent) EDT/ XGS Long term debt/ XGS Public & guaranteed / XGS Private non-guaranteed/ XGS Use of IMF credit/ XGS Short-term debt/ XGS EDT/ GNI Long term debt/ GNI Public & guaranteed / GNI Private non-guaranteed/ GNI Use of IMF credit/ GNI Short-term debt/ GNI TDS/ XGS INT/ XGS INT/ GNI RES/ EDT RES/ MGS (months) Short-term debt/ Total debt Concessional debt/ EDT Multilateral debt/ Total debt XGS/ GNI ratio MGS/ GNI ratio C/A Balance as % of GNI

1684 1673 1673 0 8 3 204 203 203 0 0.9 0.3 8.6 2.9 0.3 0.5 0.4 0.2 99 15 12 25 -6.4

528 516 516 0 11 1 177 173 173 0 3.7 0.2 7.7 1.9 0.6 5 2.6 0.1 98 42 34 44 6.3

592 582 582 0 9 0 142 140 140 0 2.2 0.0 10.4 2.5 0.6 9 5.5 0.0 98 50 24 28 …

Source: Global Development Finance 2005, World Bank Debt Sustainability Laos faces risks from a high debt burden. Even in high case projection, the NPV of public external debt is above the threshold level for eligibility from debt relief under the Highly Indebted Poor Countries (HIPC) initiatives and others. 25

IMF defines debt sustainability as” a situation in which a borrower is expected to be able to continue servicing its debts without an unrealistically large future correction to the balance of income and expenditure” Lao PDR is trying to restructure the Bilateral debt for reduction of debt burden and uncertainty, to enhance access to export markets in order to increase debt service capacity and to sstrengthening institutional set up for debt management. 5.3 Major Areas of Concerns and Recommendations •

Medium term debt service burden of Lao PDR is manageable with favourable debt service ratio, low share of short-term debt and high share of concessional debt. However, sustainability of debt requires that the country should continue with sound economic policies and reforms, particularly for fiscal reforms and attraction of foreign investment.

•

Lao PDR falls under the high debt stock-high risk category among low-income countries and needs to be prudent in utilization of debt for high return projects.

•

External debt service/exports ratio increased from 7.7% in 1999 to 10.4% in 2003 and is a matter of concern. It is desirable to diversify exports and to encourage nondebt creating financial flows.

•

Lao PDR is potentially eligible for debt relief under HIPC. It is advisable for the country to avail of such facilities from multilateral financial institutions.

•

Despite relatively high economic growth in the recent past, savings and investment ratios of Lao PDR remain low at 17 per cent and 21 per cent of GDP, respectively. It is desirable to encourage savings by creating a conducive macroeconomic environment and establishing efficient institutional set up. It is also necessary to encourage investment by reducing regulatory and entry barriers and the transactions cost for doing business.

•

Government revenue at 12.5 per cent of GDP is low and puts constraints on public expenditures, which is also low at 17 per cent of GDP. It is desirable to continue with sound fiscal and monetary policies to encourage private participation including foreign investment. It is also necessary to take appropriate tax reforms and to strengthen tax administration for enhancing revenue collections.

•

Trade deficit at 15 per cent of GDP in 2004 is also high and vulnerable to external shocks needs to be reduced by encouraging exports.

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•

Current account balance at 10.3 per cent of GDP in 2005 is also high and needs to be reduced to avoid external shocks by broad basing exports and flows on invisibles account.

•

Despite significant reduction in recent years, current inflation rate at more than 9 per cent is high as it hurts everybody particularly the poor whose incomes are not indexed to prices. Containment of inflation should remain high on the agenda of the government. Government should adopt anti-inflationary fiscal and monetary policies.

•

Given a flexible exchange rate regime, exchange rate volatility is one area of concern. It is necessary to manage exchange rate by appropriate monetary policies for orderly movement of exchange rates.

•

Foreign reserves could be increased to more comfortable levels over the medium term and should be monitored regularly.

•

There is high dependency on a limited number of exportable products, which makes the country vulnerable to external shocks. It is necessary to diversify exports and to encourage trade creating foreign investment.

•

It is desirable to develop human resources and institutional framework to take the country forward in a globalised setting.

•

Debt recording system is defunct and it is desirable to urgently get the system back on track to enable proper recording and monitoring of external debt.

•

Financial and capital markets are still at an early stage of development despite improvements made during the past two decades. It is advisable to achieve a sound banking and financial system with more efficient regulation, supervision and legal systems and active use of global standards for capital adequacy requirements, accounting, auditing and disclosure.

•

Weak bond market needs to be developed to boost both savings and investment.

•

Most of the external debts are highly concessional. Yet the external debt has increased sharply in recent years from 69 per cent of GDP in 2003 to 82 percent of GDP in 2004. The rising debt stock and debt service ratios are matter of concern. It is desirable to tighten, streamline and prioritize new borrowings for development needs.

•

External debt is denominated mostly in dollars. Exchange rate depreciation in terms of US dollar may create problems for financing debt services and contingent liabilities for the government. It is advisable to set benchmarks for composition of public debt in terms of domestic and external debt, interest rates and maturity of external debt.

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•

Lao PDR is reluctant to benefit from the HIPC initiative due to fear that it may loose concessional loans/grants provided by some bilateral donors. It will be beneficial for the country to avail of HIPC facilities from multilateral organizations as it will improve capability of the country to take structural reforms and stabilization policies for enhancing efficiency, productivity and competitiveness of industries and to impart dynamism to overall growth process. 1.1.1.1.1.1.1.1 6. Concluding Observations

International best practices for management of external debt leads to the following broad conclusions: (p) Management of external debt is closely related to the management of domestic debt, which in turn depends on the management of overall fiscal deficit. (q) Debt management strategy is an integral part of the wider macro economic policies that act as the first line of defense against any external financial shocks. (r) For an emerging economy, it is better to adopt a policy of cautious and gradual movement towards capital account convertibility. (s) At the initial stage, it may be prudent to encourage non-debt creating financial flows (Foreign Direct Investment and Equity Portfolio) followed by liberalization of long-term and medium-term external debt. (t) Big bullet loans are bad for small economies, as these can create refinancing risk that many countries would be well advised to avoid. (u) 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 attention on surveillance of overall debt- internal and external, private and public. In each of the major Asian crisis economies- Indonesia, Korea and Thailand- weakness in the government balance sheet was not the source of vulnerability, rather vulnerability stemmed from the un-hedged sort-term foreign currency debt of banks, finance companies and corporate sector. (v) 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 advanced economies have experienced how bad banks can lead to large costs to the economy and an unexpected weakening of the government’s balance sheet. Government guarantees of private debt can also have similar adverse impact. (w) It is necessary to adopt suitable policies for enhancing exports and other current account receipts that provide the means for financing imports and debt services.

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(x) Detailed data recording and dissemination are pre-requisites for an effective management and monitoring of external debt and formulation of appropriate debt management policies.

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(y) There is a need to set up an independent Public Debt Office with the following functions:

• •

i.

• • • •

To deal with both domestic & external debt To set bench marks on interest rate, maturity mix, currency mix, composition of debt in terms of domestic and external debt Identification and measurement of contingent liabilities Policy formulation for debt management Monitoring risk exposures Building Models in ALM framework

(z) It is vital that external contingent liabilities and short-term debt are kept within prudential limits. (aa) It is important to strengthen public and corporate governance and enhance transparency and accountability. (bb) It is also necessary to strengthen the legal, regulatory and institutional set up for management of both internal and external debt. (cc) (dd) A sound financial system with well developed debt and capital market is an integral part of a country’s debt management strategy.

Selected References Bandera, Amarakoon (2006a) Regional overview and importance of strengthening debt management strategy, presentations made in Phnom Penh, Cambodia on 20 February 2006 and in Vientiane, Lao PDR on 23 February 2006. ________ (2006b) Recommendations and conclusions on the management of external debt in Cambodia, presentation made in Phnom Penh, Cambodia on 21 February 2006. ________ (2006c) Recommendations and conclusions on the management of external debt in Lao PDR, presentation made in Vientiane, Lao PDR on 24 February 2006. Chhon, Keat (2006) Opening remarks at the National Workshop on Capacity Building for Management of External Debt in the Era of Rapid Globalisation, Phnom Penh, Cambodia 20 February 2006.

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Das, Tarun (2006a) Conceptual issues and debt sustainability, presentations made in Phnom Penh, Cambodia on 20 February 2006 and in Vientiane, Lao PDR on 23 February 2006. _______ (2006b) Intercountry comparisons of external debt and international best practices for management of external debt, presentations made in Phnom Penh, Cambodia on 21 February 2006 and in Vientiane, Lao PDR on 24 February 2006. _______ (2006c) Management of external debt in India and lessons for developing countries, presentations made in Phnom Penh, Cambodia on 21 February 2006 and in Vientiane, Lao PDR on 24 February 2006. ________ (2006d) Management of External Debt- International Experiences and Best Practices, Best Practices series No.9, UNITAR, Geneva. ________ (2006e) Management of Public Debt- International Experiences and Best Practices, Best Practices series No.10, UNITAR, Geneva ESCAP (2005) Implementing the Monterrey Consensus in the Asian and Pacific RegionAchieving Coherence and Consistency, United Nations, New York, 2005. International Monetary Fund (2003) External Debt Statistics- Guide for Compilers and Users, 2003, IMF, Washington D.C. _______ And the World Bank (2003) Guidelines for Public Debt Management: Accompanying Document and Selected Case Studies, 2003, Washington D.C. Naron, Hang Chuon (2006a) Situation analysis and current issues of Cambodian economy with special emphasis on fiscal and debt issues, presentation made in Phnom Penh, Cambodia on 20 February 2006. _______ (2006b) Debt management strategies and issues relating to legal and institutional framework, presentation made in Phnom Penh, Cambodia on 20 February 2006. Saysamone Xaysouliane (2006) Macroeconomic performance, fiscal sustainability and debt management in Lao PDR, presentation made in Vientiane, Lao PDR on 23 February 2006. Taliercio, Rob (2006) External debt and risk management, presentation made in Phnom Penh, Cambodia on 21 February 2006. Thirong, Pen (2006) Issues of external debt management in Cambodia, presentation made in Phnom Penh, Cambodia on 21 February 2006.

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World Bank (2000) Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C.

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