External Debt Management- 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

Total Ext Debt As % of GDP (US$ Bln)

1990-91 1995-96 2000-01 2001-02 2002-03 2003-04 2004-05

83.8 93.7 101.3 98.4 105.0 111.7 123.3

Short term

Per cent

Per cent

Official Creditors 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

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Official Debtors Per cent

Concessional Per cent

60 57 43 44 42 40 39

46 45 35 36 37 36 34

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 Responsibilityand 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. 5

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. Selected References 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.

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

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