Samoa-external Debt Management By Tarun Das-part-1-text

Sustainable External Debt ManagementInternational Best Practices and Lessons for Samoa

Dr. Tarun Das*, Economic Adviser, Ministry of Finance, India And Resource Person, ESCAP, United Nations, Bangkok.

September 2005 _______________________________________________________________________ * This report expresses personal views of the author and should not be attributed to the views of either the Ministry of Finance, Government of India or the UN-ESCAP. The author would like to express his gratitude to the UN-ESCAP and the Ministry of Finance, Government of Samoa to provide an opportunity to prepare this report and the Ministry of Finance, Government of India to grant necessary permission for that.

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Sustainable External Debt ManagementInternational Best Practices and Lessons for Samoa Dr. Tarun Das, Economic Adviser, Ministry of Finance, India And Resource Person, ESCAP, United Nations, Bangkok.

Contents 1. Conceptual Issues 1.1 Definition of external debt 1.2 Debt Sustainability and Fiscal Deficit 1.3 Debt Sustainability and Current Account Deficit 1.4 Liquidity versus Solvency 2. Debt Sustainability Measurements 2.1 Economy wide model in ALM framework 2.2 Different Types of Risk 2.3 Risk Management 2.4 Sustainability Indicators 2.5 World Bank Classification of External debt 3. Inter Country Comparisons 3.1 Top ten debtor countries 3.2 Selected countries in Asia and Pacific 3.3 South Asia, and East Asia & Pacific 4. International Best Practices 4.1 New Zealand 4.2 Australia 4.3 Ireland 4.4 European Union 4.5 Fund-Bank Conditionality 4.6 HIPC Initiatives 4.7 Sovereign Debt Management 5. Management of External Debt in India 5.1 External debt situation in India 5.2 External debt management policies 5.3 Organisational structure 5.4 Contingent liabilities 5.5 Fiscal Responsibility and Budget Management Act 2003 5.6 Monitoring and Dissemination of data 5.7 Capacity building 5.8 Trends of external debt indicators 2

6. Management of external debt in Samoa 6.1 Public external debt in Samoa 6.2 Overall external debt in Samoa 6.3 Lessons from international best practices (a) External Debt Management Policies (b) Capacity Building Selected References Statistical Tables: Annex-1: Economic size of selected economies in 2003 Annex-2-A: Debt Indicators for top ten debtor countries in 2003 Annex-2-B: Indebtedness Classification of top ten debtor countries in 2003 Annex-3: Key indebtedness indicators for selected countries in 2001-2003 Annex-4: Key external debt sustainability indicators for selected countries in 2003 Annex-5: Further external debt sustainability indicators for these countries in 2003 Annex-6: Classification of selected ESCAP countries by levels of external debt and per capita income in 2003 Annex-7: External debt in Samoa

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1. Conceptual Issues Debt sustainability basically implies the ability of a country to service all debts – internal and external on both public and private accounts- on a continuous basis without affecting adversely its prospects for growth and overall economic development. It is linked to the credit rating and the creditworthiness of a country. However, there is no simple answer to the question- what should be the sustainable or optimal level of debt for a country? Before discussing various measures for sustainable debt management, it is useful to clarify certain basic concepts regarding measurement of external debt. 1.1 Definition of external debt The Guide on external debt statistics jointly produced by the Bank for International Settlements (BIS), Commonwealth Secretariat (CS), Eurostat, International Monetary Fund (IMF), Organisation for Economic Co-operation and Development (OECD), Paris Club Secretariat, United Nations Conference on Trade and Development (UNCTAD) and the World Bank and published by the IMF (2003) defines “Gross external debt, at any time, as the amount of disbursed and outstanding contractual liabilities of residents of a country to non-residents to repay the principal with or without interest, or to pay interest with or without principal”. This definition is crucial for collection of data and analysis of external debt: 1. First, it talks of gross external debt, which is directly related to the problem of debt service, and not net debt. 2. Second, for a liability to be included in external debt it must exist and must be outstanding. It takes into account the part of the loan, which has been disbursed and remains outstanding, and does not consider the sanctioned debt, which is yet to be disbursed, or the part of the debt, which has already been repaid. 3. Third, it links debt with contractual agreements and thereby excludes equity participation by the non-residents, which does not contain any liability to make specified payments. 4. Fourth, the concept of “residence” rather than “nationality” is used to define a debt transaction hereby excluding debt transaction between foreign-owned and domestic entity within the geographical boundary of an economy. Besides, while borrowing of overseas branches of domestic entities including banks would be excluded from external debt, borrowing from such overseas branches by domestic entities would b included as part of external debt.

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5. Fifth, it talks of contractual agreements, and excludes contingent liabilities. For a liability to be included in external debt, it must exist at present and must have contractual agreement. 6. Finally, the words “principal with or without interest” include interest free loans as these involve contractual repayment liabilities, and the words “interest with or without principal” include loans with infinite maturity such as recently popular perpetual bonds as these have contractual interest payments liabilities. Two other concepts- one relating to interest payments and another relating to short-term debt need some clarification. While calculating interest, in general an accrual method rather than the actual cash-flow method is used. In general, short-term debt is defined as debt having original maturity of less than one year. However, Southeast Asian crisis highlighted the necessity to monitor debt by residual maturity. Short-term debt by residual maturity comprises all outstanding debt having residual maturity of less than one year, irrespective of the length of the original maturity. Residual maturity concept is distinctly superior to original maturity concept. 1.2 Debt Sustainability and Fiscal Deficit Debt sustainability is closely related to the fiscal deficit, particularly to the primary deficit (i.e. fiscal deficit less interest payments). Sustainability requires that there should be a surplus on primary account. It also requires that the real economic growth should be higher than the real interest rate. Countries with high primary deficit, low growth and high real interest rates are likely to fall into debt trap. 1.3 Debt Sustainability and Current Account Deficit Economic theory states that high fiscal deficit spills over current account deficit of the balance of payments. Persistent and high levels of current account deficit is an indication of the balance of payments crisis and needs to be tackled by encouraging exports and non-debt creating financial inflows. 1.4 Liquidity versus Solvency One important conceptual issue relates to the distinction between debt service problems due to liquidity crunch and those due to insolvency. These concepts are borrowed from the financial analysis of corporate bodies, but there are distinctions between firms and countries (Raj Kumar 1999). If a firm has positive net worth but faces difficulty to meet the obligations of debt service, it is considered to be solvent but to have liquidity problem. When it has negative net worth, it is insolvent. There is difficulty to apply these concepts to a country, as it is difficult to value all the assets of a country such as natural resources, wild life, antics in museum, heritage buildings and monuments. Besides, firms can disappear due to insolvency problems, but a country cannot become bankrupt nor disappear nor are overtaken or merged purely on

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account of financial problems. So we need to consider medium and long term prospects of a country in terms of growth and balance of payments. 2

Debt Sustainability Measurements

There are broadly two approaches to determine debt sustainability of a country. One is to develop a comprehensive macroeconomic model for the medium term particularly emphasizing fiscal and balance of payments problems, and another is to assess various risks associated with debt and to monitor various debt sustainability ratios over time. 2.1 Economy wide model in ALM framework Economy wide model in general is constructed in the Asset and Liability Management (ALM) Framework and is aimed at minimizing cost of borrowing subject to specified risks or to minimize risk subject to specified cost. Benefits of such models are quite obvious in the sense that the model can be used not only for debt management but also for determination of optimal growth, fiscal profiles, medium term balance of payments etc. However, building up such models requires not only huge data but also expertise on the part of modelers for which there may be constraints in developing countries. 2.2 Different Types of Risk There should be a framework that identifies and assesses the financial and operational risks for the management of external debt. Risks can be grouped in three broad heads viz. (A)

External market based risks which include  Liquidity risk  Interest rate risk  Credit risk  Currency risk  Convertibility risk  Budget/ Fiscal risk

(B)

Operational and Management Risks which include  Operational risk  Control systems failure  Financial error risk, and

(C)

Country specific and political risks.

Box-1 provides a brief discussion the nature and implications of these risks.

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Box 1. Risks for Management of External Debt (A) External Market-Based Risks (A1) Liquidity risk. The pledging of reserves as collateral with foreign financial institutions as support for loans to either domestic entities, or foreign subsidiaries of the reserve management entity, renders reserves illiquid until the loans are repaid. Liquidity risks also arise from the direct lending of reserves to projects (particularly in real estate and share markets) with returns in domestic currency or to enterprises, which are subject to shocks in external and domestic markets and are unable to repay their liabilities in time. In fact, one of the major factors leading to East Asian financial crisis in 1997-1998 was that short-term external borrowing was invested in protected or illiquid sectors having low return and long gestation period (real estate and petrochemicals in Indonesia, Thailand, Malaysia), sectors with high or excess capacity having low or negative returns (steel, ships, semiconductors, automobiles in Korea), non-tradable (such as land, office blocks and condominiums in Thailand) that generate return in domestic currency and did not generate foreign exchange; in automobiles and electronics with inadequate attention to profitability, and speculative and unproductive lending in share markets. This created liquidity problem due to maturity mismatch between assets and liabilities of the financial intermediaries. (A2) Interest rate risks. While fixed interest rate has the advantage of having fixed obligations of interest payments over time, there may be a substantial loss in a regime of falling interest rates and global trends of soft interest rates. Solution lies to have a proper mix of variable and fixed interest rates. Losses may also arise on assets from variations in market yields that reduce the value of marketable investments below their acquisition cost. Losses may also arise from operations involving derivative financial instruments. (A3) Credit risk. Losses may arise from the investment of reserves in high-yielding assets that are made without due regard to the credit risk associated with the asset. Lending of reserves by the Central Bank to domestic banks and overseas subsidiaries of reserve management entities, may also expose reserve management entities to credit risk. (A4) Currency risk. Some element of currency risk is unavoidable with external debt. But, there are instances to denominate debt in a few currencies in anticipation of favorable exchange rates. Subsequent adverse exchange rate movements may lead to large losses. (A5) Convertibility risk: Easy convertibility of domestic currency may lead to flight of capital at the slight anticipation of crisis. (A6) Budget/ Fiscal Risk: Fiscal risk may arise from unanticipated shortfalls in revenue or expenditure overruns. Government should consider both budget and off-budget liabilities and try to minimise contingent liabilities, which may represent a significant balance sheet risk for a

government and are a potential source of future fiscal imbalances. Sound public policy requires that a government needs to carefully manage and control the risks of their contingent liabilities. The most important aspect of this is to establish clear criteria as to

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when government guarantees will be used and to use them sparingly. Experience in the industrialised countries suggests that more complete disclosure, better risk sharing arrangements, improved governance structures for state-owned entities and sound economic policies can lead to substantial reductions in the government’s exposure to contingent liabilities. (B) Operational and Management Risks (B1) Operational Risk is the risk that arises from improper management systems resulting in financial loss. It is due to improper back office functions including inadequate book keeping and maintenance of records, lack of basic internal controls, inexperienced personnel, and computer failures. Probability of default is high with inadequate operational and management systems. (B2) Control system failure risks arise due to outright fraud and money laundering because of weak or missing control procedures, inadequate skills, and poor separation of duties. (B3) Financial error risk. Incorrect measurement and accounting may lead to large and unintended risks and losses.

(c) Country specific and political risks influence multinational companies choice between exports and investments, and act as deterrents for foreign investment, whereas scale economies, lower wages, fiscal incentives, high yields, trade openness and agglomeration effects stimulate non-debt creating financial flows. Foreign capital is attracted by countries which allow free repatriation of capital and profits, and donot insist on appropriation of private capital in public interest.

2.3 Risk Management Although there is no unique solution to tackle various types of risk, general risk management practices of the government aim at minimizing risk for government bodies and public enterprises. These include development of ideal benchmarks for public debt and monitor and manage credit risk exposures. Typical risk management policies are summarized in Table-1. Table-1 Policies for Risk Management Type of Risk 1. Liquidity risk

Risk Management Policies (a) (b) (c) (d) (e) (f) (g) (h)

Monitor debt by residual maturity Monitor exchequer cash balance and flows Maintain certain minimum level of cash balance Maintain access to short-term borrowing But, fix limits for short-term debt Pre-finance maturing debt Do not negotiate for huge bullet loans Smooth the maturity profile to avoid bunching of debt services

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2. Interest rate risk 3. Credit risk

(i) (j) (k) (l) (m) (n) (o)

4. Currency risk

5. Convertibility risk

(p) (q) (r) (s) (t) (u) (v) (w) (x)

(y)

(z) 6. Budget Risk

(aa) (bb) (cc) (dd) (ee) (ff) (gg)

7. Operational risks

Develop liquidity benchmarks Fix benchmark for ratio of fixed versus floating rate debt Maintain ratio of short-term versus long-term debt Use interest rate swaps Have credit rating of various scrips by major credit rating organizations such as S&P’s, Moody’s, Japan Bond Research Institute etc. Identify key factors that determine credit-rating Develop a culture of co-operation and consultation among different departments and with credit rating organisations Set overall and individual counter-party credit limits Fix benchmark for the ratio of domestic and external debt Fix ratios of short-term and long-term debt Fix composition of currencies for external debt Fix single currency and currency pool debt Use currency swaps and have policies for use of market derivatives Try to have natural hedge by linking dominant currency of exports and remittances to the currency denomination of debt It is better to have gradual and cautious approach towards capital account convertibility. The liberalisation of capital accounts should be done in an orderly manner in line with the strengthening of domestic financial systems through adequate prudential and supervisory regulations. The golden rule is to encourage initially non-debt creating financial flows (such as foreign direct investment and portfolio equity investment) followed by long term capital flows. Short term or volatile capital flows may be liberalised only at the end of capital account convertibility. Enact a Fiscal Responsibility Act. Put limits on debt outstanding and annual borrowing as a percentage of GNP or GDP Use government guarantees and other contingent liabilities (such as insurance and pensions etc.) judiciously and sparingly Fix limits on contingent liabilities Fix targets on fiscal deficit and primary deficit Fix limits on short term borrowing Monitor debt service payments

(hh) Allow independence and transparency of different offices (such as front, back, middle and head offices) dealing with public debt (ii) Strengthen capability of different offices (jj) Try to achieve general political consensus in policy formulations.

8. Country specific (kk) Have stable and sound macro-economic policies and political risk (ll) Have co-ordination among monetary and fiscal authorities

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(mm)Try to achieve general political consensus for policy formulation. 2.4 Sustainability Indicators Debt sustainability indicators are the most widely used ratios for debt management. These indicators express outstanding external debt and debt services as a percentage of gross domestic product or other variables indicating the strength of the economy. Some commonly used debt sustainability indicators are given in Table-2. Table-2: Debt Sustainability Indicators Purpose 1. Solvency ratios

2. Liquidity monitoring ratios

Indicators (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n)

3. Debt burden ratio

4. Debt structure indicators

(o) (p) (q) (r) (s) (t) (u) (v)

Interest service ratio – the ratio of interest payments to exports of goods and services. External debt to GDP ratio External debt to exports ratio External debt to revenue ratio Present value of debt services to GDP ratio Present value of debt services to exports ratio Present value of debt services to revenue ratio Basic debt service ratio- Ratio of debt services (both interest payments and repayments of principal) on long term debt to exports of goods and services. Cash-flow ratio for total debt or the total debt service ratio (i.e. the ratio of total debt services to exports of goods and services) Interest payments to reserves ratio. Ratio of short-term debt to exports of goods and services Import cover ratio- Ratio of total imports to total foreign exchange reserves. International reserves to short-term debt ratio Short-term debt to total debt ratio Total external debt outstanding to GDP (or GNP) ratio Total external debt outstanding to exports of goods and services ratio Debt services to GDP (or GNP) ratio Total public debt to budget revenue ratio Ratio of concessional debt to total debt Rollover ratio- ratio of amortization (i.e. repayments of principal) to total disbursements Ratio of interest payments to total debt services Ratio of short-term debt to total debt

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5. Public sector indicators

(w) (x) (y) (z) (aa) (bb)

Public sector debt to total external debt Public sector debt services to exports ratio Public sector debt to GDP ratio Public sector debt to revenue ratio Average maturity of non-concessional debt Foreign currency debt over total debt

6. Financial sector indicators

(cc)

Open foreign exchange position- Foreign currency assets minus liabilities plus long term position in foreign currency stemming from off-balance sheet transactions Foreign currency maturity mismatch Ratio of foreign currency loans for real estate to total credits given by the commercial banks External sector related contingent liabilities Trends of share market prices GDRs and Foreign currency convertible bonds issued Inflows of foreign direct investment and portfolio investment

(dd) (ee) (ff) (gg) (hh) (ii) 7. Corporate sector indicators

(jj)

Leverage (debt/ equity ratio)- Ratio of normal value of debt over equity (kk) Interest to cash flow ratio (ll) Short-term debt to total debt (mm) Return on assets (nn) Exports to total output ratio (oo) Net foreign currency cash flow (pp) Net foreign currency debt over equity

8. Dynamic ratios

(qq) Average interest rate/ growth rate of exports (rr) Average interest rate/ growth rate of GDP (ss) Average interest rate/ growth rate of revenue (tt) Change of PV of debt service/ change of exports (uu) Change of PV of debt service/ change of GDP (vv) Change of PV of debt service/ change of revenue Source: Raj Kumar (1999) and IMF (2003) 2.5 World Bank Classification of External debt On the basis of ratio of PV to GNI and PV to XGS (exports of goods and services), the World Bank in their report on Global Development Finance 2005 has classified countries into three categories viz. low indebted, moderately indebted, and severely indebted countries as indicated in Table-3. While PV takes into account all debt servicing obligations over the life span of debt, GNI indicates country’s total potentials and XGS

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indicates foreign exchange earnings reflecting debt-servicing ability. Countries are also classified into low and middle income depending on the level of per capita income.

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Table-3 Cross classification of countries by income level and indebtedness

Indebtedness → Income Level ↓ Low income: GNI per capita less than US$765 Middle income: GNI per capita between US$766 and US$9,385

Severely Indebted Either PV/XGS > 220% Or PV/GNP > 80%

Moderately Indebted Either 132%
Less Indebted Both PV/XGS<132% and PV/GNP<48%

Severely Indebted Low income (SILI)

Moderately Indebted Low income (MILI)

Less Indebted Low income (LILI)

Severely Indebted Middle income (SIMI)

Moderately Indebted Middle income (MIMI)

Less Indebted Middle income (LIMI)

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Inter Country Comparisons

3.1 Top ten debtor countries Annex-2-A and Annex-2-B provide key debt indicators for top ten debtor countries in the world. It is observed that Brazil tops the list in terms of total external debt followed by China, Russian Federation, Argentina, Turkey, Mexico, Indonesia, India, Poland and Philippines in the order mentioned. It may be noted that out of ten top debtor countries in the world, the majority of the countries (viz. Russian Federation, China, Turkey, Indonesia, India and Philippines) are from the continent of Asia, and three countries (viz. Brazil, Argentina and Mexico) belong to Latin America, and only one country (i.e. Poland) belongs to Europe. Brazil, Argentina, Turkey and Indonesia are classified as severely indebted countries, whereas Russian Federation, Poland and Philippines are moderately indebted and China, Mexico and India are less indebted. India’s position has improved over the years. India ranked first in terms of total external debt in 1980, but it position improved to third in 1990 and further to eighth in 2002-2003. 3.2 Selected countries in Asia and Pacific Table-4 classifies the selected countries by the levels of per capita income and external indebtedness. Bhutan, Kyrgyz Republic, Lao PDR, Myanmar and Tajikistan are classified as severely indebted low income (SILI) countries, while Indonesia, Kazakhstan, Maldives, Samoa and Turkey fall under the category of severely indebted middle income (SIMI) countries. Detailed analysis of external debt by creditor classification, currency composition, maturity mix, sectoral distribution etc. in Samoa is presented in section 6. It also provides debt management operations and systems in Samoa and lessons from international best practices.

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Table-4: Classification of selected countries in ESCAP by levels of external indebtedness And per capita income in 2003 Severely indebted Low income SILI Bhutan Kyrgyz Rep Lao PDR Myanmar Tajikistan

Moderately indebted

Middle income SIMI Indonesia Kazakhstan Maldives Samoa Turkey

Low income MILI Cambodia Mongolia Pakistan PN Guinea Solomon Island Uzbekistan

Less indebted

Middle income MIMI Malaysia Philippines Russian Fed Sri Lanka Turkmenistan

Low income LILI Bangladesh India Nepal Vietnam

Middle income LIMI Armenia Azerbaijan China Fiji Iran Ism Rep Thailand Tonga Vanuatu

3.3 South Asia, and East Asia & Pacific Table-5 indicates that despite severe foreign exchange and financial crisis at the end of 1990s, East Asia and Pacific countries as a group achieved significant improvement in the external debt burden in 1990-2004. South Asian countries as a group also improved their debt situation. South Asia has higher shares of multilateral and concessional debt than those in East Asia and Pacific. On the other hand, the ratio of reserves as a percentage of external debt is much higher in East Asia and Pacific than in South Asia despite significant improvement in the ratio in South Asia over the period. Table-5 : Trends of Key Debt Indicators Key external debt indicators

EDT/XGS (%) EDT/GNI (%) TDS/XGS (%) INT/XGS (%) INT/GNI (%) RES/EDT (%) RES/MGS (months)

Short-term/ EDT (%) Concessional/ EDT (%) Multilateral/ EDT (%)

East Asia and Pacific 1980 1990 2000 2004

1980

South Asia 1990 2000

2004

179 17 27 14 1 51 9 23 19 9

154 16 12 5 1 40 6 7 73 25

303 31 28 15 2 7 2 10 55 31

113 23 10 4 1 78 10 4 52 36

132 36 18 7 2 31 5 16 29 15

78 32 11 4 2 57 6 13 21 13

49 24 8 2 1 141 8 27 21 12

Notes: EDT = External debt outstanding, GNI = Gross national income TDS = Total debt services, INT = Interest payments XGS = Exports of goods and services, MGS = Imports of goods and services RES = Foreign exchange reserves, Short term = Short term debt Concessional = Concessonal debt, Multilateral = Multilateral debt

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155 27 15 6 1 30 5 4 50 38

3.3.1.1.1.1.1.1 International Best Practices 3.4 New Zealand The New Zealand Debt Management Office (NZDMO) is responsible for the management of public debt since the separation of debt management policy from monetary policy in 1988. Although NZDMO is placed in a division in Treasury, it maintains some degree of autonomy from the rest of the government and has its own advisory board. The board meets at least four times a year and consists of a senior member of the Treasury and experts in risk management. The board provides advice and oversight on wide range of issues relating to operational risk management and promotes transparency in debt management policies and supervision. The treasurer or the head of the NZDMO recommends benchmarks for sovereign debt in terms of currency mix and interest rate sensitivity, and trading limits imposed on the portfolio manager. The basic objective of the NZDMO is to identify a low risk portfolio of net liabilities consistent with the government’s aversion to risk and expected costs for risk reduction. In order to minimize the net risk exposure, the NZDMO has set the duration and currency profile of the liabilities to match its assets. As most of the government assets are denominated in New Zealand dollars, the strategy has entailed gradual elimination of net foreign currency debt (which was achieved in September 1996) and lengthening maturity of domestic debt. Assets and liabilities are monitored on daily basis and the model also incorporates private sector debt management practices. The actual performance of portfolio managers is evaluated against the benchmark portfolio on daily basis. Over these years NZDMO has undertaken considerable amount of works relating to analysis and management of the government liabilities within an Asset and Liability Management (ALM) framework (Anderson 1999). It has developed both economy wide models and specific models for the management of public debt. In the wider model, basic objective is to construct a debt portfolio, which aims at hedging the economy as a whole against shocks to national income or net worth. It requires information on the nature and degree of private hedging mechanisms, which are highly dispersed and very expensive to collect. Therefore, NZDMO concentrates on the management of the government assets and liabilities. It has improved accounting principals and has adopted generally accepted accounting and auditing practices. In recent times, focus has been on maximizing returns and minimizing costs of assets and liabilities using the modern portfolio theory. In contrast to earlier works, it does not include physical assets that do not directly produce returns. The model estimates the relationship between the values of various asserts classes (e.g. equities, real estate etc,) and various government liabilities (e.g. debt and the undefended pension liabilities). To reflect the Crown’s total portfolio, the model also includes the measures of the Crown’s future tax revenues and future social expenditure liability. 15

ALM relates essentially to the management of market risk and derivatives are used to achieve desired outcomes. On the basis of ALM modeling, NZDMO specifies benchmarks for various sustainability indicators such as ratio of domestic and external debt, ratio between debts with floating and fixed interest rates, currency mix, maturity mix, limits on short term debt, interest rates etc. Like many sovereign debt management agencies the NZDMO is committed to the principles of transparency, neutrality and even-handedness in its activities. The experience of NZDMO (Anderson 2000) leads to the following conclusions: (a) ALM framework is conceptually appealing but requires huge data. (b) It is relatively easy to include all financial assets and liabilities. (c) The extension of ALM to physical assets and non-traded sovereign instruments raises a number of issues and practical difficulties. (d) ALM framework is only one component of prudent debt management. Measures to manage other risks, particularly refinancing, liquidity, and operational risks need to be established. However, gains in risk management and cost reduction are considerable. 3.5 Australia The Australian Office of Financial Management (AOFM) established on July 1, 1999 is an independent agency within Treasury and a specialised office to manage Australian government’s debt position (McCray 2000). However, it has important practical linkages with the parent departments. Its major task is to identify, measure, monitor and analyze all kinds of risk, particularly market risk, funding/ liquidity risk, credit risk, operational risk etc. AOFM recognizes that capital account convertibility and liberalisation of trade and financial flows present both opportunities and challenges for debt management. Opportunities lie in accessing a truly global and expanded market for debt with potentially low cost. However, risks arise due to increased financial market volatility and internationally mobile creditors and investors leading to vulnerability of debt service costs, market exposures of debt portfolio and balance sheet net worth. Australian government introduced accrual budgeting and accounting systems to tackle risks and contingent liabilities. There is an increasing emphasis on outcomes-oriented approach to performance reporting, public sector transparency and accountability, and focus on net worth and risks to net worth. A comprehensive risk management framework encompassing funding, market, credit, liquidity and operational risks provide the basis for a coherent and objective planning for debt. A unique feature of the Australian debt management is that the basic organisational structure, staffing numbers, skill net, financial resourcing, delegation powers and

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accountability arrangements within AOFM had practically remained unchanged since its inception. 3.6 Ireland The National Treasury Management Agency (NTMA) in Ireland is an independent public debt office and is in charge of management of all public debt- either internal or external and also all contingent liabilities (such as savings schemes of the government, pension, provident and insurance funds). The benchmarks are designed in consistent with the annual debt-service budget within which the NTMA has to operate. As such the review of the benchmark is annual and matches the budget cycle. At the beginning of the year, NTMA signs a Memorandum of Understanding (MOU) with the Finance Minister and specifies benchmarks for various parameters such as extent of internal and external loan, currency mix, maturity mix, interest rare mix etc. These benchmarks are developed after careful examination and measurement of various risks such as liquidity, debt refinancing, maturity of debt etc. MOF does not interfere with the day-to-day working of the NTMA, which has distinct front, back, middle and head offices and dealing rooms. The NTMA attempts to beat the benchmark both by funding at different dates than the benchmark stipulations in order to take advantage of favourable market conditions, and by issuing at different maturities within the broad guidelines regarding proportions of foreign currency and floating rate debt. The performance of the NTMA is evaluated at the end of the year in terms of actual and benchmark portfolios and costs. If NTMA performs better than the benchmarks agreed in the MOU, it retains the profits of debt management. Over the years, NTMA has emerged as a highly technical, efficient and profitable organisation in debt management. 3.7 European Union The Maastricht Treaty of the European Union set up the framework for the European Monetary Union, which includes introduction of common currency – the Euro. The Treaty also sets out four convergence criteria to achieve price stability, fiscal prudence and debt sustainability. These include the following: (1) Average consumer price inflation should be sustainable and, in the year prior to examination, should not be more than 1.5 percentage points over that of, at most, the three best performing countries. (2) The country should not have an excessive deficit. Prima facie a government’s budget deficit should not exceed 3% of GDP, and (3) Its debt should not be more than 60% of GDP. (4) Average nominal long-term interest rates should not exceed, by more than two percentage points the long-term interest rates of, at most, the three best performing member states in terms of price stability.

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Individual countries within European Union have developed independent debt management systems and procedures within these broad principles. Several countries have developed benchmarks for currency composition and maturity mix of external debt. Institutional constraints that limit influence the benchmarks include limiting currency composition of foreign debt to that of reserves portfolio (e.g. United Kingdom) and maintaining a fixed percentage of foreign exchange in a specific currency such as the ECU to develop debt market of that currency (e.g. France and Italy). In Sweden, the benchmark serves as the limit within which the foreign currency debt may be exposed to currency and interest rate risks. The Sweden debt Office (SNDO) lays down the risk limits and takes position in the foreign exchange and bond markets to bring the long-term cost of the debt below that of benchmark portfolio. The currency composition of the benchmark primarily matches the weights of the currencies in the ECU basket while US dollar and Japanese Yen are included in the portfolio for diversification. The SNDO may deviate from the currency mix benchmark by 3 percentage points, and that for duration benchmark by 0.5 percentage points. The interest rate structure of the benchmark is based on diversified borrowing along the yield curve to reduce shocks to specific parts of the yield curve and to reduce bunching of debt payments over time. In Denmark, benchmarks for various indicators and the maximum level of deviations from the benchmarks are specified. In Hungary, the debt management office located in the Ministry of Finance is responsible for servicing the cost of the net sovereign external debt. The authorities align the currency composition of the external debt through hedging operations with that of the currency basket to which the national currency is pegged. Emphasis is placed on lengthening the maturing of the debt, maintaining more than three quarters of the debt in fixed rate instruments, and evenly spreading debt redemptions to avoid rollover risks. 3.8 Fund-Bank Conditionality Countries seeking finances from the multilateral financial institutions like the IMF, IBRD, ADB and others have to satisfy certain conditionalities in terms of fiscal prudence, monetary discipline, sustained debt and balance of payments situation and price stability. For instance the Fund’s Structural Adjustment Facility (SAF), the Enhanced Structural Adjustment Facility (ESAF) and Stand-by Arrangement specifically provide limits on the extent of borrowing that countries can contract within any year and specify the types of borrowing a country can resort to. Non-compliance of these limits or performance criteria will usually result in withholding of further disbursement. In many cases, conditionalities imposed by the multilateral organizations helped debtor countries to implement structural reforms and stabilization policies, which were long over due. India is a case of successful reforms. Since June 1991 India had undertaken credible reforms in trade, industry, investment, fiscal and financial sectors, which were not

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possible in tranquil economic situation. In fact, conditions agreed to external donors after the Gulf crisis in 1990 helped India to come out of a severe balance of payments crisis and to avoid default on external debt payments. Major conditionalities included devaluation of Indian rupee, full convertibility on current account, partial convertibility on capital account, reduction of fiscal deficit, reduction of customs duties, rationalization of user charges for public goods and services, downsizing the government, privatization, decentralization, deli censing, deregulation and anti-corruption strategies. India was able to come out of the crisis without debt write-off or rescheduling of external debt. At the same time, India moved on a higher growth path with less inflation, less poverty, more employment and higher real wages. Fund-Bank in association with other international financial organizations are attempting to implement a new financial architecture to tackle volatile financial flows and to prevent money laundering. India along with other developing countries welcomed the establishment and implementation of internationally accepted standards and codes to promote financial stability, but urged that there should be a clear prioritization among the proliferating population of standards and that the acceptance by developing countries should remain voluntary and should not form a part of IMF conditionalities. 3.9 Heavily Indebted Poor Country (HIPC) Initiatives The HIPC Initiative was launched by the World Bank and the IMF in 1996 (and latter enhanced in 1999) as a comprehensive effort to eliminate unsustainable debt in the world’s poorest and heavily indebted countries. The initiative was designed to help the HIPCs that show a strong track record of economic reforms and adjustment, to achieve a sustainable debt position in the medium term through the provision of debt relief to these countries. It was perceived that an efficient management of public debt was the most important factor leading to unsustainable debt position. Together with sound macroeconomic policies, prudent debt management in the HIPCs remains central to ensuring durable exit from the unsustainable debt burden. A recent survey by the staff of the World Bank and the IMF revealed that there are several weaknesses in key aspects of debt management in the HIPCs, particularly in the design of their legal and institutional framework and coordination among several organizations for performing basic debt management functions (IMF and World Bank 2003). Institutional weakness is due to insufficient human, technical and financial resources, which need urgent corrections. In addition, transparency and accountability in debt management, including public access to debt information, requires strengthening. 3.10Sovereign Debt Management While organizing the Second Forum on Sovereign Debt Management in November 1999, World Bank conducted a survey on sovereign debt management in the countries participating in the Forum. The results of the survey summarised in Table-6 are revealing and self-explanatory.

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Table-6 World Bank Survey on Second Sovereign Debt Management Forum Percentage in total respondents

Items 1. Debt management objectives and priorities (a) Minimise financial costs and risks (b) Funding management (c) Management of debt (d) Development of financial markets (e) Others 2. Establishment of benchmarks for risk management (a) Countries establishing guidelines for risk management (b) Countries establishing benchmarks for foreign currency debt (c) Countries establishing benchmarks for portfolio performance (d) Countries establishing benchmarks for domestic currency debt 3. Risk management guidelines (a) Limit currency risk (b) Avoid excessive short-term debt / to smooth maturity profile (c) Debt in least volatile currency (d) Limit on debt with floating interest rate (e) Debt matching reserves (f) Others 4. Analytical techniques for undertaking risk analysis (a) Not using any analytical techniques (b) Value-at-Risk (VAR)/ Cost-at-Risk (CAR) (c) Debt sustainability indicators (d) Others 5. Constraints for establishing benchmarks (a) Lack of debt management policy (b) Lack of debt management expertise (c) No access to financial markets (d) Lack of debt monitoring (e) Difficult economic environment (f) Others 6. Use of derivatives to hedge currency and interest rate risks (a) Currency swaps (b) Interest rate swaps (c) Use of exchange commodity futures and options 7. Constraints for using derivatives (a) Lack of technical knowledge (b) Undeveloped financial markets (c) Legal constraints

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38 26 15 9 13 45 24 21 13 35 29 24 18 12 18 32 23 16 29 23 23 13 10 10 21 31 24 7 71 17 12

Percentage in total respondents

Items 8. Institutions managing the foreign currency debt (a) Ministry of Finance (b) Jointly by the Ministry of Finance and the Central Bank (c) Central Bank (d) Independent Debt Office 9. Coordination of both public and public debt (a) Ministry of Finance (b) Jointly by the Ministry of Finance (MOF) and the Central Bank (CB) (c) Partly by MOF and partly and independently by the CB (d) Debt Management Committee 10. Highest authority for approval of foreign currency debt Dom.debt (a) Finance minister/ Governor of the Central Bank 72 (b) Parliament 6 (c) Interministerial board 8 (d) President/ Prime Minister 6 (e) DG of independent authority 8 11. Average time taken for approval of external debt (a) One day or less (b) Less than a week (c) More than a week, but less than three months (d) More than three months 12. Management of Contingent liabilities (a) Subnational entities are allowed to raise their own funding abroad (b) Central govt provides explicit guarantees for IBRD loans (c) Central govt bears fully the exchange rate risk for IBRD loans (d) Central govt shares partially the exchange rate risk 13. Efficiency of Middle Office (a) Use of Market Information system (MIS) (b) Access to internet (c) No Middle Office Unit (d) Distinct Middle Office Unit (e) Middle Office placed under the direction of the Front Office 14. Main constraints for external debt management (a) Lack of proper organisational structure (b) Macroeconomic risk (c) Lack of technical staff in the middle office (d) Lack of technical staff in the back office (e) Lack of legal framework (f) Limited local debt market Source: Fred Jensen (2000) as given in World Bank (2000)

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51 30 11 9 35 24 24 18 Ext.debt 49 21 12 9 9 10 13 65 13 69 68 41 11 76 91 43 43 3 31 14 12 6 6 6

5. Management of External Debt in India 5.1 External Debt Situation in India Although India’s external debt increased from US$83.8 billion at end-March 1991 to US$123.3 billion at end-March 2005, as percentage to GDP it declined from 28.7 per cent to 16.7 per cent over the period (Table-7). External debt is predominantly long-term. The share of short-term debt in total debt declined from 10.2 per cent in 1990-91 to 5.7 per cent in 2004-05. 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-7 and Table-8) implying inflows of more private and commercial debt. This must have enhanced the cost of external borrowing. Table-7: Trends of external debt of India Year End 1990-91 1995-96 2000-01 2001-02 2002-03 2003-04 2004-05

Total Ext As % of Debt GDP (US$ Bln) Per cent 83.8 93.7 101.3 98.4 105.0 111.7 123.3

Short Official Official Conceterm Creditors Debtors ssional Per cent Per cent 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

Table-8 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

March 1991 28 36 17 23

March 2005 26 17 26 34

Total

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-9). 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.

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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. Table-9 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-10 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

5.2 External Debt Management Policies 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.

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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 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). 5.3 Organisational structure 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

24

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, 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. 5.4 Contingent liabilities As discussed earlier, in addition to direct liabilities for external debt, government of India has various contingent liabilities in terms of government guarantees for the loans taken by the public enterprises, exchange rate risk and guarantees given to the first track large power projects by the independent power producers. During 1990s, as percentage of GDP, there was a steady decline of the contingent liabilities of the central government (from 7.8% to 4.2%), but an increase in the liabilities of the states (5.7% to 7%) (Das, Bisen, Nair and Kumar 2001). Many states initiated measures to contain the growth of

25

guarantees. These include selectivity in providing guarantees, disclosing comprehensive information in budgets, setting up guarantee redemption funds, fixing statutory limits on guarantees and charging guarantee commissions on outstanding amounts. In the external sector, Government provided guarantees to the external loans taken by the public sector enterprises, fast track private power projects and oil and gas exploration companies. There was a steady decline in Government guarantees from $10.6 billion at end-March 1995 to $6.6 billion at end-March 2005. Sectoral distribution of Government guarantees indicates a growing share of guarantees extended to power (from 21.7% in 1994 to 52.7% in 2000) and housing (3.0% to 10.7%), but declining shares of petroleum (31.6% to 18.2%), civil aviation (17.2% to 4.3%) and aluminium (8.2% to 0.3%). In addition to loan guarantees by the government, RBI provided exchange rate guarantees until 1993 for attracting deposits from the non-resident Indians (NRIs). Other instances of exchange

guarantee were the Resurgent India Bonds (RIBs) launched by the State Bank of India (SBI) in August 1998 and the India Millennium Deposits (IMD) floated by the SBI in October-November 2000 for raising resources from the NRIs. Funds mobilised through RIBs were US$ 4.23 billion and those by IMDs were US$ 5.51 billion. As per the agreement, in the event of rupee depreciation, the loss up to 1% per annum would be borne by the SBI and the balance by the Government. In addition to above, contingent external liabilities arise in normal operations by the commercial and development banks, corporate bodies and the Export Import (EXIM) Bank of India for providing performance and loan guarantees, bonds, letters of credit, forward exchange contracts, underwriting commitments, deferred payment guarantees, bill discounting and exchange risk for Foreign Institutional Investment and NRI deposits. 5.5 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 progressive reduction of this limit by at least one percentage point of GDP in each subsequent year. No government guarantee in excess of 0.5% of GDP in any financial year.

26

• •

Greater transparency in the budgetary process, rules, accounting standards and policies having bearing on fiscal indicators. Quarterly review of the fiscal situation 5.6 Monitoring and dissemination of data

100% government debt data and 78% 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. 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. 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 (www.nic.in/finmin/miscellaneous).

5.7 Capacity Building 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. Expert Groups submitted the following reports:

27

(1) Report on Monitoring of Non-Resident Indian Deposits. (2) Report on Monitoring of Short-term External Debt. (3) Report on Monitoring of non-debt financial flows. (4) Report on Measurement of External Sector Related Contingent liabilities. (5) Report on Modeling Sovereign External Debt and External Debt Sustainability. (6) Report on Middle Office for Public Debt (7) Report for the Establishment of the Centre of Excellence for Training. 5.8 Trends of External Debt Indicators All these measures paid rich dividends. There has been a significant improvement in the external sector. India overcame a severe balance of payments crisis without any debt write-off. Subsequently, India was able to prepay $7.2 billion of external debt to the multilateral funding agencies and bilateral countries during 2002-03 and 2003-04. Total foreign exchange reserves increased from US$1 billion, equivalent to two weeks’ imports in June 1991 to US$142 billion equivalent to 20 months of imports in March 2005. The current account balance, which recorded a deficit of 3.1 percent of GDP in 1990-91, had a surplus since 2001-02. Foreign investment inflows improved from total of US$1 billion in 1980s to $40 billion in 1990s due to stability of the exchange rate, continual reforms in infrastructure and liberalisation of foreign investment policies. External debt indicators also showed steady improvement. In terms of stock of external debt, India’s position improved from the third rank after Brazil and Mexico in 1990 to the eighth rank after Brazil, China, Argentina, Russian Federation, Mexico, Turkey and Indonesia in 2003 (Annex-2-A). 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”. Table-11 Debt sustainability indicators for India during 1990-2005 (per cent) Year

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

Debt service ratio

Debt/GDP ratio

35.3 30.2 26.2 16.2 16.2 6.1

28.7 38.7 27.0 20.3 17.8 16.7

Debt/ Current Receipts ratio 329 312 189 110 99 95

Concessional debt to Total debt ratio 46 45 45 37 36 35

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Short Term to Total debt ratio 10 8 5 4 4 6

Short Term 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

Interest to current receipts ratio 16 13 9 6 4 2

6. Management of External debt in Samoa 6.1 Public external debt in Samoa The Ministry of Finance of the government of Samoa is in charge of the management and recording of both domestic debt and external debt of the government, while the Central Bank of Samoa is in charge of the management and recording of the private external debt. Within the Ministry of Finance, two independent divisions viz. the Aid Co-ordination Division and the Accounts Division deal with external debt and domestic debt respectively. As in the case of India, the Government of Samoa uses the Commonwealth Secretariat Debt Recording and Management System (CS-DRMS). The Debt Management Unit in the Ministry of Finance is in charge of keeping records, monitoring debt and making analysis of trends. It is specifically entrusted with the following duties and functions: • To keep accounts of government external debt. • To maintain consolidated database under the CS-DRMS. • To make forecasts and produce quarterly updates on government external debt. • To project and execute debt servicing for external loans. • To assist in preparing and finalizing subsidiary loan agreement. Presently, external debt of Samoa is managed according to the provisions and guidelines under the Public Finance Management Act (PFMA) 2001. According to this Act, before raising any loan the Finance Minister has to ensure that the access to foreign funds is in public interest, consistent with government policies, in accordance with principles of responsible fiscal management, and the government has the financial ability to meet the attendant obligations for repayment of debt and payment of interests. Table-12: Government External Debt in Samoa

1997 Total Debt stock (EDT) Multilateral Bilateral Gross Domestic Product (GDP) Exports of goods and services (XGS) International reserves (RES) EDT/ GDP (per cent) EDT/ XGS (per cent) EDT/ RES (per cent) Multilateral/ EDT (per cent) Bilateral/ EDT (per cent)

1998 1999

142.2 130.4 11.8 226.3 70.2

(in million US dollars) 2000 2001 2002

2003

147.1 147.0 143.7 141.7 147.8 162.2 128.2 135.1 149.4 135.4 135.7 129.8 13.5 12.7 12.8 11.7 11.3 13.9 219 229.1 228 234.9 275.1 341.2 76.6 85.9 100.6 75.7 79.3 70.3 57.1 60.7 60.6 55.7 49.2 55.6 73.5 Key external debt sustainability indicators (in per cent) 62.8 67.2 64.2 63.0 60.3 53.7 47.5 202.6 194.3 185.4 204.4 185.0 172.1 161.2 249.0 242.3 242.6 258.0 288.0 265.8 220.7 91.7 92.0 92.3 90.3 90.5 91.4 92.1 8.3 8.0 7.7 9.7 9.5 8.6 7.9

2004 168.5 156.0 12.5 389.9 110.5 82.3 43.2 152.5 204.7 92.6 7.4

Source: Ministry of Finance, Government of Samoa

Ministry of Finance has fairly detailed information on government external debt. Trends of government external debt, as per statistics provided by the Ministry of Finance, are 29

given in Table-12. It may be observed from the table that the ratio of government external debt to GDP has declined continuously 67.2 per cent in 1998 to 43.2 per cent in 2004, while that to exports of goods and services declined from 203 per cent to 152 per cent, and that to foreign exchange reserves declined from 249 per cent to 205 per cent during the same period. As regards creditors sources of multilateral debt, Asian Development Bank has a share of 52 per cent in the outstanding public debt followed by IDA (39 per cent), European Union (5 per cent) and OPEC and IFAD (2 per cent each). As regards creditor sources of bilateral debt, China has a predominant share of 94% followed by Saudi Arabia at a distant second with a share of 4% and France 2%.

Saudi France Fund 2%4%

IFAD EU 2% 5%

IDA 39%

ADB 52%

OPEC 2%

EU

ADB

OPEC

IDA

China 94%

IFAD

China

Figure-1: Creditor Sources of Multilateral Debt

France

Saudi Fund

Figure-2: Creditor Sources of Bilateral Debt

Maturity mix given in Table-13 indicates that 93 per cent of loans are concentrated in the upper end of maturity. As regards sectoral distribution (Table-14), infrastructure development has the highest share (34 per cent) in total debt followed by agriculture (18%), telecommunications (11%), industry (10%), and power (10%). SDR is the predominant currency followed by US dollar (Table-15). Table-13 Maturity Mix of Govt Debt Maturity % of Debt

Table-14 Sectoral distribution of govt debt Sectors % of Debt

1-2 years > 2-4 years > 4-5 years > 5-10 years > 10-15 years > 15yars Total

1. Infrastructure 2. Agriculture 3. Telecommunications 4. Industry 5. Power 6. Others Total

0.3 0.6 0.3 5.2 6.9 86.7 100

Source: Ministry of Finance, Government of Samoa

30

34 18 11 10 10 17 100

Table-15: Currency composition of government debt Currency 1. Special drawing rights (SDR) 2. United States dollar 3. Chinese Yuan/ Renminbi’s 4. Euro Total

% of govt. debt 71 17 7 5 100

6.2 Overall external debt in Samoa Along with other countries, World Bank publishes external debt statistics for Samoa in the Global Development Finance (GDF). The World Bank provides data for both public debt and private, and for both long term and short-term debt in terms of US dollar. In the latest issue of GDF (2005), the World Bank has classified Samoa as a severely indebted middle-income country. As mentioned in the previous section, the central Bank of Samoa and the ministry of Finance, Government of Samoa also publish external debt statistics. But, they provide data for only the government external debt, which is basically long-term debt, and donot provide any information on short-term debt and private external debt. Thus the external debt figures given by the World Bank and the Samoa government are not strictly comparable. The analysis in this section is based on World Bank data, which are supplemented by export data for the years 2000-2003 given by the government of Samoa. Exports data for these years are not available in the World Bank GDF (2005). As per the World Bank statistics given in Table-16, in recent years, external indebtedness of Samoa has worsened. The external debt to GNI ratio increased substantially from 56 per cent in 1990 to 138 per cent in 2003 and the external debt to export ratio increased from 98 per cent to 333 per cent over the same period. The deterioration in external debt situation is the result of declining share of concessional debt from 91 per cent in 1990 to 46 per cent in 2003 and that of multilateral debt from 88 per cent in 1990 to 43 per cent in 2003. It is also due to continual increase in the share of short-term debt in total debt from negligible amount in 1990 to 54 per cent in 2003. Although the present debt service ratio at 12 per cent is moderate and the country has sufficient foreign exchange reserves, equivalent to 11 months imports cover, increasing trend of debt services with nominal increase of exports of goods and services may create liquidity and unsustainability problems in immediate future. Substantial increase of short-term debt is a matter of concern. It is also not known for what purpose this money is being used and whether the sectors, which are using the short term external capital, has the capacity to pay back debt and make interest payments.

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Table-16 External Debt of Samoa (in US$ million) Indicators↓ \ Years → Total Debt stock (EDT) Long term debt Public & guaranteed Private non-guaranteed Use of IMF credit Short-term debt Total debt service Interest payments (INT) Interest on long term debt 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

EDT/ XGS EDT/ GNI TDS/ XGS INT/ XGS INT/ GNI RES/ EDT RES/ MGS (months) Short-term/ Total debt Concessional/ EDT Multilateral/ Total debt

1970

1980

2000

2001

2002

2003

197.4 60.2 92 192.4 147.3 53.4 91 156.6 147.3 53.4 91 156.6 0 0 0 0 0 5.8 0.8 0 50.1 1 0.2 35.8 8.5 5.5 5.5 6.5 4.3 2.7 1.3 3.2 1.4 2.3 1.2 1.4 0.4 0.1 1.8 2.9 … 164.3 235 241.1 103.9 44.4 94.1 126.9 45 19 43 45 93.6 … 74.3 96.5 142.6 5.2 2.8 69 68.2 63.7 … 12.9 8.6 -18.8 10.3 Sustainability Debt indicators (in per cent)

1990

1999

204.3 143.3 143.3 0 0 61 7.4 3.9 1.3

234.4 156.8 156.8 0 0 77.6 7.8 4.3 1.3

2.6 235 95.6 45

3.0 240.8 105.0 45

365.2 169.5 169.5 0 0 195.7 13.1 8.9 1.3 7.6 264.6 109.5

102.1

100.1

90.4

56.6 -6.5

62.5 4.9

83.9 19.1

214 87 8 4 1.6 28 7 30 69 63

223 97 7 4 1.8 27 7 33 66 61

333 138 12 8

2.7 2.7 2.7 0 0 0 0.1 0 0 0 … … 0

… … … … … 193 … 0 90 90

136 … 12 6 … 5 0.5 2 56 54

98 56 6 1 0.8 75 9 0 91 88

152 82 5 3 1.3 35 6 19 80 77

190 82 8 4 1.8 32 8 25 73 70

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3.3 23 11 54 46 43

Source: (1) World Bank, Global Development Finance 2005 (For all data except for current A/C balance and XGS for the years 2000 to 2003). (2) Economic Intelligence Unit (for current account balance in 2000-2003). (3) Ministry of Finance, Government of Samoa (for exports of goods and services in 2000-2003)

As short-term debt may create liquidity problems and add to volatility in the foreign exchange markets, the Ministry of Finance in association with the Central Bank of Samoa should make appropriate arrangements to collect information and monitor short-term external debt on regular basis.. Samoa should make all possible efforts to enhance exports and encourage tourism to earn foreign exchange for servicing external debt. However, Samoa’s export base is limited. In 2003, fresh fish accounted for 36 per cent of exports, followed by garments 30 per cent, beer 9 per cent, coconut cream 7 per cent and copra 3 per cent. Major destinations for exports were Australia (76 per cent), USA (6 per cent), American Samoa (2.5 per cent), New Zealand (2.3 per cent) and Germany (1.2 per cent). Efforts may be made to enhance exports to New Zealand, which is the major source (accounting for 22 per cent) of Samoa imports. 32

Samoa government should also encourage non-debt creating financial inflows. In recent years, the government has launched an investment drive, targeted initially at New Zealand and subsequently at Australia, Singapore and Hong Kong. The primary focus of these campaigns is to attract more direct foreign investment in hotels and other tourism projects in Samoa. Government provides tax holidays for 15 years and other fiscal incentives for foreign investors. These policies are in right directions and expected to yield rich dividends in near future. 6.3 lessons for Samoa (a) Lessons from international best practices International best practices for management of external debt discussed earlier lead 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, which 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. (d) Management of external debt is closely related to the management of domestic debt, which in turn depends on the management of overall fiscal deficit. (e) Debt management strategy is an integral part of the wider macro economic policies, which act as the first line of defense against any external financial shocks. (f)

For an emerging economy, it is better to adopt a policy of cautious and gradual movement towards capital account convertibility.

(g) At the initial stage, it is better to encourage non-debt creating financial flows followed by liberalization of long-term debt. (h) It is necessary to adopt suitable policies for enhancing exports and other current account receipts, which 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.

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(j) There is a need for setting up an integrated Public Debt Office for the following functions: o To deal with both domestic & external debt o To set bench marks on interest rate, maturity mix, currency mix, sources of debt o Identification and measurement of contingent liabilities  Policy formulation for debt management  Monitoring risk exposures o Building Models in ALM framework (k) It is vital that external forward liabilities and short-term debt are kept within prudential limits. (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) A sound financial system with well developed debt and capital market is an integral part of a country’s debt management strategy. (b) 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.

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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 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.

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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. We can conclude with the following observations made by the World Bank in their Report on Global Economic Prospects and the Developing Countries (1999): “The most pressing issue is to develop better mechanisms to facilitate private-to-private debt workouts, including standstills on external debt under some conditions, and to restore capital flows and increased international liquidity to countries in crisis. Although there are some compelling arguments for a lender of the last resort, difficult issues arise for appropriate burden sharing, the rules for intervention, and the avoidance of moral hazard. Improved regulation by creditor country authorities and better risk management of bank lending to emerging markets should also help reduce probability of crisis. More timely and reliable information is desirable, but complete transparency and better information alone will not prevent a crisis”. “The main lessons of the East Asian crisis are that countries need to build and strengthen regulatory and institutional capacities to ensure the safety and stability of financial systems, especially at the interfaces with international financial markets; and that the international architecture to prevent crises and deal with them needs to be strengthened more effectively”.

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Selected References Anderson, Philip (2000) Sovereign debt management in an Asset-Liability Management Framework, pp.139-153, in Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C. Credit Rating Information Services of India Limited (CRISIL) (1999) Corporate External Debt Management, pp.1-316, edited by Jawahar Mulraj, CRISIL, Bombay, December 1999. _________ (2001) External Debt Management- Role of Financial Institutions, pp.1-382, edited by Ashok Kumar, CRISIL, Bombay, January 2001. Das, Tarun (1999a) East Asian Economic Crisis and Lessons for External Debt Management, pp.77-95, in External Debt Management, ed. by A. Vasudevan, April 1999, RBI, Mumbai, India. _______ (1999b) Fiscal Policies for Management of External Capital Flows, pp. 194207, in Corporate External Debt Management, edited by Jawahar Mulraj, December 1999, CRISIL, Bombay. _______ (2000a) Management of external debt in India, 21-24 March 2000, IMFSingapore Regional Training Institute, Singapore. _______ (2000b) Sovereign Debt Management in India, pp.561-579, in Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C. _______ (2002a) Implications of Globalisation on Industrial Diversification in Asia, pp.ix+1-86, UN Publications Sales No.E.02.II.F.52, March 2002, ESCAP, Bangkok. _______ (2002b) Management of Contingent Liabilities in Philippines- Policies, Processes, Legal Framework and Institutions, pp.1-60, March 2002, World Bank, Washington D.C. _______ (2003a) Management of Public Debt in India, pp.85-110, in Guidelines for Public Debt Management: Accompanying Document and Selected Case Studies, 2003, IMF and the World Bank, Washington D.C. _______ (2003b) Economic Reforms in India- Rationale, Scope, Progress and Unfinished Agenda, pp.1-80, February 2003, Bank of Maharashtra, Planning Department, Pune, India.

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_______ (2003c) General Agreement on Trade in Services – Implications for the Indian financial sector, pp.6-14, July 2003, Bima Vidya, Management Development Centre, Life Insurance Corporation of India, Mumbai, _______ (2004a) Financing International Cooperation- A Case Study for India, pp.1-46, Office of Development Studies., March 2004, UNDP, UN Plaza, New York. _______ (2004b) Role of services production and trade in Asia and Pacific- Problems and prospects, pp.842-849, Proceedings of the Indian Economic Association 2004 Conference. ________ (2005a) Sustainable external debt management- conceptual issues and sustainability measures, paper presented at the National Workshop on Capacity Building for External Debt, Apia, 24 August 2005. _______ (2005b) Sustainable external debt management- international best practices, paper presented at the National Workshop on Capacity Building for External Debt, Apia, 24 August 2005. _______ (2005c) Management of external debt in India and lessons for Samoa, paper presented at the National Workshop on Capacity Building for External Debt, Apia, 24 August 2005. _______ Raj Kumar, Anil. Bisen and M.R. Nair (2002) Contingent Liability Management- A Study on India, pp.1-84, Commonwealth Secretariat, London. Economic Intelligence Unit (2004) Samoa Country Profile 2004, pp.1-22, London, U.K. ________ (2005) Samoa Country Report 2005, pp.1-7, London, U.K. ESCAP (2005) Implementing the Monterrey Consensus in the Asian and Pacific RegionAchieving Coherence and Consistency, United Nations, New York, 2005. Geithner, Timothy (2000) Sovereign risk management in an integrated world, pp.3-9, in Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C. Government of India, Ministry of Finance (2005) India’s External Debt- A Status Report, June 2005, New Delhi. Government of Samoa, Ministry of Finance (2005a) The situation analysis and current issues- Samoa economy, paper presented at the National Workshop on Capacity Building for External Debt, Apia, 24 August 2005.

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Government of Samoa, Ministry of Finance (2005b) Management of external debt in Samoa, paper presented at the National Workshop on Capacity Building for External Debt, Apia, 24 August 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. Islam, Azizul (1998) The dynamics of the Asian economic crisis and selected policy implications, paper presented at the Expert Group Meeting on “What have we learned one year into the emerging market countries financial crisis?” 21-23 July 1998, United Nations, New York. Jensen, Fred (2000) Trends in sovereign debt management in IBRD countries over the past two years, pp.14-25, in Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C. McCray, Peter (2000) Organisational models for sovereign debt management, pp.297310, in Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C. Raj Kumar (1999) Debt Sustainability Issues- New Challenges for Liberalising Economies, pp.53-76, in External Debt Management, ed. by A. Vasudevan, April 1999, RBI, Mumbai, India. Reserve Bank of India (RBI) (1999) External Debt Management- Issues, Lessons and Preventive Measures, pp.1-372, edited by A. Vasudevan, RBI, Mumbai, April 1999. Sullivan, Paul (2000) The design and use of strategic benchmarks in managing risk, pp.175-191, in Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C. World Bank (1998) Global Economic Prospects and the Developing Countries, December 1998, Washington D.C. _______ (2000) Sovereign Debt Management Forum: Compilation of Presentations,

November 2000, World Bank, Washington D.C. _______ (2005a) World Development Report, World Bank, Washington D.C. _______ (2005b) World Development Indicators 2005, World Bank, Washington. DC. _______ (2005c) Global Development Finance 2005, World Bank, Washington. DC.

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