External Debt Management



How foreign borrowing affects macroeconomic stability can be best understood in the context of production, consumption, savings, and investment. In a closed economy (no foreign trade), production comprises goods and services for personal consumption (consumer goods), capital goods (buildings, plant and equipment, inventories used by enterprises), and goods and services used by the government, which can be both for consumption (for current use) and for investment. Where there is foreign trade, production also includes goods for export; imports are a supplement to domestic consumption, for investment, for government use or for exports. There is a relationship between production and income. Put simply production creates incomes equal to the value of output. The government in taxes takes some income; some is taxed; some is saved by the private sector; the balance is spent on consumption. Foreign borrowing is the excess of imports of goods and services over exports and net borrowing creates debt, which can be repaid if exports exceed imports. In the absence of foreign borrowing (exports and imports are equal), private sector investment plus government spending is limited by the level of private sector savings and taxation.

Economic growth, of course, could be accelerated with foreign borrowing, permitting imports to exceed exports and at the same time, investment plus government expenditures to exceed savings plus taxes. There are standard indicators for measuring the burden of external debt: the ratios of the stock of debt to exports and to gross national product, and the ratios of debt service to exports and to government revenue. Although there is widespread acceptance of these ratios as measures of creditworthiness, there are no firm critical levels, which, if exceeded, constitute a danger for the indebted country.

However, the World Bank Staff has proposed a set of parameters, which it uses to demarcate "moderately" and "severely" indebted countries. Countries with a rapid export growth can support higher debt relative to exports and output. Heavily indebted, however, are vulnerable to severe macroeconomics shocks-sharply higher interest rates in the lending countries, for instance, or simply lenders cutting back on their commitments. Faced with these pressures, countries must then adjust by cutting private investment, decreasing government expenditures and or increasing government revenues.

Indicators of External Debt Sustainability

There are various indicators for determining a sustainable level of external debt. While each has its own advantage and peculiarity to deal with particular situations, there is no unanimous opinion amongst economists as to one sole indicator. These indicators are primarily in the nature of ratios i.e. comparison between two heads and the relation thereon and thus facilitate the policy makers in their external debt management exercise.

These indicators can be thought of as measures of the country's "solvency" in that they consider the stock of debt at certain time in relation to the country's ability to generate resources to repay the outstanding balance.

Examples of debt burden indicators include the (a) debt to GDP ratio, (b) foreign debt to exports ratio, (c) government debt to current fiscal revenue ratio etc. This set of indicators also covers the structure of the outstanding debt including the (d) share of foreign debt, (e) short-term debt, and (f) concessional debt in the total debt stock.

A second set of indicators focuses on the short-term liquidity requirements of the country with respect to its debt service obligations. These indicators are not only useful early-warning signs of debt service problems, but also highlight the impact of the inter-temporal trade-offs arising from past borrowing decisions. The final indicators are more forward looking as they point out how the debt burden will evolve over time, given the current stock of data and average interest rate. The dynamic ratios show how the debt burden ratios would change in the absence of repayments or new disbursements, indicating the stability of the debt burden. An example of a dynamic ratio is the ratio of the average interest rate on outstanding debt to the growth rate of nominal GDP.

These were certain aspects of external debt in the next chapter we will see how the external debt was managed by various countries of the world at the time of economic crisis.

Developments in External Sector During 1980’s

India remained unaffected by the debt crisis of early eighties facing many developing countries, due to her insignificant level of private debt. The foreign exchange constraints in the aftermath of second oil shock could be relieved by drawing substantial amount of loans from the International Monetary Fund: SDR 266 million under Compensatory Financing Facility (CFF) in 1980, SDR 529.01 million under Trust Fund Loan (TFL) in 1980-81 and SDR 5 billion under Extended Fund Facility (EFF) during 1981-84 (of which India used only SDR 3.9 billion). The foreign exchange situation also improved dramatically due to the inflow of remittances from the Gulf.

A substantial amount of import savings could be made due to large-scale import substitution in the areas of food, petroleum (after the discovery of Bombay High) and fertilizer. Thus, an improved foreign exchange scenario, which along with the available multilateral concessional assistance helped India to retain her credit-worthiness and avoid a possible liquidity crisis of the Latin American type in early 1980s. In fact taking the advantage of the improved foreign exchange scenario Indian policy makers attempted to relax the severity of the controlled trade regime in the 80s.

The liberalization of the import control regime, particularly the category of Open General License (OGL) and export-related licenses, opened up a variety of imports that were required by a wider range of emerging consumer goods industries. Export growth remained sluggish during the eighties, due to the slowdown in the growth of world trade, decline in primary commodity prices in the global market, and the expansionary policy at home, as the later might have reduced the exportable surplus to some extent. Indeed the trade deficits went up from $ 5.9 billion in 1984-85 to $ 7.9 billion in 1990-91 (with $ 9.1 billion in 1988-89) and the current account deficits from $ 2.4 billion to $ 8.9 billion during the same period (based on RBI data).

With the near stability in the inflows of concessional assistance, financing of deficits were made by raising commercial loans from the eurocurrency markets in the form of syndicated loans and eurobonds as well as accepting short term foreign currency deposits from the non-resident Indians.

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