Sustainable External Debt Management-

International 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 Management-
International 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

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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 Risk Management Policies

1. Liquidity risk (a) Monitor debt by residual maturity

(b) Monitor exchequer cash balance and flows
(c) Maintain certain minimum level of cash balance
(d) Maintain access to short-term borrowing
(e) But, fix limits for short-term debt
(f) Pre-finance maturing debt
(g) Do not negotiate for huge bullet loans
(h) Smooth the maturity profile to avoid bunching of debt services

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 (i) Develop liquidity benchmarks
2. Interest rate risk (j) Fix benchmark for ratio of fixed versus floating rate debt
(k) Maintain ratio of short-term versus long-term debt
(l) Use interest rate swaps
3. Credit risk (m) Have credit rating of various scrips by major credit rating
organizations such as S&P’s, Moody’s, Japan Bond Research
Institute etc.
(n) Identify key factors that determine credit-rating
(o) Develop a culture of co-operation and consultation among different
departments and with credit rating organisations
(p) Set overall and individual counter-party credit limits
4. Currency risk (q) Fix benchmark for the ratio of domestic and external debt
(r) Fix ratios of short-term and long-term debt
(s) Fix composition of currencies for external debt
(t) Fix single currency and currency pool debt
(u) Use currency swaps and have policies for use of market derivatives
(v) Try to have natural hedge by linking dominant currency of exports
and remittances to the currency denomination of debt
5. Convertibility risk (w) It is better to have gradual and cautious approach towards capital
account convertibility.
(x) 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.
(y) 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.
(z) Short term or volatile capital flows may be liberalised
only at the end of capital account convertibility.
6. Budget Risk (aa) Enact a Fiscal Responsibility Act.
(bb) Put limits on debt outstanding and annual borrowing as a
percentage of GNP or GDP
(cc) Use government guarantees and other contingent liabilities (such
as insurance and pensions etc.) judiciously and sparingly
(dd) Fix limits on contingent liabilities
(ee) Fix targets on fiscal deficit and primary deficit
(ff) Fix limits on short term borrowing
(gg) Monitor debt service payments

7. Operational risks (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 Indicators

1. Solvency ratios (a) Interest service ratio – the ratio of interest payments to
exports of goods and services.
(b) External debt to GDP ratio
(c) External debt to exports ratio
(d) External debt to revenue ratio
(e) Present value of debt services to GDP ratio
(f) Present value of debt services to exports ratio
(g) Present value of debt services to revenue ratio
2. Liquidity (h) Basic debt service ratio- Ratio of debt services (both
monitoring ratios interest payments and repayments of principal) on long
term debt to exports of goods and services.
(i) 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)
(j) Interest payments to reserves ratio.
(k) Ratio of short-term debt to exports of goods and services
(l) Import cover ratio- Ratio of total imports to total foreign
exchange reserves.
(m) International reserves to short-term debt ratio
(n) Short-term debt to total debt ratio

3. Debt burden ratio (o) Total external debt outstanding to GDP (or GNP) ratio
(p) Total external debt outstanding to exports of goods and
services ratio
(q) Debt services to GDP (or GNP) ratio
(r) Total public debt to budget revenue ratio
(s) Ratio of concessional debt to total debt
4. Debt structure (t) Rollover ratio- ratio of amortization (i.e. repayments of
indicators principal) to total disbursements
(u) Ratio of interest payments to total debt services
(v) Ratio of short-term debt to total debt

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5. Public sector (w) Public sector debt to total external debt
indicators (x) Public sector debt services to exports ratio
(y) Public sector debt to GDP ratio
(z) Public sector debt to revenue ratio
(aa) Average maturity of non-concessional debt
(bb) Foreign currency debt over total debt

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

7. Corporate sector (jj) Leverage (debt/ equity ratio)- Ratio of normal value of
indicators 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 → Severely Indebted Moderately Indebted Less Indebted

Either PV/XGS > 220% Either Both PV/XGS<132%
Or PV/GNP > 80% 132%<PV/XGS<220% and PV/GNP<48%
Income Level ↓ or 48%<PV/GNP<80%

Low income: GNI per Severely Indebted Moderately Indebted Less Indebted
capita less than Low income (SILI) Low income (MILI) Low income (LILI)
US$765
Middle income: GNI Severely Indebted Moderately Indebted Less Indebted
per capita between Middle income (SIMI) Middle income (MIMI) Middle income (LIMI)
US$766 and US$9,385

3 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 Moderately indebted Less indebted

Low income Middle income Low income Middle income Low income Middle income
SILI SIMI MILI MIMI LILI LIMI
Bhutan Indonesia Cambodia Malaysia Bangladesh Armenia
Kyrgyz Rep Kazakhstan Mongolia Philippines India Azerbaijan
Lao PDR Maldives Pakistan Russian Fed Nepal China
Myanmar Samoa PN Guinea Sri Lanka Vietnam Fiji
Tajikistan Turkey Solomon Island Turkmenistan Iran Ism Rep
Uzbekistan 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 East Asia and Pacific South Asia
1980 1990 2000 2004 1980 1990 2000 2004

EDT/XGS (%) 179 132 78 49 154 303 155 113

EDT/GNI (%) 17 36 32 24 16 31 27 23
TDS/XGS (%) 27 18 11 8 12 28 15 10
INT/XGS (%) 14 7 4 2 5 15 6 4
INT/GNI (%) 1 2 2 1 1 2 1 1
RES/EDT (%) 51 31 57 141 40 7 30 78
RES/MGS (months) 9 5 6 8 6 2 5 10
Short-term/ EDT (%) 23 16 13 27 7 10 4 4
Concessional/ EDT (%) 19 29 21 21 73 55 50 52
Multilateral/ EDT (%) 9 15 13 12 25 31 38 36
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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 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.

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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

16
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.

17
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

18
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.

19
 Table-6 World Bank Survey on Second Sovereign Debt Management Forum

Items Percentage
in total
respondents
1. Debt management objectives and priorities
(a) Minimise financial costs and risks 38
(b) Funding management 26
(c) Management of debt 15
(d) Development of financial markets 9
(e) Others 13
2. Establishment of benchmarks for risk management
(a) Countries establishing guidelines for risk management 45
(b) Countries establishing benchmarks for foreign currency debt 24
(c) Countries establishing benchmarks for portfolio performance 21
(d) Countries establishing benchmarks for domestic currency debt 13
3. Risk management guidelines
(a) Limit currency risk 35
(b) Avoid excessive short-term debt / to smooth maturity profile 29
(c) Debt in least volatile currency 24
(d) Limit on debt with floating interest rate 18
(e) Debt matching reserves 12
(f) Others 18
4. Analytical techniques for undertaking risk analysis
(a) Not using any analytical techniques 32
(b) Value-at-Risk (VAR)/ Cost-at-Risk (CAR) 23
(c) Debt sustainability indicators 16
(d) Others 29
5. Constraints for establishing benchmarks
(a) Lack of debt management policy 23
(b) Lack of debt management expertise 23
(c) No access to financial markets 13
(d) Lack of debt monitoring 10
(e) Difficult economic environment 10
(f) Others 21
6. Use of derivatives to hedge currency and interest rate risks
(a) Currency swaps 31
(b) Interest rate swaps 24
(c) Use of exchange commodity futures and options 7
7. Constraints for using derivatives
(a) Lack of technical knowledge 71
(b) Undeveloped financial markets 17
(c) Legal constraints 12

20
 Items Percentage
in total
respondents
8. Institutions managing the foreign currency debt
(a) Ministry of Finance 51
(b) Jointly by the Ministry of Finance and the Central Bank 30
(c) Central Bank 11
(d) Independent Debt Office 9
9. Coordination of both public and public debt
(a) Ministry of Finance 35
(b) Jointly by the Ministry of Finance (MOF) and the Central Bank (CB) 24
(c) Partly by MOF and partly and independently by the CB 24
(d) Debt Management Committee 18
10. Highest authority for approval of foreign currency debt Dom.debt Ext.debt
(a) Finance minister/ Governor of the Central Bank 72 49
(b) Parliament 6 21
(c) Interministerial board 8 12
(d) President/ Prime Minister 6 9
(e) DG of independent authority 8 9
11. Average time taken for approval of external debt
(a) One day or less 10
(b) Less than a week 13
(c) More than a week, but less than three months 65
(d) More than three months 13
12. Management of Contingent liabilities
(a) Subnational entities are allowed to raise their own funding abroad 69
(b) Central govt provides explicit guarantees for IBRD loans 68
(c) Central govt bears fully the exchange rate risk for IBRD loans 41
(d) Central govt shares partially the exchange rate risk 11
13. Efficiency of Middle Office
(a) Use of Market Information system (MIS) 76
(b) Access to internet 91
(c) No Middle Office Unit 43
(d) Distinct Middle Office Unit 43
(e) Middle Office placed under the direction of the Front Office 3
14. Main constraints for external debt management
(a) Lack of proper organisational structure 31
(b) Macroeconomic risk 14
(c) Lack of technical staff in the middle office 12
(d) Lack of technical staff in the back office 6
(e) Lack of legal framework 6
(f) Limited local debt market 6
Source: Fred Jensen (2000) as given in World Bank (2000)

21
 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 Total Ext As % of Short Official Official Conce-
End Debt GDP term Creditors Debtors ssional
(US$ Bln) Per cent Per cent Per cent Per cent Per cent
1990-91 83.8 28.7 10.2 64 60 46
1995-96 93.7 27.0 5.4 64 57 45
2000-01 101.3 22.6 3.6 51 43 35
2001-02 98.4 21.2 2.8 52 44 36
2002-03 105.0 20.3 4.4 48 42 37
2003-04 111.7 17.8 4.0 45 40 36
2004-05 123.3 16.7 5.7 43 39 34

Table-8 Creditors and Debtors Composition of External debt of India (per cent)
Creditor Composition (per cent) Debtor composition (per cent)
Creditors March March Debtors March March
1991 2005 1998 2005
Multilateral 28 26 Government 50 39
Bilateral 36 17 Non-government 50 61
Non-resident Indians 17 26 -- Financial Sec 22 34
Others 23 34 -- Public sector 10 17
-- Private sector 13 4
-- Short-term 5 6
Total 100 100 Total 100 100

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.

22
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 non-
government 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 As per cent As per cent to

to GDP total external debt
1994 4.3 13.1
1995 3.7 12.5
2000 1.3 7.3
2002 1.5 7.1
2003 1.3 6.2
2004 1.0 5.8
2005 1.0 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.

23
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) 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.
(b) 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.
(c) 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.
(d) 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 Debt Debt/GDP Debt/ Concessional Short Short Short Interest to
service ratio Current debt to Term to Term to term debt current
ratio Receipts Total debt ratio Total debt Forex to GDP receipts
ratio ratio reserves ratio ratio
1990-91 35.3 28.7 329 46 10 382 3.0 16
1991-92 30.2 38.7 312 45 8 126 3.2 13
1995-96 26.2 27.0 189 45 5 30 1.4 9
2000-01 16.2 20.3 110 37 4 9 0.8 6
2003-04 16.2 17.8 99 36 4 4 0.7 4
2004-05 6.1 16.7 95 35 6 5 0.6 2

28
 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 (in million US dollars)

1997 1998 1999 2000 2001 2002 2003 2004
Total Debt stock (EDT) 142.2 147.1 147.0 143.7 141.7 147.8 162.2 168.5
Multilateral 130.4 135.4 135.7 129.8 128.2 135.1 149.4 156.0
Bilateral 11.8 11.7 11.3 13.9 13.5 12.7 12.8 12.5
Gross Domestic Product (GDP) 226.3 219 229.1 228 234.9 275.1 341.2 389.9
Exports of goods and services (XGS) 70.2 75.7 79.3 70.3 76.6 85.9 100.6 110.5
International reserves (RES) 57.1 60.7 60.6 55.7 49.2 55.6 73.5 82.3
Key external debt sustainability indicators (in per cent)
EDT/ GDP (per cent) 62.8 67.2 64.2 63.0 60.3 53.7 47.5 43.2
EDT/ XGS (per cent) 202.6 194.3 185.4 204.4 185.0 172.1 161.2 152.5
EDT/ RES (per cent) 249.0 242.3 242.6 258.0 288.0 265.8 220.7 204.7
Multilateral/ EDT (per cent) 91.7 92.0 92.3 90.3 90.5 91.4 92.1 92.6
Bilateral/ EDT (per cent) 8.3 8.0 7.7 9.7 9.5 8.6 7.9 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
IFAD EU France
Fund
2% 5% 2%4%
IDA
39%
ADB
OPEC 52%
China
2% 94%

EU ADB OPEC IDA IFAD China France Saudi Fund

Figure-1: Creditor Sources of Figure-2: Creditor Sources of

Multilateral Debt 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 pre-
dominant currency followed by US dollar (Table-15).

Table-13 Maturity Mix of Govt Debt Table-14 Sectoral distribution of govt debt
Maturity % of Debt Sectors % of Debt
1-2 years 0.3 1. Infrastructure 34
> 2-4 years 0.6 2. Agriculture 18
> 4-5 years 0.3 3. Telecommunications 11
> 5-10 years 5.2 4. Industry 10
> 10-15 years 6.9 5. Power 10
> 15yars 86.7 6. Others 17
Total 100 Total 100
Source: Ministry of Finance, Government of Samoa

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 Table-15: Currency composition of government debt

Currency % of govt. debt

1. Special drawing rights (SDR) 71
2. United States dollar 17
3. Chinese Yuan/ Renminbi’s 7
4. Euro 5
Total 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 → 1970 1980 1990 1999 2000 2001 2002 2003
Total Debt stock (EDT) 2.7 60.2 92 192.4 197.4 204.3 234.4 365.2
Long term debt 2.7 53.4 91 156.6 147.3 143.3 156.8 169.5
Public & guaranteed 2.7 53.4 91 156.6 147.3 143.3 156.8 169.5
Private non-guaranteed 0 0 0 0 0 0 0 0
Use of IMF credit 0 5.8 0.8 0 0 0 0 0
Short-term debt 0 1 0.2 35.8 50.1 61 77.6 195.7
Total debt service 0.1 5.5 5.5 6.5 8.5 7.4 7.8 13.1
Interest payments (INT) 0 2.7 1.3 3.2 4.3 3.9 4.3 8.9
Interest on long term debt 0 2.3 1.2 1.4 1.4 1.3 1.3 1.3
Interest on short term debt 0 0.4 0.1 1.8 2.9 2.6 3.0 7.6
Gross national income (GNI) … … 164.3 235 241.1 235 240.8 264.6
Exp.of goods and services (XGS) … 44.4 94.1 126.9 103.9 95.6 105.0 109.5
Workers remittances 0 19 43 45 45 45 45 45
Imp.of goods & services (MGS) … 74.3 96.5 142.6 93.6 102.1 100.1 90.4
International reserves (RES) 5.2 2.8 69 68.2 63.7 56.6 62.5 83.9
Current account balance … 12.9 8.6 -18.8 10.3 -6.5 4.9 19.1
Sustainability Debt indicators (in per cent)

EDT/ XGS … 136 98 152 190 214 223 333

EDT/ GNI … … 56 82 82 87 97 138
TDS/ XGS … 12 6 5 8 8 7 12
INT/ XGS … 6 1 3 4 4 4 8
INT/ GNI … … 0.8 1.3 1.8 1.6 1.8 3.3
RES/ EDT 193 5 75 35 32 28 27 23
RES/ MGS (months) … 0.5 9 6 8 7 7 11
Short-term/ Total debt 0 2 0 19 25 30 33 54
Concessional/ EDT 90 56 91 80 73 69 66 46
Multilateral/ Total debt 90 54 88 77 70 63 61 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.

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 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-by-
case 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.

35
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”.

36
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Credit Rating Information Services of India Limited (CRISIL) (1999) Corporate

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_________ (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
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_______ (1999b) Fiscal Policies for Management of External Capital Flows, pp. 194-
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_______ (2000a) Management of external debt in India, 21-24 March 2000, IMF-
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_______ (2000b) Sovereign Debt Management in India, pp.561-579, in Sovereign Debt

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_______ (2002a) Implications of Globalisation on Industrial Diversification in Asia,

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_______ (2002b) Management of Contingent Liabilities in Philippines- Policies,

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_______ (2003a) Management of Public Debt in India, pp.85-110, in Guidelines for

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37
_______ (2003c) General Agreement on Trade in Services – Implications for the Indian
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_______ (2004b) Role of services production and trade in Asia and Pacific- Problems
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________ (2005a) Sustainable external debt management- conceptual issues and

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_______ Raj Kumar, Anil. Bisen and M.R. Nair (2002) Contingent Liability
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38
Government of Samoa, Ministry of Finance (2005b) Management of external debt in
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39