Management of External Debt in India

And Lessons for Developing Countries

Dr. Tarun Das1,

Economic Adviser, Ministry of Finance, India
And Resource Person, UN-ESCAP, Bangkok.

1. India - External Debt Indicators

External debt indicators of India showed steady improvement over time. Despite severe
balance of payments difficulties due to the impact of the gulf crisis in early 1990s and
hardening of international oil prices in recent years, India never defaulted on its
obligations of external payments. On the contrary, India pre-paid $7 billion worth of
external debt to multilateral and bilateral lenders during 2003-2004. In terms of total
external debt stock, India’s position improved from the first rant in 1980 to third rank
after Brazil and Mexico in 1990 and further to the eighth rank after Brazil, China,
Argentina, Russian Federation, Mexico, Turkey and Indonesia in 2003. The debt-to-GDP
ratio declined continuously from 38 % in 1991 to 20 % in 2003 and further to 18 % in
2004. The debt-service ratio (i.e. the ratio of total debt services to gross receipts on the
current account of the external sector) also declined continuously from 35 % in 1990 to
16 % in 2003-2004 and further to 6 % in 2005. The World Bank now classifies India as a
“low indebted country”. External debt is predominantly long-term. The share of short-
term debt in total debt declined from 10.2 per cent in 1990-91 to 5.7 per cent in 2004-05.
Eighty per cent of government debt comes from multilateral and bilateral sources.

Table-1-A: Trends of external debt of India

Year Total Ext Debt As % of GDP Short term Official Official Conce-
End 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

1
This report expresses personal views of the author and should not be attributed to the
views of the Ministry of Finance, Government of India or the UN-ESCAP, Bangkok. The
author would like to express his gratitude to the UN-ESCAP, particularly to the Poverty
and Development Division, for providing an opportunity to prepare this report and the
Ministry of Finance, Government of India for granting necessary permission for that.

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 Table-1-B Debt sustainability indicators for India during 1990-2005 (per cent)
Year Debt service ratio Debt/ Current Short Term debt Short term debt Int. to current
Receipts ratio to Forex reserves to GDP ratio receipts ratio
1990-91 35.3 329 382 3.0 16
1991-92 30.2 312 126 3.2 13
1995-96 26.2 189 30 1.4 9
2000-01 16.2 110 9 0.8 6
2003-04 16.2 99 4 0.7 4
2004-05 6.1 95 5 0.6 2

Official creditors and official borrowers

Shares of official debtors, official creditors and concessional loans in total external debt
declined substantially during 1990 to 2005 (Table-2) implying inflows of more private
and commercial debt. This must have enhanced the cost of external borrowing.

Table-2 Creditors and Debtors Composition of External debt of India (per cent)
Creditor Composition (per cent) Debtor composition (per cent)
Creditors 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-3). Other important currencies are SDR, Indian rupees, Japanese Yen, Pound
sterling and Euro which together accounted for 55 per cent of the outstanding external
debt at the end of March 2005.

Contingent Liabilities- Government guaranteed external debt

Government of India raises external loans on its own account under external assistance
program and also provides guarantees to external borrowings by the public sector
enterprises, developmental financial institutions and a few private sector companies
under the BOT schemes for infrastructure development. All loans taken by the 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.

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 Table-3 Currency composition of India’s external debt

Currency March 1996 March 2005

US dollar 41 45
SDR 15 16
Indian Rupees 15 19
Japanese Yen 14 11
Euro 9* 5
Pound sterling 3 3
Others 3 1
Total 100 100
* DM, French Franc, Netherlands Guild

Table-4 Total contingent liabilities (i.e. government guaranteed debt)

Year 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

2 External Debt Management- Policies and Organisational Set-up

India has been able to manage its external debt situation despite serious balance of
payments problems at the beginning of 1990s on account of gulf war leading to
disruptions of Indian exports and remittances by non-resident Indians living in the gulf.
Policy emphasis has been on resorting to concessional and less expensive fund sources,
preference for longer maturity profiles, monitoring short-term debt, pre-payment of high
cost debt and encouraging exports and non-debt creating financial flows.

Careful management of external debt allowed India to retain policy-making sovereignty

and not to be wholly influenced by the conditionalities imposed by the multilateral
funding agencies. In fact, in recent years India prepaid a part of more expensive debt
from the World Bank, the Asian Development Bank and some bilateral countries. They
insisted for substantial reduction of food and fertilizer subsidies and overall fiscal deficit,
which were not politically feasible for a coalition government. Effective public debt
management also helped government to adopt a step-by-step approach to liberalization
and to adopt effective safety nets for the weaker and vulnerable sections of the society by
expanding and strengthening various anti-poverty and poverty alleviation programs.

India adopted a cautious, gradual and step-by-step approach towards capital account
convertibility. Initially non-debt creating financial flows (such as FDI and portfolio
equity) were liberalized followed by liberalization of long-term debt flows and partial

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

The organisational structure for sovereign external debt management consists of the
following offices:

(a) 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
category states) and 30:70 mix of grant and loan to other states. Loans carry an interest
rate of 11.5% with maturity of 20 years including moratorium of 5 years. The system
involves certain amount of concession provided to the states.

Recently, on considering the high transactions cost of large number of low value projects,
tied assistance, and strict conditionalities, government has taken a policy decision to
prune the number of bilateral creditors from over 18 to only six namely Japan, United
Kingdom, Germany, USA, European Commission and Russian Federation. Government
has also decided to pre-pay outstanding bilateral debt except to Japan, Germany, USA
and France. The decision was also partly influenced by the substantial build up of foreign
exchange reserves and low interest rates in the domestic countries.

Those bilateral countries, from which it has been decided not to receive development
assistance on government account, have been advised to provide their development
assistance to non-governmental organisations and the Universities etc. Accordingly,

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countries like Australia, Belgium, Canada, Denmark, France, Italy, Netherlands, Norway,
Sweden, Switzerland and others are now providing assistance directly to the NGOs for
primary education, urban water supply and sanitation, HIV/AIDS prevention and care,
strengthening environment institutions and poverty alleviation program.

India provides technical assistance under the Technical and Economic Cooperation
(ITEC) Program and the Special Commonwealth African Assistance plan (SCAAP) to
141 developing countries in Asia, Africa, Latin America, Eastern Europe and the Pacific.
India is also participating actively in the international initiative for economic
development of HIPC (Heavily Indebted Poor Countries) and other developing countries.
Under the HIPC, India is providing credit lines to seven eligible HIPC countries viz.
Mozambique, Tanzania, Zambia, Ghana, Guyana, Nicaragua and Uganda. The
government has waived the outstanding dues from these countries. In addition, India
provides credit lines to a number of developing countries.

An effective system is in place to measure and monitor the level and indicators of debt.
Some of the important sustainability and liquidity indicators include external debt to GDP
ratio, debt service ratio, maturity and present value of debt, short-term debt by original
and residual maturity, ratios of debt to other indicators such as exports of goods and
services, and foreign exchange reserves. Statistical improvement and technological
upgradation have been done to monitor these parameters on real time basis.

3 Fiscal Responsibilityand Budget Management (FRBM) Act 2003

Indian government enacted a Fiscal Responsibility and Budget Management Act in 2003.
The Act came into force in April 2004. The Act mandates the Central government to
eliminate revenue deficit by March 2009 and to reduce fiscal deficit to 3% of GDP by
March 2008. Under section 7 of the Act, the central government is required to lay before
both houses of Parliament Medium Term Fiscal Policy Statement, Fiscal Policy Strategy
Statement and Macro Economic Framework Statement along with the Annual Financial
Statement. Four fiscal indicators to be projected for the medium term. These include
revenue deficit, fiscal deficit, tax revenue and total debt as % of GDP.

The Act stipulates the following targets for the Central government:
• Reduction of revenue deficit by 0.5% of GDP or more every year.
• Reduction of gross fiscal deficit by 0.3% of GDP or more every year.
• No assumption of additional debt exceeding 9% of GDP for 2004-05 and
reduction of this limit by at least one percentage point of GDP in each year.
• No government guarantee in excess of 0.5% of GDP in any financial year.
• Greater transparency in the budgetary process, rules, accounting standards and
policies having bearing on fiscal indicators.
• Quarterly review of the fiscal situation.

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 4 Monitoring, Dissemination and Capacity Building

100% government debt data and 80% of total external debt data are computerized on the
basis of Commonwealth Secretariat DRMS. The Ministry of Finance has undertaken
projects to computerise fully NRI deposits and short-term debt, which account for the
residual 22% of total external debt. Time lag for data update is 8 weeks, which is well
below the IMF benchmark set under the Special Data Dissemination Standard (SDDS). A
Status Report on External Debt is presented by the Finance Minister to the Parliament
every year. The report is also posted on the MOF homepage.

Historical trends and future projections of debt stock and debt services are available for
analysis, scenario building and as MIS inputs. Debt Data are updated quarterly for March,
June, September, December. June 2005 debt data are now under compilation. Data by
both Creditors and Debtors classification and by currency, maturity and interest mix are
available. Data cross-classified by institutions and instruments are also available.

World Bank provided a Grant under the Institutional Development Fund (IDF) for
strengthening capacity building and policymaking process for management of Indian
external debt. The Grant yielded rich dividends and involved all stakeholders in the
policy of policymaking and helped in bridging research and policy. The IDF Grant helped
to computerise the database and disbursements and payments system for external public
debt on real time basis and reduced transactions cost significantly. Under the IDF grant
the Ministry of Finance organized three international seminars and one workshop with
active participation by the World Bank, RBI, academicians and all stakeholders
concerned with external debt and non-debt creating financial flows. The executive
agencies published three Books on papers and proceedings (CRISIL 1999 and 2001 and
RBI 1999). These seminars recommended various reforms for external sectors. Most of
the policy recommendations were accepted by the government.

Ministry of Finance also set up various working groups comprising members from the
government, RBI, financial institutions, private and public corporate bodies and
professionals having expertise and the experience on the selected subjects. Members
visited foreign countries to understand international best practices for management of
external debt. These countries included Australia, Ireland, New Zealand, UK and USA.

5 Lessons from external debt management in India

Management of external debt in India leads to the following broad conclusions:

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

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(d) At the initial stage, it may encourage non-debt creating financial flows followed
by liberalization of long-term and medium-term external debt.

(e) Big bullets are bad for small economies, as these can create refinancing risk that
many countries would be well advised to avoid.
(f) It is not enough to manage the government balance sheet well, it is also necessary
to monitor and make an integrated assessment of national balance sheet and to put
more attention on surveillance of overall debt- internal and external, private and
public. In each of the major Asian crisis economies- Indonesia, Korea and
Thailand- weakness in the government balance sheet was not the source of
vulnerability, rather vulnerability stemmed from the un-hedged sort-term foreign
currency debt of banks, finance companies and corporate sector.
(g) It is not sufficient to manage the balance sheet exposures, it is equally important
manage off balance sheet and contingent liabilities. Emerging as well as advanced
economies have experienced how bad banks can lead to large costs to the
economy and an unexpected weakening of the government’s balance sheet.
Government guarantees of private debt can also have similar adverse impact.
(h) It is necessary to adopt suitable policies for enhancing exports and other current
account receipts that provide the means for financing imports and debt services.

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

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

• To deal with both domestic & external debt

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

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

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

(m)It is also necessary to strengthen the legal, regulatory and institutional set up for
management of both internal and external debt.

(n)
(o) A sound financial system with well developed debt and capital market is an
integral part of a country’s debt management strategy.

6 External Debt Management Strategy

In all the East Asian crisis economies, weaknesses in financial systems as a result of weak
regulation and supervision and a long tradition of a heavy government role in credit
allocation led to misallocation of credits and inflated asset prices. Another vital weakness
of all countries was associated with large unhedged private short-term foreign currency
debt in a setting where the private corporate sector was highly leveraged.

Short-term foreign currency denominated debt created two kinds of vulnerabilities in

these economies. First, if some creditors pulled out their money, each individual creditor
had an incentive to join the queue. As a result, even a debtor that had been fully solvent
before the crisis could be plunged into insolvency. Second, such debts also created
vulnerabilities associated with the exchange rate depreciation. Exchange risk was either
borne directly by the financial institutions or passed on to the corporations as the funds
was on lent (thereby converting exchange risk into credit risk). These factors were further
complicated by the interaction of exchange rate and credit risks. Currency depreciation
led to wide spread insolvency and created additional counter-party risk, which in turn
added momentum to the exit of foreign capital.

The management of debt crisis faced by the East Asian countries was not without
precedence. Following the inception of the Latin American debt crisis in 1982, and on the
presumption that the debt problem was one of liquidity and not solvency, the initial debt
management strategy aimed at normalising the relationship between the debtors and
creditors through a combination of economic adjustment by debtor countries and
negotiations on financial relief. The financing modalities provided debtor countries with
some financial relief through interest rate spreads, reduced fees, and extension of
maturities and provision of some new finances. The negotiations conducted on a case-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

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future. Whenever such a financial crisis occurs in future, it is necessary to formulate an
international debt management strategy on the basis of negotiations among international
private lenders, investors and borrowers for sharing the responsibility for debt relief, for
rescheduling or for delaying claims on repayment.

More effective structures for orderly debt workouts, including better bankruptcy laws at
the national level and better ways at the international level of associating private sector
creditors and investors with official efforts are needed to help resolve sovereign and
private debt problems.

In the case of East Asian crisis, considerable thought was given to mechanisms that
involve private sector to forestall and resolve crisis in a more timely and systematic way.
A range of options are available in this respect, viz. (a) to contract credit and swap
facilities with groups of foreign banks, to be activised in the event of liquidity pressures,
such as those contracted by Argentina and Mexico; (b) embedding call options in certain
short-term credit instruments to provide for an automatic extension of maturities in times
of crises; (c) feasible modifications of terms of sovereign bond contracts to include
sharing clauses; and (d) a possible role for creditor councils for discussion between
debtors and creditors. However, these are complex issues and need to be designed
carefully so that there are no perverse incentives, which may encourage private creditors
to bail themselves out at the first sight of difficulty, rather than providing net new
financing in the event of a crisis.

Developing countries need to strengthen their debt management strategy by developing

comprehensive debt sustainability models, which will integrate external sector,
particularly the flows of external debt, with broad macro-economic variables and provide
early warning regarding any possible debt trap. In this respect, separate debt models may
be developed with respect to sovereign external debt and private debt.

All countries need to monitor very carefully short-term debt, long-term debt by residual
maturity, all guarantees and all contractual contingent liabilities arising out of both debt
and non-debt creating financial flows.

A more comprehensive approach is needed when trying to deal with excessive private
borrowing and risk taking in the presence of large capital inflows and weak financial
systems. This often means applying more flexible exchange rates, tighter fiscal policy
and improved financial system. Domestic financial sector liberalisation should also
proceed carefully and in step with tighter financial regulation and supervision, and
internationally recognised prudential norms for capital adequacy and provisioning for
non-performing assets by commercial banks and financial institutions.

Selected References

Das, Tarun (2006a) Conceptual issues and debt sustainability, presentations made in
Phnom Penh, Cambodia on 20 February 2006 and in Vientiane, Lao PDR on 23 February
2006.

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_______ (2006b) Intercountry comparisons of external debt and international best
practices for management of external debt, presentations made in Phnom Penh,
Cambodia on 21 February 2006 and in Vientiane, Lao PDR on 24 February 2006.

_______ (2006c) Management of external debt in India and lessons for developing
countries, presentations made in Phnom Penh, Cambodia on 21 February 2006 and in
Vientiane, Lao PDR on 24 February 2006.

________ (2006d) Management of External Debt- International Experiences and

Best Practices, Best Practices series No.9, UNITAR, Geneva.

________ (2006e) Management of Public Debt- International Experiences and Best

Practices, Best Practices series No.10, UNITAR, Geneva

ESCAP (2005) Implementing the Monterrey Consensus in the Asian and Pacific Region-
Achieving Coherence and Consistency, United Nations, New York, 2005.

International Monetary Fund (2003) External Debt Statistics- Guide for Compilers
and Users, 2003, IMF, Washington D.C.

_______ And the World Bank (2003) Guidelines for Public Debt Management:
Accompanying Document and Selected Case Studies, 2003, Washington D.C.

Naron, Hang Chuon (2006a) Situation analysis and current issues of Cambodian
economy with special emphasis on fiscal and debt issues, presentation made in Phnom
Penh, Cambodia on 20 February 2006.

_______ (2006b) Debt management strategies and issues relating to legal and
institutional framework, presentation made in Phnom Penh, Cambodia on 20 February
2006.

Saysamone Xaysouliane (2006) Macroeconomic performance, fiscal sustainability and

debt management in Lao PDR, presentation made in Vientiane, Lao PDR on 23 February
2006.

Taliercio, Rob (2006) External debt and risk management, presentation made in Phnom
Penh, Cambodia on 21 February 2006.

Thirong, Pen (2006) Issues of external debt management in Cambodia, presentation

made in Phnom Penh, Cambodia on 21 February 2006.

World Bank (2000) Sovereign Debt Management Forum: Compilation of Presentations,

November 2000, World Bank, Washington D.C.

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