Final Project Comp

TYBMS External Debt Management
Introduction to External Debt Management
EXTERNAL DEBT (or foreign debt) is that part of the total debt in a country that is
owed to creditors outside the country. The debtors can be the government,
corporations or private households. The debt includes money owed to private
commercial banks, other governments, or international financial institutions such as
the IMF and World Bank.
D EFINITION
IMF defines it as "Gross external debt, at any given time, is the outstanding amount
of those actual current, and not contingent, liabilities that require payment(s) of
principal and/or interest by the debtor at some point(s) in the future and that are
owed to nonresidents by residents of an economy."
In this definition, IMF defines the key elements as follows:
(a) Outstanding and Actual Current Liabilities: For this purpose, the decisive
consideration is whether a creditor owns a claim on the debtor. Here debt liabilities
include arrears of both principal and interest.
(b) Principal and Interest: When this cost is paid periodically, as commonly occurs,
it is known as an interest payment. All other payments of economic value by the
debtor to the creditor that reduce the principal amount outstanding are known as
principal payments. However, the definition of external debt does not distinguish
between whether the payments that are required are principal or interest, or both.
Also, the definition does not specify that the timing of the future payments of
principal and/or interest need be known for a liability to be classified as debt.
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(c) Residence: To qualify as external debt, the debt liabilities must be owed by a
resident to a nonresident. Residence is determined by where the debtor and creditor
have their centers of economic interest - typically, where they are ordinarily located -
and not by their nationality.
d) Current and Not Contingent: Contingent liabilities are not included in the
definition of external debt. These are defined as arrangements under which one or
more conditions must be fulfilled before a financial transaction takes place. However,
from the viewpoint of understanding vulnerability, there is analytical interest in the
potential impact of contingent liabilities on an economy and on particular institutional
sectors, such as government.
Generally external debt is classified into four heads i.e. (1) public and publicly
guaranteed debt, (2) private non-guaranteed credits, (3) central bank deposits, and (4)
loans due to the IMF. However the exact treatment varies from country to country.
For example, while Egypt maintains this four head classification, in India it is
classified in seven heads i.e. (a) multilateral, (b) bilateral, (c) IMF loans, (d) Trade
Credit, (e) Commercial Borrowings, (f) NRI Deposits, and (g) Rupee Debt.
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IMPORTANT ASPECTS RELATED TO EXTERNAL DEBT MANAGEMENT
F INANCING T ECHNIQUES
Countries have a limited ability to support external borrowing. At the same time, the
supply of finance is also limited. Consequently, borrowers must choose the best
combination from the available sources of external finance to suit the needs of
individual projects-and of the economy as a whole. The country wishes to minimize
the problems in servicing new debt, while making maximum use of grants and foreign
loans on concessional terms. These are clearly the cheapest from of financing, but
their availability is generally restricted to the poorest developing countries; and even
for those countries, they are inadequate to meet needs. A maximum leverage can be
obtained from concessional financing by combining it with other types of financing.
Other sources of credits are export financing and loans from international commercial
banks.
Authorities should ensure that credits from financial markets are part of a package that
provides the best possible external financing mix for the economy, as well for an
individual project. For projects the best mix could mean one with: (1) maximum
concessional loans or maximum market finance (2) the maximum capital that can be
rolled over easily, or (3) the minimum debt service due in the years before returns
materialize. Authorities must also ensure that the aggregate financing package meets
national financing priorities, This involves an assessment of such aspects as: the
sources of finance ,including the amounts that can be borrowed and the prospects for
future supply; the currency composition of foreign borrowing that would minimize
exposure to exchange rate fluctuations; the exposure to interest rate fluctuations over
the life of the loan; and the impact of new borrowing on the structure of debt service
obligations.
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H OW MUCH TO B ORROW
The amount that any country ought to borrow is governed by two factors: how much
foreign capital the economy can absorb efficiently, and how much debt it can service
without risking external payment problems. Each factor will depend on the quality of
economic management. Borrowings can be on different terms and in different
currencies, which complicates the policy decision. There may be uncertainty too about
evolving debt-servicing capacity. Interaction between debt servicing capacities, the
type of finance, and the borrowing decision increases in complexity as the number of
loans increases.
M ANAGING R ISK
Countries are sometimes exposed to BOP shocks arising from unfavorable changes in
the relative prices of exports and imports, suppose that a country’s exports earnings
are in dollars and its foreign debts are repayable in yen deterioration in the exchange
rate of the dollar vis-a-vis the yen will add to the debt servicing obligation of the
borrowing country. Fluctuations in commodity prices, foreign exchange rates and
world interest rates are largely beyond the control of countries. It is possible to hedge
against this risk. Managing risk is an important part of public debt management.
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K NOWING T HE D EBT
Information on external debt and debt service payments is essential for the day-to-day
management of foreign exchange transactions as well as managing debt and for
planning foreign borrowing strategies, At the most detailed level, the information
enables central authorities to ensure that individual creditors are paid promptly; at
more aggregated levels; debt data are needed for assessing current foreign exchange
needs, projecting future debt service obligations, evaluating the consequences of
further future borrowing and the management of external risk The component of
external debt statistics include details of each loan contract and its schedule of future
service payments, figures on loan utilization, and the payments of debt service
obligations. From these data elements summary figure on foreign borrowing,
outstanding debt, and projected debt are assembled. The resulting statistics provide
inputs for budget and BOP projections.
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EXTERNAL DEBT AND MACROECONOMIC CONSIDERATIONS
How foreign borrowing affects macroeconomic stability can be best understood in the
context of production, consumption, savings, and investment. In a closed economy
(no foreign trade), production comprises goods and services for personal consumption
(consumer goods), capital goods (buildings, plant and equipment, inventories used by
enterprises), and goods and services used by the government, which can be both for
consumption (for current use) and for investment. Where there is foreign trade,
production also includes goods for export; imports are a supplement to domestic
consumption, for investment, for government use or for exports.
There is a relationship between production and income. Put simply production creates
incomes equal to the value of output. The government in taxes takes some income;
some is taxed; some is saved by the private sector; the balance is spent on
consumption. Foreign borrowing is the excess of imports of goods and services over
exports and net borrowing creates debt, which can be repaid if exports exceed
imports. In the absence of foreign borrowing (exports and imports are equal), private
sector investment plus government spending is limited by the level of private sector
savings and taxation.
Economic growth, of course, could be accelerated with foreign borrowing, permitting

imports to exceed exports and at the same time, investment plus government
expenditures to exceed savings plus taxes. There are standard indicators for measuring
the burden of external debt: the ratios of the stock of debt to exports and to gross
national product, and the ratios of debt service to exports and to government revenue.
Although there is widespread acceptance of these ratios as measures of
creditworthiness, there are no firm critical levels, which, if exceeded, constitute a
danger for the indebted country.
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However, the World Bank Staff has proposed a set of parameters, which it uses to
demarcate “moderately” and “severely” indebted countries. Countries with a rapid
export growth can support higher debt relative to exports and output. Heavily
indebted, however, are vulnerable to severe macroeconomics shocks-sharply higher
interest rates in the lending countries, for instance, or simply lenders cutting back on
their commitments. Faced with these pressures, countries must then adjust by cutting
private investment, decreasing government expenditures and or increasing
government revenues.
After this lets have a look at external debt sustainability in detail in Chapter 2.
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External Debt Sustainability
Sustainable debt is the level of debt which allows a debtor country to meet its current
and future debt service obligations in full, without recourse to further debt relief or
rescheduling, avoiding accumulation of arrears, while allowing an acceptable level of
economic growth. (UNCTAD/UNDP, 1996)
External-debt-sustainability analysis is generally conducted in the context of medium-

term scenarios. These scenarios are numerical evaluations that take account of
expectations of the behavior of economic variables and other factors to determine the
conditions under which debt and other indicators would stabilize at reasonable levels,
the major risks to the economy, and the need and scope for policy adjustment.
In these analysis, macroeconomic uncertainties, such as the outlook for the current
account, and policy uncertainties, such as for fiscal policy, tend to dominate the
medium-term outlook.
World Bank and IMF hold that “a country can be said to achieve external debt
sustainability if it can meet its current and future external debt service obligations in
full, without recourse to debt rescheduling or the accumulation of arrears and
without compromising growth.” According to these two institutions, external debt
sustainability can be obtained by a country “by bringing the net present value (NPV)
of external public debt down to about 150 percent of a country’s exports or 250
percent of a country’s revenues.”
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I NDICATORS OF E XTERNAL D EBT S USTAINABILITY
There are various indicators for determining a sustainable level of external debt.
While each has its own advantage and peculiarity to deal with particular situations,
there is no unanimous opinion amongst economists as to one sole indicator. These
indicators are primarily in the nature of ratios i.e. comparison between two heads and
the relation thereon and thus facilitate the policy makers in their external debt
management exercise.
These indicators can be thought of as measures of the country’s “solvency” in that

they consider the stock of debt at certain time in relation to the country’s ability to
generate resources to repay the outstanding balance.
Examples of debt burden indicators include the (a) debt to GDP ratio, (b) foreign debt
to exports ratio, (c) government debt to current fiscal revenue ratio etc. This set of
indicators also covers the structure of the outstanding debt including the (d) share of
foreign debt, (e) short-term debt, and (f) concessional debt in the total debt stock.
A second set of indicators focuses on the short-term liquidity requirements of the

country with respect to its debt service obligations. These indicators are not only
useful early-warning signs of debt service problems, but also highlight the impact of
the inter-temporal trade-offs arising from past borrowing decisions. The final
indicators are more forward looking as they point out how the debt burden will evolve
over time, given the current stock of data and average interest rate. The dynamic
ratios show how the debt burden ratios would change in the absence of repayments or
new disbursements, indicating the stability of the debt burden. An example of a
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dynamic ratio is the ratio of the average interest rate on outstanding debt to the growth
rate of nominal GDP.
These were certain aspects of external debt in the next chapter we will see how the
external debt was managed by various countries of the world at the time of economic
crisis.
Debt Management Strategy - A Global Overview
The design of an adequate strategy for public debt management should include proper
consideration of a number of questions. Among them, several come to mind: (a) how
much public debt should be issued in domestic markets and how much in foreign
capital markets? (b) What should be the currency denomination of new public debt
issues? (c) What is the optimal maturity structure of public debt? (d) Should
governments consider redeeming in advance some issues and refinance them on
different terms? (e) Should public debt be issued at fixed or variable rates and (f)
should public debt issues be directed to a particular segment of the market (financial
institutions, other institutional investors, corporate sector, etc).Most of these choices
entail a trade-off between the level and the variance of debt costs and are highly
dependent on both the domestic macroeconomic context and conditions in
international markets.
Nonetheless, the debt management strategy has important implications for the
economy as a whole. Good liability management should result in lower borrowing
costs and unobstructed access to international capital markets, while minimizing any
crowding-out effects on private sector borrowing. The choice of the specific
characteristics of the debt portfolio involves difficult decisions. While on a pure cost-
based analysis it is tempting to choose short-term over long-term debt, the latter might
Brady bond spreads for different emerging market economies have behaved similarly,
though at different levels, in the midst of financial crises or increased uncertainty.
Thus, the liquidity of emerging markets’ securities and the collective behavior of
institutional investors make the financial authorities’ tasks more difficult, particularly
since systemic risk may rise swiftly. Over the past decade, capital mobility has
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increased many times over and its main features have also changed, especially those
related to the allocation between foreign investment and traditional lending. Mexico,
as a recipient economy, has witnessed those events.
Total capital inflows to Mexico grew from a yearly average of US$ 2 billion in 1987–
88 to $36 billion in 1993. The 1994 crisis caused an important reduction of these
flows, to $23 billion in 1995. For 1996–97 capital inflows were on average $10 billion
per year.. That is, foreign investment more than compensated for the decline in
indebtedness. For 1998–99 capital inflows are estimated to have averaged $16 billion
per year. Foreign direct investment grew from $4 billion in 1993 to $11 billion in
1994 and has kept a stable level of around $10 billion per year since then. On the
other hand, portfolio investment has shown more erratic behavior. Having reached a
peak of $29 billion in 1993, it turned negative in 1995 (–$10 billion) and for 1996–99
has averaged under $1 billion per year. The important reduction in the flows of
foreign portfolio investment to Mexico since the crisis of 1994–95 is primarily
explained by the adoption of a floating exchange rate regime.
This regime has proved to be extremely helpful in inhibiting short-term foreign

investments by reducing their expected return, once adjustment is made for exchange
rate risk. Without the implicit guarantee to portfolio investment provided by the semi-
fixed exchange rate regime, foreign direct investment started to play a more dominant
role in financing
Mexico’s current account deficit blurred. The Exchange Stabilization Fund prevented
the liquidity crisis from turning into a solvency crisis, whose repercussions would
have been far more devastating.
Prior to 1994, both debtors and the banking system in general were in a fragile
situation. Past due loans had increased substantially, and the lack of proper
provisioning started to erode banks’ capital.
In addition, some commercial banks faced severe problems that were not revealed in
their financial statements, and, in some instances, banks disregarded existing
regulations and proper banking practices (Mancera (1997)). In this environment, the
effect of the currency depreciation, rising inflation and higher interest rates on the
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credit service burden seriously jeopardized the Mexican financial system. At that
time, the materialization of systemic risk and its impact on the economy were major
concerns.
Faced with this situation, the government and the central bank implemented a
comprehensive programme to deal with the banking sector crisis, without derailing
monetary policy from its main task of procuring the reduction of inflation. The
successful mix of policies ensured the consistency of Mexico’s macroeconomic
framework and allowed the economy to recover and rapidly return to international
markets. An important element of the overall strategy was to provide liquidity to
commercial banks to comply with their external obligations. To this end, a dollar
facility was made available to them by the central bank. Thus, Banco de México
played the role of lender of last resort for commercial banks at a time of distress,
making foreign exchange available to banks through a specially designed credit
window. These dollar-denominated loans were channeled through the Fund for the
Protection of Savings (FOBAPROA).At the beginning of April 1995, the dollar-
denominated credits granted through FOBAPROA reached a maximum of US$ 3.8
billion. However, the high level of interest rates purposely charged on such credits
induced a rapid amortization, as banks sought other sources of financing. By 6
September 1995, the 17 commercial banks that had participated in this scheme had
already repaid their credits.
In this sense, the programme achieved its stated purpose, namely that of providing
temporary assistance. Once international markets were reopened to Mexican agents
(July 1995), the main objectives for the immediate future included the refinancing of
the Exchange Stabilization Fund in the market, have a smaller refunding risk and thus
be preferable in the end.
That is, a better schedule of amortizations lowers country risk and finance costs over
the medium term, both for the government and for the private sector. Likewise,
borrowing domestically may turn out to be more expensive than in external markets.
Yet borrowing in domestic markets could trigger a rapid development of these
markets and pave the way for a solid corporate domestic market in the future. In sum,
a good liability management strategy is one that helps minimize the cost of borrowing
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over the medium and long term. The objective is certainly not to save the last basis
point in each transaction, but rather to bring down the overall borrowing cost. Thus, a
smooth debt amortization profile is crucial. There is no doubt that emerging
economies have to work hard to ensure desirable characteristics in the debt profile,
even if initially costly. At the end of 1994, Mexico faced a liquidity crisis
accompanied by a very high refinancing risk.
This forced the country to seek support from the international community to confront
the heavy short-term debt burden. Economic policy was oriented towards rapidly re-
establishing macroeconomic stability. This was the only way to stop capital flight and
gradually restore Mexico’s access to international financial markets. To deal with the
scenario just described, a comprehensive package of policy measures was put
together. The stabilization programme was built upon restrictive fiscal and monetary
policies and was reinforced by the financial package (Exchange Stabilization Fund)
assembled by the US financial authorities and multilateral organizations. The rescue
package amounted to more than US$ 52 billion: $17.8 billion committed by the IMF,
$20 billion by the United States government, $10 billion by the Bank for International
Settlements, $3 billion by commercial banks and $1.5 billion by the Bank of Canada.
It is worth mentioning, however, that in 1995 Mexico’s drawings amounted to only
$24.9 billion. A solvent government might still face liquidity problems that limit its
ability to service its debt. For instance, an overly pessimistic view about the future of
the economy might lead lenders to curtail the amount of financing temporarily even if
the country is in fact solvent. Eventually, liquidity problems might escalate,
negatively affecting the government’s access to international capital markets.
At the same time; the private pension fund system has continued to grow, making
long-term resources more widely available. Today, Mexico’s foreign debt
amortization schedule is light and well distributed over time. The overall debt burden,
including domestic and external debt, diminished from levels above 450/0 of GDP in
1990 to approximately 280/0 in 1998. This trend is thought to have continued in
1999.The country’s solvency and liquidity indicators compare favorably to those of
other countries: external debt as a share of GDP amounted to 170/0 in early 1999,
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while the ratio of total exports to external debt was 1.7. An example of Mexico’s
strategy to ensure external financing when conditions in international capital markets
turn adverse is the credit line secured with international financial institutions in
November 1997.
After having a look at the global scenario of external debt lets understand the debt
management in India .
External Debt Development and Management
SOME REFLECTIONS ON INDIA
INTRODUCTION
In 1990-91 when India got into a severe foreign exchange crisis her outstanding level
of external debt was $ 83. 8 billion. The level of debt was about 40 per cent of Gross
Domestic Product and the debt service payment was about 30 per cent of exports of
goods and services. Several destabilizing forces acting on the Indian foreign exchange
markets were a downgrade of India’s sovereign credit ratings to non-investment
grade, reversal of capital flows, exacerbated the foreign exchange crisis and
withdrawal of the foreign currency deposits held by non-resident Indians. One can
best describe the severity of the situation by quoting from the then Finance Minister
of India Dr Manmohan Singh’s Budget 1992-93 speech to the Parliament:
"When the new Government assumed office (June 1991) we inherited an economy on
the verge of collapse. Inflation was accelerating rapidly. The balance of payments
was in serious trouble. The foreign exchange reserves were barely enough for two
weeks of imports. Foreign commercial banks had stopped lending to India. Non-
resident Indians were withdrawing their deposits. Shortages of foreign exchange had
forced a massive import squeeze, which had halted the rapid industrial growth of
earlier years and had produced negative growth rates from May 1991 onwards".
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With this background a study on India’s external debt would obviously raise certain
questions such as: how did India manage historically with a very low volume of
external capital inflows; how is that the third world debt crisis of early 80s had a little
impact; how is it then that India got into a massive foreign exchange crisis in 1990-91;
how was India spared from the contagious currency crisis of 1997; and how did India
managed to improve her rank from what was third debtor after Brazil and Mexico in
1991 to eighth in 2002 in the list of the top fifteen debtor countries(as per the Global
Development Finance report 2004 published by the World Bank).
Still more notable is the fact that India never defaulted to international lenders in her
entire credit history (except one or two instances of corporate rescheduling).
Although the level of debt has increased to $ 112.1 billion by end-December 2003, the
magnitude of debt is no longer an issue at present. The economic reforms and debt
management policies pursued since 1991 have helped to bring down the share of
external debt in GDP to 20.2 per cent and the debt service ratio to 15.8 percent by
end-December 2003. The reforms involving trade and capital account liberalization
have changed the nature and composition of capital flows into Indian economy. The
gradual opening of the capital account and improved credit standing internationally,
supported by the prudent macroeconomic policies, have established investors’
confidence.
The above scenario although presupposes several accomplishments underlying the

country’s external debt management history, the Indian economy nevertheless
displayed several episodes of imbalances in her debt, capital flows and external
sector. India’s external debt management in the light of the development in her overall
macroeconomic policies and draws lessons for countries in the region. It needs to be
mentioned here that the trends in debt need to be reviewed along with the
developments in external sector and capital flows, because the overall trade regime,
involving trade restrictions, export subsidisation and exchange controls would govern
to a large extent the behaviour of external debt.
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B URDEN OF E XTERNAL D EBT IN INDIA
It is a source of some comfort that India's external debt continues to be at a stable

level. According to the status paper prepared by the Union Finance Ministry, the stock
of foreign debt stood at $98.4 billion at the end of December 2001. After a substantial
increase of $16 billion between 1991 and 1995, partly on account of fresh loans and
partly on account of exchange rate movements, the total debt has fluctuated between
$93 billion and $99 billion since 1995. Going by a number of indicators, India's
external debt situation is far better today than it was during the balance of payments
(Bop) crisis of 1991.
While the absolute size of foreign debt is important, more relevant is the weight this
debt imposes on the economy. And, on that count, the burden has become lighter and
lighter, even as the stock of outstanding has remained more or less constant. Annual
repayments of loans and interest as a percentage of current receipts — the debt service
ratio, which was as high as 35 per cent in 1990-91, has fallen to 13 per cent today.
Debt as a percentage of the gross domestic product has nearly halved since the early
1990s. And the short-term debt to GDP ratio, which crossed 10 per cent in 1990-91
and precipitated the Bop crisis of that year, has been held under 3 per cent. Overall,
India is now classified by the World Bank as a "less" indebted country, which is two
rungs below the extreme category of "severely" indebted countries, which is where
Brazil, Argentina and Indonesia now belong. In absolute terms as well, India's
position has improved globally. In the mid-1990s, India was the third largest debtor in
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the world; today it is ranked ninth. All this has taken place in spite of the fact that new
loans are increasingly being raised on commercial rather than concessional terms, as
was the practice for decades.
CAUSES FOR INCREASE IN EXTERNAL DEBT
The important causes for the sharp increase in India’s external debt were the
following:
Increase in Trade Deficit
The enormous increase in trade deficit has been a very important reason for the sharp
increase in India’s external debt. the poor export performance of India has also been
responsible for the large trade deficit. The impact of oil price hike has already been
pointed out earlier.
Decline in the Net Invisibles
During the 1980s, there was a gradual decline in invisibles surplus. Invisibles
surpluses had traditionally financed a large part of India’s deficit. There was a steep
fall in this since the beginning of the eighties. Net invisibles financed nearly 73% of
the trade deficit in 1980-81. During the sixth plan (1980-85), on an average it
financed more than 60% of the trade deficit. By 1990-91 it dropped to 13%,
compelling the nation to take increasing recourse to external source for meeting the
payment obligation. This falling trend in the net invisibles had been caused by the
adverse trends in invisible payments on the one hand and invisibles receipts on the
other.
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Change in the Composition of the Debt
One important source of the BOP problem in the 1980s and afterwards is the change
in the source of financing the large current account deficit. In the earlier period, i.e.
until the beginning of the 1980s, almost the entire deficit was financed through
inflows of concessional assistance, which kept the debt-service burden low. As
against this, the eighties were marked by a reduction in flows of concessional
assistance to India, particularly from the World Bank Group. The credits from the
IDA on soft terms declined, while loans from the World Bank on market terms
increased sharply. As a result, the average interest rate on India’s official debt
increased from 2.4% in 1980 to 6.1% in 1982. The debt service payments on
multilateral loans tripled from $371 million in 1984 to $1106 million in 1989. Further,
the average maturity of loans declined from 40.8 years in 1980 to 24.4 years in 1989.
Between 1980 and 1989, the debt to private creditors, including commercial banks
and non-residents increased almost ten-fold, from $2.3 billion to $22.8 billion. The
debt service as a percentage of export earnings nearly tripled during this period, from
9.1% to 26.3%.
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E XTERNAL D EBT M ANAGEMENT P OLICY
India’s Debt-GDP ratio which shows the magnitude of external debt to domestic
output had declined from 38.7 % at the end of March 1992 to 22.3% at end March
2001.Similarly the debt service ratio that measures the ability to serve debt obligations
has declined from 35.3% of current receipts in 1990-91 to 16.3% in 2000-01.
This improvement in external debt should be attributed both to a cautious policy on

foreign borrowings (which includes annual caps on commercial loans which would
not have been possible if the rupee was fully convertible) and to the steady growth in
current receipts in the BOP. There are, however, enough areas of concern, which
should prevent complacency and persuade the Government to go slow on capital
account convertibility. The first is that while the short-term debt to GDP ratio was
only 2.8 per cent at the end of 2001, the more accurate measure of immediate
repayments— total debt of a residual maturity of one year — was 9 per cent of GDP
in December 2001. This is still not a very heavy burden, but it is not something to be
taken lightly.
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The second concern should be that the estimate of debt servicing in the years ahead
(based on past borrowings) shows that there are going to be two major humps round
the corner. In 2003-04 and 2005-06, repayments of the expensive Resurgent India
Bonds and India Millennium Deposits fall due. Debt service in both years will then
cross $12 billion. This will be the largest since 1995-96, though the Government
hopes that not all the repayments will be repatriated. The third concern should be the
impact of the Government's decision to make even the existing non-repatriable bank
deposits by non-resident Indians fully payable in foreign exchange. As a consequence,
two such schemes were discontinued last April and outstandings transferred to
repatriable accounts where they will be held till maturity. The stock of deposits in one
of these schemes was itself over $7 billion. This means that if these deposits are taken
out of the country when they mature they will add to India's debt service burden. And
if they are renewed they will add substantially to India's external debt burden. Either
way, the Government's decision is going to have a negative impact on the Bop.
Problems of External Debt Management In India
Borrowing costs are not limited to interest costs. First, there is the dependency
syndrome, which leads to the development of constituencies at the various levels of
government to keep the borrowing momentum in full swing, actively supported by the
multilateral development agencies. Second, there is an element of uncertainty in
regard to whether the loans will be available when most needed, with the uncertainty
increasing in the event of any demonstration of national self-reliance in area
unacceptable to the stockholders of the lending agencies. Third, neither the civil
servants negotiating the loans nor their political bosses have a direct responsibility for
loan repayment, with the result that there is bound to be a relatively high degree of
laxity in ensuring the best and most productive use of the borrowed funds. Fourth,
there is hardly any evidence to indicate that countries with heavy indebtedness really
can ever develop to such an extent that they will be free from such indebtedness.
E XTERNAL D EBT D EVELOPMENT U NTIL 1970’ S

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Looking at historically one observes that external capital played a very insignificant
role in India’s development process. The industrialisation strategy adopted since the
1950s emulated an import substituting trade regime, with both imports and exports
being strictly regulated through quota and duties. The level of current account deficit
was as low as 1.2 per cent in 1970, matching the availability of external finance, most
of which were contracted from the official creditors and at concessional interest rates.
Private commercial borrowings from the international capital markets were nil. The
total external debt outstanding at $ 8.4 billion was just about 13.3 per cent of GDP for
the year 1970.
India responded very well to the first oil shock of 1973, with prudent macroeconomic
management. The deflationary stance of macroeconomic policies coupled with
massive inflows of inward remittances from Gulf led to even a surplus on current
account in 1976-77, which helped to build up the reserve level.
Imports were virtually restricted to the level of exports, and thus the entire inflows of
worker's remittances and net aid inflows (after adjusting the gross flows for debt
service) were ploughed back to build up the reserves.
It was no surprise, therefore, to find that during this period gross aid inflows were
sharply reduced by the donors, as these were only going to swell further the reserves.
By 1978-79, the reserve level reached about 9 months of import requirements. There
was strong opinion in some quarters as to whether India could take advantage of this
comfortable foreign exchange situation to relax the severity of the import control
regime. To some extent imports were liberalised in 1976-77 and 1977-78 through the
introduction of Open General License (OGL), but the persistence of almost total
protection of the Indian industrial sector prevented any significant loosening of
import.
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The second oil shock had a major impact on India’s balance of payments, however,
with the prices of POL more than doubling during the course of 1979. The oil imports
accounted for almost 58 percent of total imports and 46 percent in terms of export
earnings. The primary focus of balance of payment management after the second
shock was to finance the deficit, rather to control it through deflationary stance of the
first oil shock-type.
D EVELOPMENTS IN E XTERNAL S ECTOR D URING 1980’ S
India remained unaffected by the debt crisis of early eighties facing many developing
countries, due to her insignificant level of private debt. The foreign exchange
constraints in the aftermath of second oil shock could be relieved by drawing
substantial amount of loans from the International Monetary Fund: SDR 266 million
under Compensatory Financing Facility (CFF) in 1980, SDR 529.01 million under
Trust Fund Loan (TFL) in 1980-81 and SDR 5 billion under Extended Fund Facility
(EFF) during 1981-84 (of which India used only SDR 3.9 billion). The foreign
exchange situation also improved dramatically due to the inflow of remittances from
the Gulf.
A substantial amount of import savings could be made due to large-scale import

substitution in the areas of food, petroleum (after the discovery of Bombay High) and
fertilizer. Thus, an improved foreign exchange scenario, which along with the
available multilateral concessional assistance helped India to retain her credit-
worthiness and avoid a possible liquidity crisis of the Latin American type in early
Page | 22
1980s. In fact taking the advantage of the improved foreign exchange scenario Indian
policy makers attempted to relax the severity of the controlled trade regime in the 80s.
The liberalization of the import control regime, particularly the category of Open
General License (OGL) and export-related licenses, opened up a variety of imports
that were required by a wider range of emerging consumer goods industries. Export
growth remained sluggish during the eighties, due to the slowdown in the growth of
world trade, decline in primary commodity prices in the global market, and the
expansionary policy at home, as the later might have reduced the exportable surplus to
some extent. Indeed the trade deficits went up from $ 5.9 billion in 1984-85 to $ 7.9
billion in 1990-91 (with $ 9.1 billion in 1988-89) and the current account deficits from
$ 2.4 billion to $ 8.9 billion during the same period (based on RBI data).
With the near stability in the inflows of concessional assistance, financing of deficits
were made by raising commercial loans from the Eurocurrency markets in the form of
syndicated loans and Eurobonds as well as accepting short term foreign currency
deposits from the non-resident Indians.
Table 1: Indicators of Current Account Sustainability for India (Per cent)
Indicator 1971 197 198 198 199 199 200

- 6- 1- 6- 1- 6- 1-
1975 198 198 199 199 200 200
0 5 0 5 0 3
Trade Deficit/ GDP -0.9 -1.4 -2.5 -2.1 -1.2 -2.5 -2.2
Current Account -0.4 0.2 -1.5 -2.2 -1.3 -1.3 0.2
Deficit/GDP
Gross Fiscal -3.3 -5.0 -6.8 -8.1 -5.7 -5.1 -5.9
Deficit/GDP
Private Sector: SI 2.7 4.7 3.8 4.8 7.3 6.6 9.9
Gap
External Debt/GDP 15.3* 12.8* 13.2* 15.8* 33.9 24.3 21.2
Short-term .. .. .. 10.0 6.7 5.3 3.6
Debt/Total Debt
Non-Debt Capital .. .. .. 6.0 27.1 49.3 94.8
Flows/Total Capital
Flows
Debt Servicing .. .. .. 30.2 28.9 19.7 15.3
Page | 23
Changes in REER .. -2.1 0.8 -4.9 -2.9 -0.8 4.8

Import Cover 4.3 7.4 4.2 3.3 5.9 7.2 11.2
(Months)
* Comprising of external assistance, commercial borrowings and IMF loans only. Thus, the external
debt-GDP ratio for these periods is not comparable with the subsequent period.
SI Gap: Saving Investment Gap
Source: Reserve Bank of India.
The imbalances in the external sector coincided with the macroeconomic imbalances
in the economy, particularly in the form of increasing domestic money supply and
budget deficits (see Table 1). The expansionary monetary and fiscal policies did not
take into account the likely repercussion in the form of spill over effects on balance of
payments. In fact, the generation of the excess liquidity that accompanied the
liberalised import structure swelled the level of current account deficit.
The principal mode of balance of payment adjustments in India during the second half
of the eighties was the managed depreciation of the rupee. Between 1985-90, the
NEER of the rupee depreciated by almost 50 per cent and the REER by 30 per cent.
It is clear that in a situation where the balance of payment problem was basically due
to the macroeconomic imbalances, which arose primarily from the expansionary
macroeconomic policies and the liberalised import structure, the expenditure
switching effects of devaluation did not work.
The debt management policies in 1970’s and 1980’s was not helping India develop
and there arised a need to make changes in the policies.
Page | 24
DEBT POSITION DURING 1990’s
India’s external debt at end-September 1999 stood at US $98.87 billion as against US

$97.68 billion at end-March 1999. Despite the increase in debt stock, there has been
considerable improvement in major debt indicators, which reflects an over all
improvement in the external debt scenario of the country. In this regard, it is
noteworthy that the Debt-GDP ratio improved from 41.0 per cent in 1991-92 to 23.5
per cent in 1998-99 (Table 6.12). The debt service payments as ratio of current
receipts continued to improve steadily from 30.2 per cent in 1991-92 to 18 per cent in
1998-99. Short-term debt (i.e., debt with an original maturity of up to one-year)
declined from US $ 8.54 billion at end-March 1991 to US $ 4.61 billion at end
September 1999. The share of short term to total debt fell from 10.2 per cent at end
March 1991 to 4.7 per cent at end- September 1999 (Figure 6.5).
Page | 25
Simultaneously, the ratio of short term debt to foreign currency assets has continued
to improve from the high of 382.1 per cent at the end March 1991 to 15.1 per cent at
end September 1999. (Table 6.12). The share of concessional debt to total external
debt was 38.7 per cent at the end September 1999 as against around 45 per cent during
first half of the decade. The share has been declining gradually since the mid-nineties
showing signs of structural change in the composition of external debt.
Page | 26
India has been among the top ten developing country debtors. However, its
comparative indebtedness position has improved over the years. India ranked as the
third largest debtor country after Brazil and Mexico in 1991 while in 1997 it ranked
eighth after Brazil, Mexico, China, Korea, Indonesia, the Russian Federation and
Argentina.Table 6.13 gives comparative indebtedness position for the top 15 debtor
countries. India has the most favorable short term to total debt ratio. Since India has a
high proportion of concessional debt, its Present Value (PV) of debt is low, and it
ranks tenth on this count (as against eighth position in terms of total indebtedness).
Page | 27
External debt management continues as an area of high priority. To consolidate the

gains already made, the focus of external debt management policy would be continued
stress on high growth rate of exports, keeping the maturity structure as well as the
total amount of commercial debt under manageable limits and encouraging non-debt
creating flows of foreign investment
Page | 28
CRISIS AND R EFORM IN THE 1990 S
The foreign exchange crisis opened up several internal conflicts of an inward looking
economy. The policy makers considered the unsustainable balance of payment
situation as the symptom and the disease was inherent in the trade and industrial
policy that protected the Indian economy from both internal and external competition.
The shrinking share of India's exports in the global trade was considered as the
reflection of the receding exports competitiveness and the absence of a right kind of
commodity mix in India's export basket. The inefficiency of the trade regime had
much to do with the prohibitive tariffs and a pervasive system of import controls.
The entire regime of discretionary management of foreign exchange had constrained
growth, proliferated black markets in foreign exchange and created avenues for
considerable rent-seeking activities.
India’s approach to the 1990-91 crises was not to default on her external obligations,
rather to pursue macroeconomic reforms, and remain current on debt servicing by
borrowing from multilateral sources. As part of the overall macroeconomic reforms,
sweeping changes were introduced in the areas of trade and exchange rate policies.
The Congress led government, which assumed office at the Centre in June 1991,
accepted the medium term structural adjustment programme of the IMF. An
immediate fall out of this programme was the sharp devaluation of the rupee. In July
1991 the rupee was devalued at two stages, from £ 1 Rs.34.36 to Rs.41.59.
This was followed by a plethora of trade policy reform measures, beginning August
1991, by slashing cash subsidies for the export sector and relieving the economy from
the QR and tariff regimes adopted since fifties.
India’s reform efforts since 1990s had led to a resumption of growth, decline in
inflation, improved fiscal deficit, and a sustainable balance of payments. As we shall
Page | 29
see later this had remarkably reduced the external debt burden and brought several
beneficial changes in the composition of capital flows in years to come.
D EVELOPMENTS TO 1991 F OREIGN E XCHANGE C RISIS
By 1990, there was a marked deterioration in India's balance of payments. Although

there was satisfactory growth in exports, it was overshadowed by growth in imports,
stagnant flows in invisibles such as tourism and private transfers, and mounting debt
service burden. The current account deficits which were sustained mainly by
borrowing from commercial sources and NRI deposits, with short maturities and
variable interest rates, resulted in a ballooning of repayment burden towards 1990.
The size of external debt reached $ 83 billion in March 1991, 45 percent of which was
contracted from private creditors and at variable interest rates.
The debt service payments had reached 30 percent of export earnings by March 1991,
which was close to some of the heavily indebted countries such as Indonesia (31 per
cent), Mexico (28 per cent), and Turkey (28 per cent).
Interest components alone were about $ 4 billion, comprising some 50 per cent of the
total current account deficits and 21 per cent of the total merchandise exports. The
growth of exports in US dollar terms was not sufficient even to pay for the interests
for each of the three years to 1990-91 and India had to make for amortization
payments by resorting to fresh borrowing.
The foreign exchange crisis was exacerbated by the Gulf war that began in August
1990, causing shortfall in exports to West Asia, loss of remittances from Kuwait and
Iraq, huge foreign exchange costs of emergency repatriation from the region and,
most importantly, additional cost of oil imports due to the oil price increase.
The Gulf crisis coincided with recessionary trends in the West that had depressed the
demand for India’s exports.
Page | 30
Furthermore, the economic decline in Eastern Europe led to a contraction of exports

to these markets.
The uncertain political climate at home along with the precarious balance of payments
situation led to the erosion of India's credit ratings abroad. The Moody's downgraded
India's status to BB in 1990, which was the highest speculative grade for long-term
debt.
There were indications that the net resource transfer on account of official and private
credit had become negative in 1990-91 i.e. the fresh inflows were not even adequate
to meet the obligations on account of amortization and interest payments. The level
of foreign exchange reserves fell to just $ 1 billion in 1990-91. This desperate
situation led the Reserve Bank of India to sell 20 tonnes of gold in May 1991 and
pledge another 46.91 tonnes in July 1991, for meeting the urgent foreign exchange
needs and financing current account deficits. An imminent foreign exchange crisis
loomed large before the Indian economy, with unsustainable external debt burden.
Page | 31
R ESPONSE TO 1991 CRISIS AND ITS EFFECTS
Ten years ago India was in the midst of a full-blown balance of payments crisis. We
have come a long way since those dark days of collapsing confidence, thanks mainly
to sound economic policy and partly to good luck. It’s a story of successful economic
reform.
To begin with, it’s worth recalling just how bad our external economic position had
had become in 1991. By March the current account deficit in the BoP had cumulated
to a record level of nearly 10 billion dollars or over 3 per cent of GDP. Exports were
falling. The foreign borrowing spree had taken the ratio of short-term external debt to
foreign currency reserves to an astronomical 380 per cent. Foreign currency reserves
skated close to a pitiful billion dollars throughout the spring and summer of the year.
NRI deposits were bleeding away. Access to commercial external credit was
becoming extremely costly and difficult. Even the normally sober government
Economic Survey for the year admitted “A default on payments, for the first time in
out history had become a serious possibility in June 1991”.
Faced with this prospect, the new Government (with Manmohan Singh as finance
minister) undertook emergency measures to restore external and domestic confidence
in the economy and its management. The rupee was devalued, the fiscal deficit was
cut and special balance of payments financing mobilized from the IMF and World
Bank. The government also launched an array of long overdue and wide-ranging
economic reforms. Aside from various measures of domestic liberalization, the
strategy for restoring external sector health embraced six key planks.
First, and most importantly, the exchange rate was made market-dominated after a
two year transition. It improved greatly the incentives to exporters and to NRIs
remitting funds to India through official channels. Correspondingly the rupee cost of
importing became higher. Most important, the price of foreign exchange stopped
Page | 32
being fixed by politically apprehensive governments. Second, the heavy anti-export

bias (and pro high-cost import substitution bias) was reduced through phased cuts in
our extraordinarily high customs tariffs.
Third, almost all the economic (and not so economic) evils of the import license-
permit raj were gradually phased out. Fourth, there was a decisive opening up to
foreign direct and portfolio investment. Fifth, short term foreign debts were reduced
and strictly controlled; medium term commercial borrowing was also made subject to
prudential caps and minimum maturities. Finally, there was a deliberate policy to
build up foreign exchange reserves to provide more insurance against external stresses
and uncertainties.
The fruits of these policy thrusts soon came in bountiful measure. Export growth
zoomed up to 20 per cent in 1993/94 and the two years thereafter. Inward remittances
by NRIs quadrupled from two billion dollars in 1990/91 to eight billion in 1994/95
and rose further to exceed twelve billion in 1996/97. The current account deficit in the
BoP never again exceeded two per cent of GDP and averaged only about one per cent
for the ten years after 1990/91. Foreign investment soared from a negligible hundred
million dollars in 1990/91 to over 6 billion dollars in 1996/97. Foreign exchange
reserves climbed steeply from the precarious levels of 1991 to over $ 26 billion by the
end of 1996/97. The debt service ratio was halved over the decade. The critical ratio
of short-term foreign debt to forex reserves (proven critical again in the recent Asian
Crisis) plummeted down from the stratospheric heights of 1991 to a very safe 20 per
cent in March 1995.
It would be hard to find more convincing evidence of success of the external sector
reforms. But more evidence was soon forthcoming as the gales of contagion swept
through Asia in 1997/98. India’s external policies of flexible exchange rates, strict
control of short-term borrowing and ample forex reserves, backed by timely monetary
policy, passed this rigorous test with high marks.
With many key performance indicators (such as overall economic growth and fiscal
deficit), the year 1996/97 seems to mark a turning point. Export growth dropped
sharply that year and has averaged below 10 per cent in the last 5 years despite of a
Page | 33
good recovery in 2000/01. Foreign investment has actually fallen since the peak of
1996/97 and totaled only $3.4 billion in 2000/01. External debt indicators have
continued to improve but not decisively.
Remittance inflows have plateaued after 1996/97.True, the current account deficit has
remained low but this mainly reflects the stagnation of non-oil imports because of a
sluggish industrial economy. Only software exports have bucked the lackluster trend
of recent years. What’s amiss and what should we do?
First, we should draw the right lessons from our earlier success. The most important
and most encouraging lesson is that when we pursue good economic policies we
quickly get the rewards in the form of strong economic performance. Second, the
strength our external sector depends crucially on the productivity and competitiveness
of our producers in agriculture, industry and services. Rigid labour laws and
reservation of products of small scale industry handicap our competitiveness. The
sooner the budget speech promises on these are implemented, the better. Our
infrastructure sectors of power, roads, ports and railways are notoriously inefficient
compared to our international competitors. The sooner we reform them, the more
competitive our producers will become. Our customs tariffs are usually high and have
changed a little after the sizable reductions between 1991 and 1997. protection
reduces efficiency and productivity. Here too, budget speech intentions await
fulfillment. Third, foreign direct investments (FDI) could play a big role in boosting
output, exports and employment, as it has in China which is host to almost 20 times
the amount of FDI each year than we are. The same factors of poor infrastructure,
rigid labour laws, high government borrowings and weak export orientation that deter
domestic investment also inhibit FDI.
Over the past year the world economy has slowed and India (like everyone else) faces
a tougher external economic environment. The disastrously wrong response to this
would be to turn more inward. Our painfully slow economic progress in the three
decades up to 1980 provides ample testimony to bankruptcy of inward-looking
development strategies. The correct response is to improve productivity and complete
harder. That means implementing the policy priorities, noted above, with even greater
vigour and consistency. Only good economic policies will yield more growth, less
Page | 34
poverty and a stronger external sector. We have seen that before and we must ensure
it in our future.
1997 A SIAN CRISIS AND I TS I MPACT
The Southeast Asian crises had several common elements: speculative attack on the
currencies (with sharp depreciation); the authorities being forced to defend the
plummeting currency by depleting large volumes of international reserves; banking
crisis compelling the governments to extend massive financial assistance to banks
through budgetary support to prevent a collapse.
Another distinguishing feature of the crisis was the effect of contagion; crisis in one
country spreading into several others in the region. The contagion impact depended on
the degree of financial markets integration as well as the existing state of the
economy.
The speculative attacks were on those countries’ currencies that were competing in
the same world markets for goods and capital.
The Asian crisis had only a marginal impact on India, with negligible impact on her
foreign exchange markets, the level of reserves and the banking system. It has been
observed that the macroeconomic fundamentals prevailing at the time coupled with
the flexible exchange rate management and control on short-term capital flows helped
India to withstand the currency crisis.
The crises demonstrated that the major objective of sound debt management policy
could be to achieve or maintain debt sustainability, while meeting key economic
macroeconomic goals.
Page | 35
At the time of currency crisis India’s balance of payments situation had become
sustainable due both to a reduction in the current account deficit and to a substantial
increase in net capital inflows. The current account deficit had fallen from its peak
level of $ 9.8 billion in 1990- 91 to US $3.7 billion in 1997-98; the later was
estimated at 1.5% of the GDP.
The 1997 level of current account deficit as per cent of GDP was 7.9% in Thailand,
4.9% in Korea and Malaysia, 3.3% in Indonesia and 4.7% in Philippines. India’s
external debt at the end of 1997-98 was $92.9 billion or 23.8 per cent of GDP. The
debt-GDP ratio was very high for the affected Southeast Asian countries: Thailand
(56.8%), Indonesia (67%), Philippines (54%) and Malaysia (49%).
Table 2: Selected Indicators of India’s External Sector (% growth unless noted)
Item/Year 91-92 92-93 93-94 94-95 95-96 96-97 97-98
1. Growth of Exports -1.1 3.3 20.2 18.4 20.3 4.5 2.6
2. Growth of Imports -24.5 15.4 10.0 34.3 21.6 10.1 5.8
3. Exports/Imports 86.7 77.6 84.8 74.8 74.0 70.2 83.3
4. Reserves to Imports 5.3 4.9 8.6 8.4 6.0 6.6 7.0
5. Short-term debt/Reserves 76.7 64.5 18.8 16.9 23.2 25.5 19.8
6. Debt service Ratio 30.2 27.5 25.6 26.2 24.3 21.4 18.3
7. Current account balance* -0.4 -1.8 -0.4 -1.1 -1.8 -1.0 -1.5
8. External Debt* 41.0 39.8 35.8 32.3 28.2 25.9 23.8
9. Debt service payments* 3.3 3.3 3.3 3.6 3.6 3.3 2.8
* As % of GDP Source: Economic Surve
The level of international reserves, which was just $ 5.5 billion in 1991-92, increased
to $29.4 billion 1997-98, providing about 7 months of imports cover. Nevertheless,
exports continued to finance over 80% of India’ imports, thus making the trade
account near self-sustaining. By the end of March 1998, the combined level of
Page | 36
portfolio flows and short-term debt constituted about 75 per cent of the country’s
foreign exchange reserves.
Indeed, the entire volatile inflows were said to have been added to reserves that had
given sufficient leeway for stabilizing speculations in the foreign exchange markets.
The net capital inflows into India increased from $4.7 billion in 1991-92 to $9.5
billion in 1996-97, which came down marginally to $8.2 billion in 1997-98, because
of the uncertain domestic and international environment (mainly arising out of
sanctions from the US). In the aggregate, there was already a shift towards non-debt
creating flows, by way of foreign institutional investors (FII) into India’s debt and
equity markets, euro equity issues by Indian companies, which had reached at $5.5
billion in 1997-98.
Debt flows (to cover aid, commercial borrowings, NRI deposits, drawings from IMF)
in contrast was actually coming down significantly, reaching about $3.0 billion in
1997-98.
Short-term debt was repeatedly considered as an important risk factor in the

precipitation of foreign exchange crisis, especially when coupled with high or
unsustainable current account deficits. The share of short-term debt in the total debt
was just 6% in India at the time of crisis, which compares with 41% in Thailand, 25%
in Indonesia, 28% in Malaysia and 19% in Philippines. By the end of March 1998,
the combined level of portfolio flows and short-term debt constituted about 75 per
cent of the country’s foreign exchange reserves. Indeed, the entire volatile inflows
was said to have been added to reserves that had given sufficient leeway for
stabilizing speculations in the foreign exchange markets.
It needs to be recognized that the short term flows also have provided the necessarily
liquidity to an otherwise thin currency market in India.
The Asian crisis had therefore important policy lessons, and particularly in the context
of external debt management and capital flows. It is by now abundantly clear that the
Page | 37
crisis was not just because of the high current account deficit but much to do with the
way the current account deficit was financed, the nature of capital flows (such as debt
vs non-debt creating flows), and finally the way external capital being used for (such
as financing investment as opposed to consumption or non tradable). The relative
immunity to the crisis had also much to do with the structure of capital flows.
Although the Indian rupee was fully convertible on the current account, convertibility
on the capital account front was rather asymmetric, with somewhat more restrictions
on capital outflows than on inflows. With controls on trade, foreign exchange
transactions and short-term capital flows, it was therefore possible to insulate the
Indian economy from external shocks.
Exchange rate was considered the most important variable affecting the currency
crisis. After a devaluation of about 22% in July 1991 India shifted to a system flexible
exchange rate management based on “partial convertibility” in March 1992 and
finally to “market determined” exchange rate system in March 1993. The market
driven exchange rate also had obliged the policy makers to have lower inflation,
disciplined fiscal and monetary policies, and stable real exchange rate for attaining
sustainable balance of payments.
Under the circumstances the Reserve Bank retained the necessary flexibility in
managing the currency, by quoting its own reference rate and actively intervening at
that rate from time to time. In addition the market driven exchange rate also
prevented excessive risk-taking by agents that would have occurred a fixed or a
pegged exchange rate regime.
In fact, the existence of exchange risks has discouraged some of the more speculative
short-term capital flows in to India, thereby reducing the need for policy
interventions.
The conduct of exchange rate policy had also stabilizing impact on the currency and
capital flows pursued with appropriate mechanisms of intervention and sterilization.
Looking from the experience, one noticed some kind of self-balancing mechanisms to
have worked in the Indian foreign exchange markets. At a time of exchange market
Page | 38
pressure, the policy seemed to have been not to defend the currency fully by spending
reserves and, thereby, offering the speculators an easy target. In addition the market
driven exchange rate also prevented excessive risk-taking by agents that would have
occurred a fixed or a pegged exchange rate regime. In fact, the existence of exchange
risks have discouraged some of the more speculative short-term capital flows into
India, thereby reducing the need for policy interventions.
E VOLVING DEBT AND CAPITAL F LOWS S CENARIO T OWARDS 2003

India’s external $ 112.1 billion stood at the end of December 2003, which increased
from $ 83.8 billion in March 1991(Table 3). The growth rate during the period was at
an annual average rate of 2 per cent per annum. Some of the increase has been due to
valuation changes, resulting from the weakening of US dollar vis -a- vis other
currencies (for example, $ 5.7 billion out of $6.8 billion increase in external debt
during 2002-03 was due to such valuation changes).
In terms of the level of outstanding debt India ranked as eighth in 2002 from among
the top fifteen debtor countries in the world, coming after Brazil, China, Russian
Federation, Mexico, Argentina, Indonesia and Turkey. This implied a marked
improvement in her debtor position since 1991 foreign exchange crisis, when her rank
was third from among the top fifteen debtor countries, i.e. coming after the two most
heavily indebted countries such as Brazil and Mexico.
Table 3: India's External Debt
Share in total External Debt

End-March 1991
End-March 1996
End-March 2001
End-Dec 2003
(US $ mn.)
(US $ mn.)
(US $ mn.)
(US $ mn.)
Page | 39
Multilateral 20900 25 28616 31 31898 32 30558 27

Bilateral 14168 17 19213 20 15323 16 17942 16
IMF 2623 3 2374 3 0 0 0 0
Export Credit 4301 5 5376 6 5368 5 4773 4
Commercial 10209 12 13873 15 23227 24 20582 18
Borrowing
NRI Deposits* 10209 12 11011 12 17154 17 29867 27
Rupee Debt 12847 15 8233 9 3042 3 2635 2
Short-term Debt 8544 10 5034 5 2745 3 5773 5
Total External debt 83801 100 93730 100 98757 100 112130 100
Share of 44.8 42.3 36.0 36.4
Concessional Debt
to Total Debt
Source: India’s External Debt: A Status Report, Government of India, 2003.
An important aspect of India’s external debt has been its concessionality. As of

December 2003 about 36. 4 per cent of the overall debt portfolio was characterized by
concessional debt, contracted mainly from multilateral and bilateral institutions. Due
to the concessional nature of indebtedness the present value concept becomes the
appropriate measure, obtained by discounting the future debt service payments for
individual loans by appropriate discount rates and aggregating such present values.
The present values India’s external debt stood at $ 82.9 billion in the year 2002 which
is 80 per cent of the total outstanding debt. According to Global development Finance,
the present value of external debt in the year 2002 was 17 per cent of GNP, lowest
within the top fifteen debtor countries except China (with 14 per cent in 2002).
Page | 40
External Debt- GDP Ratio*

45
38.7
40 37.5
33.8
35
30.8
28.7
30 27
24.5 24.3
2tn5 23.6
2 2.1 22.6
e 21.1
20.2
c
2re0
P
15
10
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
The effectiveness of debt management policy should be judged in terms of the debt
serving capacity, which can be gauged by indicators measuring solvency as well as
liquidity. In Table 4 we analyze the most commonly used indicators debt
sustainability: debt service ratio, interest service ratio, debt to gross domestic product
ratio, short-term debt to total debt and short term debt to foreign exchange reserves.
As seen from Table there is remarkable improvement in all the ratios during 1990-
2003. The stock of external debt to GDP ratio declined from its peak of 38.7 per cent
in 1991-91 to 20 percent in 2002-03. The debt service ratio which reached a record
level of over 35 per cent in 1990-91, declined steadily to 14.7 per cent in 2002-03.
The most notable outcome of external debt management during 1990s has been the
control over short-term debt. The level of short-term debt amounted to only US $5.0
billion by December 2003. The share of short term debt to total debt declined
significantly from over 10 per cent in 1990-91 to 4.4 per cent in 2002-03, which
actually was the lowest for India from among the top 15 debtor countries.
The volume of short-term debt, which was 146 per cent of foreign exchange reserves
in 1990-91, declined to just 6 per cent in 2002-03. By taking into account the
Page | 41
residual/remaining maturity within the component of short-term debt, it still remains

modest at $ 12. 7 billion or 11.7 per cent of total external debt by end-December
2003(Table 5).
Table 4: Indicators of Debt Sustainability for India
Year Solvency Indicators Liquidity Indicators

DSR ISR DGDP STD/TD STD/FER
1990-91 35.3 15.5 28.7 10.2 146.5
1991-92 30.2 13.0 38.7 8.3 76.7
1992-93 27.5 12.5 37.5 7.0 64.5
1993-94 25.4 10.5 33.8 3.9 18.8
1994-95 26.2 9.7 30.8 4.3 16.9
1995-96 24.3 8.8 27.0 5.4 23.2
s1996-97 21.2 7.3 24.5 7.2 25.5
1997-98 19.0 7.5 24.3 5.4 17.2
1998-99 17.8 7.8 23.6 4.4 13.2
1999-00 16.2 7.3 22.1 4.0 10.3
2000-01 17.2 6.6 22.4 3.6 8.6
2001-02 13.9 5.4 21.0 2.8 5.1
2002-03 14.7 4.1 20.3 4.4 6.1
DSR = Debt Service Ratio; ISR = Interest Service Ratio; DGDP = Debt to Gross Domestic Product
Ratio; STD = Short-Term Debt; TD = Total Debt; FER = Foreign Exchange Reserves.
Source: Reserve Bank of India
Table 5: India’s Short Term External Debt by Residual Maturity (US $ million)
199 199 200 200 2002

8 9 0 1
Short-term debt by original 5,046 4,274 3,936 3,628 2,745
maturity
(5.4) (4.4) (4.0) (3.6) (2.8)
Long-term debt maturing within 6,723 7,059 8,359 6,767 11,465
one yr
(7.2) (7.3) (8.5) (6.7) (11.6)
Total Short-term debt by 11,76
residual maturity 9
Page | 42
(12.6) (11.7) (12.5) (10.3) (14.4)
Note: Figures in the bracket represent per cent to total external debt.
Source: India’s External Debt: A Status Report, June 2003.
Total External Debt and Foreign Currency Assets

120
100
80
n
o
il
li
B 60
$
S
U
40
20
0
En d End End End End End End End End End End End End E nd End
Mar 91Mar 92Mar 93Mar 94Mar 95Mar 96Mar 97Mar 98Mar 99Mar 00Mar 01Mar 02Dec 02Mar 03Dec 03
To tal Extern al Debt Fo reig n Curren cy Asset s
Table 5: Reserve Indicators for India
Year Import Cover Reserves Reserves to

of Reserves to Short Term
(months) External debt
Debt
1990-91 2.5 7.0 68.3
1991-92 5.3 10.8 130.4
1992-93 4.9 10.9 155.1
1993-94 8.6 20.8 530.9
1994-95 8.4 25.4 590.0
1995-96 6.0 23.1 430.8
1996-97 6.5 28.3 392.8
1997-98 6.9 31.4 582.0
1998-99 8.2 33.5 760.2
1999-00 8.2 38.7 966.4
Page | 43
2000-01 8.6 41.8 1,165.4

2001-02 11.3 54.8 1,971.1
2002-03 13.8 72.0 1,650.9
The level of foreign exchange reserves went up from just 2.5 months of import cover
during 1990-91 is currently sufficient for over a year imports. The buildup reserves
were an outcome of the capital account opening in India as well as official policy
keeping in view the factors such as the level of current account deficit; the size of
short-term liabilities, debt servicing, the possible variability in portfolio investments
and other types of capital flows; unanticipated pressures on the balance of payments
arising out of external shocks such as oil price hikes. Looking at the sectoral
composition of external debt one finds that the share of government and government
guaranteed debt account for about 48 per cent of total external debt in December
2003. Debt contracted by the corporate sector, which also include government owned
public sector undertakings, are showing an increasing trend.
Table 6: Government Guaranteed External Debt ($ Millions)
1994 1996 1998 1999 2001 2002 2003

1 Govt. Debt 5594 5309 4652 4613 44027 4361 45647
3 5 0 7 9
2 Non-Got Debt 3675 4063 4701 5074 57105 5513 66483
2 5 1 9 8
4 Total External Debt(1+2) 9269 9373 9353 9688 10113 9875 11213
5 0 1 6 2 7 0
3 of which with Govt. Guarantee*: 1056 8545 7269 7174 6315 7022 6851
( a+b+c ) 8
a. Financial Sector 1709 1098 2323 2496 1429 1761 1807
b. Public Sector 8533 7070 4605 4363 4639 5070 4985
c.Private Sector 326 377 341 315 247 191 59
5 Govt. Debt and Guaranteed 6651 6164 5378 5331 50342 5064 52498
Debt(1+3) 1 0 9 1 1
6 Percent of Govt. Debt and 71.8 65.8 57.5 55.0 49.8 51.3 46.8
Guaranteed Debt to Total External
Page | 44
Debt(5/4)
7 Percent of Govt. Guaranteed Debt 28.8 21.0 15.5 14.1 11.1 12.7 11.0
to Non- Govt Debt(3/2)
Comparing the external debt indicators of the top 15 debtor countries for the years
1990 and 2001 one observes very comfortable situation for India (Table 7). India’s
debt had grown at 18 per cent as compared to over 300 percent rise in Korea, China,
Malaysia and Russian Federation and over 200 per cent rise in Argentina, Brazil,
Chile, Colombia, Indonesia and Turkey. Most of the solvency indicators for India
have shown perceptible improvement during the decade and fare well from among the
top fifteen indebted countries: level of external debt to exports of goods and services,
external debt to GNP, debt service ratio and interest service ratio, etc all show
considerable improvement during the decade. The adjustments in the debt indicators
are far better for India as compared to all other debt countries, particularly in the post
Asian crisis years.
COMPOSITION OF CAPITAL FLOWS
The pattern of capital flows into India reveals a shift in its composition, from debt to
non-debt creating flows with decreasing importance of short-term flows such as
foreign currency deposits and short term debt, and an increasing share of foreign
direct and portfolio investment flows(Table 8). The share of non-debt flows in total
capital flows have increased to 46.6 per cent during 2002-03. Portfolio investments
flows from FIIs are allowed since 1993, the cumulative investment of which was $ 19
billion in 2003 with about 10 per cent of the total market capitalization of the Indian
stock market.
Page | 45
Table 7: Comparison of External Debt Indicators of Top Fifteen Debtor Countries
Page | 46
Country Debt Concessional PPG to Total External Debt to External debt Debt Service Interest Service Short Term Short Term
Outstanding Debt to Total Debt Current receipts to national Ratio Ratio Debt to Total Debt to
($ billion) Debt (%) Income Debt Reserves
Years 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001 1990 2001
Argentina 62.2 136.7 0.8 1.0 75.3 75.1 373.7 373.7 46.0 52.5 37.0 66.3 16.3 29.9 16.8 14.6 228.1 137.4
Brazil 120.0 226.4 2.5 1.2 73.2 41.3 325.5 314.4 26.5 46.9 22.2 75.4 6.1 23.6 19.8 12.5 318.7 79.1
Chile 19.2 38.4 1.9 0.9 54.2 14.5 179.6 162.6 67.3 60.0 25.9 28.1 16.7 8.3 17.6 6.7 55.7 17.8
China 55.3 170.1 17.6 15.4 82.3 53.9 91.4 54.9 15.2 15.0 11.7 7.8 5.4 2.5 16.8 25.8 31.5 20.4
Colombia 17.2 36.7 5.7 2.4 85.2 59.3 181.0 210.6 45.1 46.2 40.9 36.1 17.9 15.3 8.4 10.2 31.1 36.8
India 83.8 98.8 45.9 36.0 84.9 85.0 328.9 121.6 28.7 21.0 35.3 13.9 15.5 5.4 10.2 2.8 365.4 5.4
Indonesia 69.9 135.7 26.4 20.7 68.7 50.4 233.9 205.9 64.0 97.2 33.3 23.6 13.3 8.9 15.9 16.1 149.3 80.0
Korea, Rep. 35.0 110.1 12.6 0.3 53.7 30.6 45.6 58.5 13.8 26.1 10.8 13.8 3.4 2.8 30.9 31.9 73.0 34.2
Malaysia 15.3 43.4 14.6 7.3 75.6 55.5 44.4 41.6 36.4 54.4 12.6 6.0 3.4 2.1 12.4 11.8 19.5 16.7
Mexico 104.4 158.3 0.8 0.7 72.7 54.5 191.4 85.5 41.1 26.2 20.7 26.1 13.4 6.9 15.4 11.4 163.1 40.2
Philippines 30.6 52.4 20.0 21.3 78.6 65.3 230.1 125.1 69.4 69.2 27.0 18.6 13.3 6.7 14.5 11.6 479.1 45.0
Poland 49.4 62.4 7.7 9.9 79.5 39.8 251.3 113.5 88.8 35.7 4.9 28.0 1.7 5.0 19.4 11.2 213.6 27.2
Russian Fed 59.3 152.6 0.0 0.0 80.1 66.8 .. 128.0 10.3 50.9 .. 14.5 .. 6.6 19.9 13.7 .. 64.4
Thailand 28.1 67.4 15.2 12.6 44.4 39.2 89.8 84.2 33.3 60.4 16.9 25.1 6.5 4.1 29.6 19.6 62.6 40.9
Turkey 49.4 115.1 15.1 3.5 78.6 48.6 196.1 205.7 32.5 78.8 29.4 40.0 13.5 11.1 19.2 14.2 157.0 86.6
Table 9: Composition of Capital Inflows to India
Types of Flows 1990- 1995- 1997- 1999- 2000- 2001- 2002-

91 96 98 00 01 02 03
Total Net Capital 7.1 4.1 9.8 10.4 10.0 10.6 12.1
Inflows($ bn)
PERCENT
Non-debt Creating 1.5 117.5 54.8 49.7 67.8 77.1 46.6
Inflows
a) FDI 1.4 52.4 36.2 20.7 40.2 58.0 38.5
b) Portfolio 0.1 65.1 18.6 29.0 27.6 19.1 8.1
Investment
Debt Creating 83.3 57.7 52.4 23.1 59.4 9.2 -10.6
Inflows
a) External 31.3 21.6 9.2 8.6 4.3 11.4 -20.0
Assistance
Page | 47
b) ECB # 31.9 31.2 40.6 3.0 37.2 -14.9 -19.4

c) Short- term 15.2 1.2 -1.0 3.6 1.0 -8.4 8.1
Credits
d) NRI Deposits 21.8 27.0 11.4 14.7 23.1 26.0 24.6
e) Rupee Debt -16.9 -23.3 -7.8 -6.8 -6.2 -4.9 -3.9
Service
Other Capital @ 15.2 -75.2 -7.2 27.2 -27.2 13.7 64.0
Total (1 to 3) 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Memo: Excluding 84.7 33.7 82.4 67.4 71.4 89.3 83.8
b & c*
# refers to medium and long-term borrowings

GDRs/ADR FIIs Offshore Tot

Table 10: Portfolio s# * funds al
Investment in India 1992- 240 1 3 244
(US $ Million) 93
1993- 1,520 1,66 382 3,567
94 5
1994- 2,082 1,50 239 3,824
95 3
1995- 683 2,00 56 2,748
96 9
1996- 1,366 1,92 20 3,312
97 6
1997- 645 979 204 1,828
98
1998- 270 -390 59 -61
99
1999- 768 2,13 123 3,026
00 5
2000- 831 P a g e1,84| 4 8 82 2,760
01 7
2001- 477 1,50 39 2,021
02 5
2002- 600 377 2 979
03
#: Represents the amount raised by Indian corporates through Global Depository Receipts (GDRs)
and American Depository Receipts (ADRs).
*: Represents fresh inflow of funds by Foreign Institutional Investors.
SPECIAL PURPOSE EXTERNAL COMMERCIAL BORROWING
The Indian Government had obtained external borrowing using special provisions three times
since 1991: India Development Bonds (IDBs), 1991; Resurgent India Bonds (RIBs), 1998; and,
India Millennium Deposits (IMDs), 2000. These borrowings were used only to meet the
unfavorable external circumstances, and served as alternative to sovereign borrowings. The
maturity of these issuances were about five years, mostly subscribed by non-resident Indians,
Page | 49
with redemption only at maturity and offering reasonable spread over comparable government
bond yields. These instruments were considered as substitutes for foreign currency deposits,
which extended the duration of the country’s debt profile.
Table 11: Special Borrowings by India since 1991
Type of Amount(US $ Interest 5-Year Sprea

Borrowings Million) Rate (%) Government d
Bond Yield (Col
3-4)
India Millennium 5,520
Deposits, 2000
Mobilization in US Dollar 5,182 8.50 5.57 2.93
Mobilization in Pound 258 7.85 4.63 3.22
Sterling
Mobilization in Euro 80 6.85
Resurgent India Bonds, 4,230
1998
Sterling
Mobilization in Euro 63 6.25
India Development Bonds, 1,627
1991
Sterling
Source: India’s External Debt: A Status Report, Government of India, October 2001.
FOREIGN CURRENCY DEPOSITS
Page | 50
Many countries allow foreign currency deposits from expatriates as a source for balance of
payments financing. Such schemes were introduced in India in 1970 allowing non-Resident
Indians/Overseas Corporate Bodies to place deposits denominated in foreign currency as well as
local currency with the Indian banks, with interest rate fixed and exchange rate guaranteed by the
Reserve Bank of India. The two oil shocks of 1970s brought substantial amount of US dollar
deposits from the gulf countries. By the end of March 1990, the total NRI deposits were to the
extent of $ 12 billion. However these short-term deposits have proved to be very volatile,
responding to macroeconomic instability as well as political risks. The external payments
difficulties of 1990-91 demonstrated the vulnerability associated with these deposits.
Considering the huge fiscal costs of exchange guarantee and higher interest rates offered on such
deposits as compared to international rates, the policy later years withdrew the exchange rate
guarantee and reduced considerably the interest rate spread. A scheme called Non-resident Non-
Composition
repatriable Rupee of External
Deposit (NRNRRD) wasDebt
alsoas at End Dec
introduced 2003to avoid the reversibility
in order
(Share in %)
character of the deposits, but was later withdrawn in April 2002.
Composition of External Debt as at End Dec 2003

(Share in %)
Short term Debt

Rupee Debt 5%
2%
NRI Deposit
27%
Multilateral
27%
Short term Debt

Rupee Debt 5%
2%
Commercial Debt Bilateral
19%
NRI Deposit Export Credit 16%
27% 4%
Multilateral
27%
Page | 51
Commercial Debt Bilateral

19% Export Credit 16%
4%
12: Outstanding Balances NRI Deposit Schemes (US $ million)
End- NR(E) FCNR( FCNR( NR(NR)R FC(O) Tot

March RA A)* B) D** N al
1975 40 – – – – 40
1980 856 188 – – – 1,044
1985 2,304 770 – – – 3,074
1990 3,777 8,638 – – – 12,415
1995 4,556 7,051 3,063 2,486 10 17,166
1996 3,916 4,255 5,720 3,542 13 17,446
1997 4,983 2,306 7,496 5,604 4 20,393
1998 5,637 1 8,467 6,262 2 20,369
1999 6,045 – 7,835 6,618 – 20,498
2000 6,758 – 8,172 6,754 – 21,684
2001 7,147 – 9,076 6,849 – 23,072
2002 8,449 – 9,673 7,052 – 25,174
2003 14,923 – 10,199 3,407 – 28,529
Page | 52
* : Withdrawn effective August 1994.

** : Withdrawn effective April 2002.
Let us view the financial highlights of the fiscal 2007-08 in form of charts and tables in the next
chapter.
India’s External Debt as at the end of March 2008
The external debt data are compiled and released by the Reserve Bank/Government of
India on a quarterly basis with a lag of one quarter. As per current practice, India’s
external debt statistics for the quarters ending March and June are compiled and
released by the Reserve Bank, while the external debt data for quarters ending
September and December are compiled and released by the Ministry of Finance,
Government of India. The data on India’s external debt for end-March 2008, which was
released by the Reserve Bank on June 30, 2008, are presented below:
CURRENT SCENARIO
• India’s total external debt is placed at US $ 221.2 billion at the end of March 2008. At
this level, the external debt stock increased by about US $ 51.5 billion or over 30.4% over
Page | 53
the end-March 2007 level.(Table 1 & Chart 1). The increase was mainly due to external
commercial borrowings (ECBs) that contributed around 39.5% of the increase in total
external debt, followed by short-term debt (contribution being 34.8%).
• The valuation effect, on account of appreciation of the US dollar against other major
international currencies, has had a moderating impact on the stock of external debt.
Page | 54
• Out of increase in US $ 51.5 billion in external debt during the year 2007-08, valuation
effect reflecting the depreciation of the US dollar against other major international
currencies and Indian rupee accounted for US $9.9 billion of the increase. This would
imply that excluding the valuation effects, the stock of external debt as at end-March
2008 increased by about US $41.6 billion over the end-March 2007 level.
Page | 55
• Among the various components of debt, NRI deposit, trade credit and multilateral debt
have risen during the year (Table 2).
• External Commercial Borrowings (ECBs) (including FCCBs) at US $62.0 billion
recorded the maximum increase of US $20.4 billion (48.9 per cent) during the year
(Table 2) (Chart 2). This was mainly due to the rising financing requirements of the
Indian companies on account of their ongoing technological upgradation and capacity
expansion.
• The data on short term debt now includes supplier’s credit up to 180 days with effect
from end-March 2005. Short term debt also recorded an increase of US $17.9 billion
during 2007-08. Under short term debt, while trade related credits rose significantly by
Page | 56
around US $17.7 billion in line with the rising imports, FII debt investment in
government papers rose by about US $254 million.
• All other components of external debt also recorded an increase during 2007-08:
multilateral debt (US $4.0 billion), bilateral debt (US $3.6 billion), export credit above
one year maturity (US $3.2 billion) and NRI deposits (US $2.4 billion). Rupee debt
recorded a marginal rise of US $69 million.
• The US dollar continues to remain the predominant currency accounting for 57.1% of the
total external debt stock as at the end of March 2008, followed by the Indian rupee
(14.5%), Japanese yen (12.1%) and SDR (10.2%). (Table 4 & Chart 3).
Page | 57
I NDICATORS OF D EBT S USTAINABILITY
There has been a perceptible improvement in external debt indicators over the years reflecting
the growing sustainability of external debt of India.
• External debt to GDP has risen to 18.8 per cent at end-March 2008 from 17.8 per cent at
end-March 2007. This ratio was 30.8 per cent at end-March 1995.
• The debt service ratio was placed at 5.4% during 2007-08 as against a double digit figure
till 2003-04.
Reflecting the rise in short term debt during 2007-08, the ratio of short-term to total debt and
short term debt to reserves rose to 20.0 per cent and 14.3 per cent, respectively.
Page | 58
• The share of concessional debt in total external debt declined to 19.9 per cent at end-
March 2008 from 23.3 per cent at end-March 2007 reflecting the continuing increase in
the non-concessional private debt in India’s external debt stock.
India’s foreign exchange reserves exceeded the external debt by US $ 88.5 billion providing a
cover of 140.0 per cent to the external debt stock at the end of March 2008 (Chart 4)
Comparing the cross country online data on external debt provided by the World Bank up to
2006 for the top twenty debtor countries of the developing world reveal the following (Table 6):
Page | 59
• India’s position was fifth in 2006 in terms of external debt stock.

• In terms of the ratio of external debt to Gross National Product (GNP). India’s position
was second lowest, with China having the lowest ratio of external debt to GNP.
• India’s debt service ratio was third lowest with China and Malaysia having first and
second lowest debt service ratio, respectively.
• The element of concessionality in India’s external debt portfolio was the second highest
after Indonesia.
• In terms of reserves to total debt, India’s position was fifth China, Malaysia, Thailand and
Russia.
A detailed account of India’s external debt as at end-March 2008 in US dollar is presented in

Statement below:
Page | 60
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India's external debt - GDP ratio down at 15.8 per cent: Chidambaram news
Mumbai: India's total external debt has declined from 21.1 per cent of GDP in 2001-02 to 15.8
per cent of GDP in 2005-06, finance minister P Chidambaram informed the Sabha during
question hour.
Around 36.4 per cent of the country's total external debt comprised of loans raised by Indian
corporates through external borrowings, export credit and short-term credits, the finance minister
said.
The share of government debt in total external debt was 33.4 per cent, while non-government
debt accounted for the remaining portion in December last year, he said.
He said the government was pursuing a ''prudent'' external debt management policy by raising
funds on concessional terms and from less expensive sources with longer maturities, among
other things.
This has forced the Reserve Bank of India (RBI) to keep in abeyance measures announced in
October for greater liberalization of external commercial borrowings (ECBs).
In its review of the credit policy in October 2006, the RBI had said it would allow banks to
borrow through the ECB route up to 50 per cent of their Tier-I capital, subject to a cap of $10
million, but this would include borrowing for export credit. Earlier, banks were allowed to
borrow 25 per cent of their Tier-I capital, excluding any loans taken for on-lending to exporters.
Page | 64
A day ahead of the presentation of the monetary policy, the RBI said, "In view of the prevailing
market conditions and likely impact on liquidity, it has been decided to keep the
operationalisation of the policy announcement in abeyance."
Loans raised by the private sector from international capital markets with maturities of more than
three years are classified as ECBs.
The latest external debt data released by the government show that commercial borrowings from
global sources have risen by 11 per cent to $35.98 billion in December 2006 from $32.46 billion
in September 2006.
Commercial borrowing accounted for 25.2 per cent of India's $ 142.7 billion external debt in
December 2006. In the previous quarter, commercial borrowings represented 23.8 per cent of the
total external debt of $136.5 billion.
During fiscal 2006-07, the government had put a $22 billion ceiling on external commercial
borrowings (ECBs), with a $500 million cap on individual company borrowings.
Long-term debt outstanding increased over the quarter by $6.798 billion to $132.641 billion,
while short-term debt declined by $610 million (5.7 per cent) to $10.015 billion as on December-
end 2006.
With domestic interest rate firming up, deposits by non-resident Indians have also gone up by
Rs1,867 crore ( 5.1 per cent) to Rs38,382 crore at December-end 2006.
Inflationary pressures in the last few weeks have led to a rise in the value of the rupee. The rupee
touched a nine-year high against the dollar on Monday. The RBI is likely to continue tough
measures to check liquidity growth and prevent a further rupee rise.
The RBI has identified ECBs as one of the "major contributors to capital inflows". "Higher
recourse to ECBs was enabled by lower spreads on external borrowings and rising financing
requirements for capacity expansion domestically," the RBI has pointed out.
Page | 65
Policy Perspectives on External Debt Management
The debt management policy following the balance of payments crisis evolved into a multi-
pronged strategy. This evolving policy regime was based broadly on the recommendations of the
Rangarajan Committee (1993) which implied (i) the continuation of an annual cap, minimum
maturity restrictions and prioritizing the use of ECBs; (ii) LIBOR based ceilings on interest rates
and minimum maturity requirements on NRI deposits to discourage the volatile component of
such deposits; (iii) containment of short-term debt together with controls to prevent its undue
increase in future; (iv) retiring/ restructuring/ refinancing of more expensive external debt; (v)
measures to encourage non-debt creating financial flows such as foreign direct and portfolio
investments; (vi) incentives and schemes to promote exports and other current receipts; and (vii)
conscious build-up of foreign exchange reserves to provide effective insurance against external
sector uncertainties.
These policies pursued with varying intensity yielded good results in making a turnaround in
India’s external debt scenario, which is reflected in the sustained improvement in her key debt
indicators. A transparent policy on external commercial borrowings with the stated objectives of
prudent debt management seems to have emerged in recent years. India began considering the
need for a Public Debt Management Office in 2000. Attention was focused on building up of the
institutional capability for debt analysis for effective public debt management and an appropriate
institutional structure for it in the public sector.
Page | 66
The institutional arrangement of debt reporting is shared between the Ministry of Finance (MOF)
and the Reserve Bank of India (RBI), with the External Debt Management Unit (EDMU) in the
Ministry of Finance serving as the apex unit for monitoring, computerization and management
related decisions.
The majority of the country’s total external debt data relating to external assistance and external
commercial borrowings have been computerized on the Commonwealth Secretariat Debt
Recording and Management System(CS : DRMS).
The ECB guidelines issued by the Ministry of Finance from time to time put a cap on the overall
amounts that can be borrowed in a financial year, allowing a longer maturity for larger
borrowing, caps on borrowing cost and restrictions on end-use (See the Appendix). These
restrictions have proved to be helpful in avoiding debt-servicing difficulties. The annual review
of a cap on ECB is fixed considering the requirement of different sectors and the medium term
balance of payments scenario. ECB approvals are monitored regularly to ensure that the total
debt is maintained within the limits of debt management.
The ECB guidelines in a way impose restrictions on the leveraging capabilities of Indian
companies in terms of the amounts and the periods for which the borrowings can be made.
Corporate access external commercial borrowings for expansion of existing capacities as well as
for fresh investment. At the moment different rules apply for different forms of financing which
therefore restricts the choice of financing available.
In this way, to a large extent, funding depends upon the government rules rather than the
characteristics of the projects. There are no sovereign guarantees; corporate today access
oversees capital markets based on the strength of their balance-sheet and their brand. The
government has relaxed recently to prepay external debt, thus the possibilities for lowering the
interest costs due to falling interest rate environment.
Page | 67
The concern is gradually shifting towards managing corporate borrowing, as the volume of
external debt on the government account has been decreasing. Corporate can also undertake
liability management for hedging the interest and exchange rate risks on their underlying foreign
currency exposures without prior approval of the Ministry of Finance or the Reserve Bank of
India.
The policy gives greater priority for projects in the infrastructure, core and export sectors. The
regulatory structure has been evolving to influence the activities that would be financed through
external borrowings, thereby restricting the funds from recycling into financial markets as well
as real estate. To lengthen the maturity profile of external debt, commercial borrowings of eight
years and above are kept outside the ceiling.
Keeping in view the volatility the short term capital flows are monitored and restricted mostly for
trade related purposes. As regards the foreign currency and local currency denominated deposits,
from the non-resident Indians, there has been a significant change in terms of the removal of
exchange guarantees provided by banks, gradual shift in policy in favor of local currency
denominated deposits, promotion of non-repatriable deposits, and aligning interest rates to
international rates such as LIBOR.
Page | 68
External Commercial Borrowings Policy Guidelines
External Commercial Borrowings (ECB) refer to commercial loans availed from non-resident lenders
with minimum average maturity of 3 years. Borrowers can raise ECB from internationally recognized
sources such as (i) international banks, international capital markets, multilateral financial institutions
(such as IFC, ADB) (ii) export credit agencies and (iii) suppliers of equipment, foreign collaborators and
foreign equity holders.
A. A CCESS M ECHANISM
Under the present framework, ECB can be raised through two routes viz. (i) Automatic Route and (ii)
Approval Route.
(i) Automatic Route
(ii) Eligible Borrowers: Corporates registered under the Companies Act except financial intermediaries (such
as banks, financial institutions’ (Fis), housing finance companies and NBFCs) are eligible.
Cases considered:
(i) Up to USD 20 million or equivalent with minimum average maturity of 3 years.
(ii) Above USD 20 million and up to USD 500 million or equivalent with minimum maturity of 5 years.
Eligible Borrowers:
a) Financial Institution dealing exclusively with infrastructure or export finance will be considered on a
case by case basis.
Page | 69
b) Banks and Financial Institutions which have participated in the textile or steel sector restructuring packages
approved by the Government will also be permitted to the extent of their investment in the package and
assessment by RBI based on prudential norms.
Cases considered: cases falling outside the purview of the automatic route limits and maturity period mentioned
earlier. Such cases falling under the Approval Route will be considered by an Empowered Committee of the RBI.
B. G ENERAL TERMS AND CONDITIONS:

All-in-cost ceilings
The present all-in-cost ceilings for ECB are as follows:
Maturity All-in-cots ceiling* over 6 month LIBOR
i) 3 years and up to 5 years 200 basis points

ii) More than 5 years 350 basis points
* All-in-cost ceiling includes rate of interest, other fees and expenses in foreign currency except commitment fee,
prepayment fee, and fees payable in Indian rupees. Also, payment of withholding tax is excluded for calculating the
all-in-cost.
END-USE
(i) ECB can be raised only for investment (such as import of capital goods, new projects,
modernization/expansion of existing production units) in the real sector-industrial sector
including small and medium enterprises and infrastructure sector in India.
(ii) Utilization of ECB proceeds is permitted in the first stage acquisition of shares in the
disinvestments process and in the mandatory second stage offer to the public under the
disinvestments programme of PSU shares.
(iii) Utilization of ECB proceeds is not permitted for on-lending or investment in capital market by
corporates.
Page | 70
(iv) Utilization of ECB proceeds is not permitted in real estate. ‘Real Estate’ excludes development of
integrated townships as per provisions of Press Note No. 3 (2002 series) dated 4.1.2002 of the
D/O Industrial Policy & Promotion.
(v) End-uses of ECB for working capital, general corporate purpose and repayment of existing rupee
loans are not permitted.
C. P AYMENTS
Prepayment of ECB up to USD 100 million is permitted without prior approval of RBI, subject to compliance with
stipulated minimum average maturity period as applicable for the loan.
Refinance of existing ECB
Refinancing of existing ECB by raising fresh loans at lower cost is permitted, subject to the condition that
the outstanding maturity of the original loan is maintained.
E. Foreign Currency Convertible Bonds (FCCB)

The liberalization norms applicable to ECB are also extended to FCCB in all respects.
Source: India’s External Debt: A Status Report, Government of India, 2003.
Page | 71
Politics of External Debt Management
There has been overall jubilation on the performance of the Indian economy on the external
front.
The country's foreign currency debt has gone up to $105 billion, up from the $100 billion the
previous year, but few are worried as this rise is being attributed to revaluation gains and to the
discontinuation of a rupee deposit window open to non-resident Indians (NRIs).
The country's foreign exchange reserves have crossed the $80-billion mark and the Reserve Bank
of India is facing the tough task of trying to check the inflows to manage inflation and take the
sustained pressure off the rupee.
The burgeoning foreign currency cushion has made it possible for the country to retire its
multilateral dollar debts amounting to about $2.8 billion last year, and a similar amount is to be
prepaid this year.
Page | 72
The Finance Ministry has further made statements that it no longer wants small aid packages and
it proposes to prune its bilateral donor list to just six strategic countries, including Britain, the
EU, Germany, Japan, the US and Russia.
The net result is that 22 donor countries have received the axe, including such long-time bilateral
lenders as Canada, conveying the overall impression that India views itself as the big brother
amongst nations, of course with the exception of the big six.
Such rhetoric would go down well with the Swadeshi lobby, and could generally be considered
harmless, provided it does not contain the seeds of economic de-stability over a longer period of
time.
Yet, the measures taken by the BJP Government on the external debt management front are not
that reassuring, if one looks at the manner in which the external debt portfolio is being
restructured. Here, one gets the impression that the Government is paying a high price to score a
few political brownie points.
To illustrate the point, take the case of the Resurgent India Bonds (RIBs). The Centre raised
about $5.5 billion in the post-Pokhran period. The sum was raised not because it was needed but
more to cock-a-snook at the international community for threatening it with sanctions. The
Government claimed that its credit worthiness was high among the wealthy NRIs in the US, the
UK and West Asia; though it did take the precaution of setting a high rate of return on the
offering to ensure it was fully subscribed. The offering mopped up an unexpected $5.5 billion
and the rates were subsequently justified as being on a par with the paper issued by the Brazilian
government at that time. However, the RIBs were undoubtedly high cost funds, when viewed
against the background that India did not need the funds in the first place.
Five years down the line, these bonds are now coming up for repayment. Given the rates, the
burgeoning foreign exchange reserve and the lack of dependence on these funds, one would
assume that the Government would jump at the opportunity of retiring these bonds. Instead, the
Page | 73
State Bank of India (SBI), which raised the loans on behalf of the Government, plans to roll them
over.
A conversion of the dollar debt into a rupee loan is being worked into the rollover option, which
could be an advantage, if one did not have the funds to prepay them. However, availability of
funds is not an issue and a financial cushion against sanctions is no longer necessary, it is not
clear why a rollover option is being considered at all. Some could argue that India's reserves are
not comparable with China's $217.9 billion, next only to Japan's $399.3 billion in 2001, but they
are closer to Republic of Korea's $103 billion, Taiwan's $123 billion and Singapore's $76.2
billion during the same period. Besides, the sum involved in retiring the RIBs is miniscule in
proportion to the reserve accumulated thus far, which would earn only moderate returns in a
global falling interest rate regime.
The story of the poor external debt management does not end there. Take, for instance, the
Government's decision to retire foreign currency multilateral loans amounting to $2.8 billion last
year, with an equal sum being retired this fiscal, and its decision to do away with small aid
packages. The net result is that concessional loans are being repaid and the list of donors is now
set to be pruned by 22 countries, including long-time donors, limiting the donor list to just six.
Since Russia stands included in this list, apart from Britain and the US, one can assume that India
nurtures certain geopolitical aspirations by positioning itself as a big brother among the
economically smaller nations. That by itself is acceptable, provided that this goal is achieved by
following the basic fiscal prudence of replacing high-cost loans with low-cost debt.
In the past, the `anti' feelings against multilateral loans have been strong and retirement of this
class of debt could be justified on the grounds that it is necessary to maintain the suzerainty of
the nation. In that case, the cost and pain involved in the retirement are not a parameter.
However, this rationale fails when one looks at India's approach to bilateral aid management.
Here, the Government wants to continue to borrow from those countries, which could wield
significant influence on its sovereignty, while it has chosen to axe donors who would least affect
its economic and political decision-making.
Page | 74
The buzz today is that the aim of the whole exercise is not economic but political: The
Government wants to show up nations that had criticised it for the Gujarat carnage. If that is
indeed so, then this is one lesson, which is being taught at an extremely high cost for Indians
The Future
“The best way to predict the future is to invent it” - Alan Kay
Given the sustainable level of current account and foreign exchange reserves in India, it is very
unlikely that the foreign exchange situation becomes critical again. It also seems unlikely that
international investors will substantially reduce their exposure, given the strong fundamentals of
the Indian economy. External debt management will continue to be an area of high priority in the
context of overall management of the Indian economy. To consolidate the gains already made,
the focus of external debt management policy should stress on high growth rate of exports,
Page | 75
keeping the maturity structure as well as the total amount of commercial debt under manageable
limits, tight control on short-term debt, and encouraging non-debt creating foreign investments
flows. These combined with the policy efforts aimed at achieving a commensurate growth in
current receipts to service the existing debt will help retain the sustainability status in the long
run.
Articles
India’s external debt increases to Rs.632, 051 crore (US$142.7 billion)
India's external debt stock increased by US$6.2 billion to US$142.7 billion (Rs.632,051 crore) as
at the end of December 2006 from US$136.5 (Rs. 627,112 crore) billion at end-September 2006
(Table 1). The rise in external debt outstanding at end-December 2006 was due to an increase in
Page | 76
multilateral debt, external commercial borrowings and NRI deposits, offset by a marginal decline
in short-term debt.
While long-term debt outstanding increased over the quarter by US$6,798 million to
US$132,641 million, short-term debt declined by US $610 million (5.7 per cent) to US$10,015
million at end-December 2006. Under long-term debt, all the components showed an increase
over the quarter. The largest increase was recorded by commercial borrowings; an increase of
11.0 per cent over the quarter taking the amount outstanding to US$ 35,980 million. While
multilateral debt rose by US$975 million, bilateral debt showed an increase of US$ 36 million.
Export credit outstanding rose by US$299 million. While Rupee debt remained broadly at the
same level as at the end of previous quarter, NRI deposits rose by US$1,867 million to
US$38,382 million.
Non-Resident deposits continued to account for the largest share of 26.9 per cent in the total debt
outstanding at end-December 2006, followed by commercial borrowings at 25.2 per cent and
multilateral debt at 24.2 per cent. The share of bilateral debt was 11.1 per cent. Export credit and
Rupee debt accounted for 4.2 per cent and 1.4 per cent, respectively. The share of short-term debt
was 7.0 per cent as compared to 7.8 per cent at end-September 2006.
India’s foreign currency reserves (foreign currency assets of the RBI, gold, SDRs and Reserve
Tranche Position) in the International Monetary Fund was US$177.3 billion at end-December
2006. Foreign currency assets of the RBI stood at US$170.2 billion as on December 31, 2006
providing a cover of around 119 per cent to total external debt stock.
US dollar continued to be the major currency of composition in India’s external debt portfolio.
The share of US dollar in the debt stock of the country which increased from 45.4 per cent at
Page | 77
end-March 2006 to 46.7 per cent in the quarter ended September 2006, had marginally come
down to 46.3 per cent at end-December 2006.
Government continued to pursue prudent external debt management policies to maintain external
debt within manageable limits. These include emphasis on raising funds under Government
borrowing on concessional terms and from less expensive sources with longer maturities,
monitoring of short-term debt, prepaying high cost loans, rationalizing interest rates on NRI
deposits, restricting end-use of external commercial borrowings, limiting trade credits and
encouraging non-debt creating capital flows
Source: Press Information Bureau
Posted On: 3/30/2007
External borrowings becoming more expensive
Bangalore June 21, With global interest rates showing signs of hardening, external commercial
borrowings (ECBs) are beginning to become more expensive.
Page | 78
Bankers said they have already cautioned some of the intending external commercial borrowers
to hedge their open positions.
Most international borrowings are currently linked to the London Inter Bank Offered Rate
(LIBOR). Six-month LIBOR is currently 5.5 per cent. Inclusive of swap and hedging costs, the
effective rates were currently in the region of about 9 per cent. This was assuming that corporates
were borrowing at rates of about 100 basis points over LIBOR.
The bankers said that indications of a potential hardening of rates were available from the recent
hardening of US Treasury yields. The 10-year US Treasury has moved up to 5.2 per cent now
from 4.6 per cent in March end, a 0.6 percentage point increase. They said that this trend was
likely to continue.
Firming of international dollar yields was triggered by China's sale of US Treasuries as a move
to reshuffle its $1.2-billion dollar holdings of exchange reserves.
China's international reserves are mostly invested in US Treasuries, and long-term bonds.
According to data from the US Treasury Department, China and Hong Kong together sold close
to about $7 billion between March and April this year.
India's holdings of US Treasuries on the other hand remained constant at $20 billion for the same
period, according to the data. This sell off was leading to a hardening of dollar yields, the
bankers said.
The rising yields notwithstanding, India Inc's interest in ECBs stemmed from the advantageous
interest rate situation, the bankers said. Currently, ECBs despite rising yields were still cheaper
than comparable domestic borrowings by at least 2.5 to 3 per cent.
Domestic corporates as a result had borrowed a little over $5 billion to fund their rupee
expenditure till March 2007. The ECB flows have continued well into this year and medium rung
companies have also begun exploring the option of tapping foreign currency borrowings.
Page | 79
External commercial borrowings decline in Jan

30 Mar, 2008
MUMBAI: Overseas corporate borrowings by the India Inc declined in January as compared to
the preceding two months despite softening interest rates globally as the Central government has
put curb on overseas debt.
The total overseas borrowings raised by 52 companies through External commercial borrowings
(ECBs) and foreign currency convertible bonds declined to 1.18 billion dollars in January from
2.26 billion dollars in December and 2.21 billion dollars in November, according to latest figures
released by the Reserve Bank.
The Centre has been tightening the norms for ECBs as huge inflows of capital are appreciating
rupee and in turn hurting exports. It has announced that not more than USD 20 million raised
through ECBs can be brought back to India for rupee expenditure purposes. To remit even USD
20 million, prior approval of the RBI is needed.
The ECB data for January showed that most of the overseas debts were used for importing
capital goods with NTPC borrowing USD 380 million, followed by Delhi International Airport at
USD 200 million and Ashok Leyland at USD 200 million. Jet Airways borrowed USD 231
million, however, for financial lease.
Similarly, December also saw the import of capital goods as the prime reason of these
borrowings. While Reliance Telecom Infrastructure borrowed the highest amount USD 500
million for the import of capital goods and telecommunications, Shipping Corporation of India
raised USD 339 million for capital goods.
In November, National Aviation Company of India was the highest borrower at USD 601 million
Page | 80
for financial lease, followed by Firstsource Solutions which mopped up USD 275 million for
overseas acquisitions.
Page | 81

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TYBMS External Debt Management

Introduction to External Debt Management

In this definition, IMF defines the key elements as follows:

IMPORTANT ASPECTS RELATED TO EXTERNAL DEBT MANAGEMENT

EXTERNAL DEBT AND MACROECONOMIC CONSIDERATIONS

Economic growth, of course, could be accelerated with foreign borrowing, permitting

External Debt Sustainability

External-debt-sustainability analysis is generally conducted in the context of medium-

I NDICATORS OF E XTERNAL D EBT S USTAINABILITY

These indicators can be thought of as measures of the country’s “solvency” in that

A second set of indicators focuses on the short-term liquidity requirements of the

Debt Management Strategy - A Global Overview

This regime has proved to be extremely helpful in inhibiting short-term foreign

External Debt Development and Management

SOME REFLECTIONS ON INDIA

The above scenario although presupposes several accomplishments underlying the

B URDEN OF E XTERNAL D EBT IN INDIA

It is a source of some comfort that India's external debt continues to be at a stable

CAUSES FOR INCREASE IN EXTERNAL DEBT

Increase in Trade Deficit

Decline in the Net Invisibles

Change in the Composition of the Debt

E XTERNAL D EBT M ANAGEMENT P OLICY

This improvement in external debt should be attributed both to a cautious policy on

Problems of External Debt Management In India

E XTERNAL D EBT D EVELOPMENT U NTIL 1970’ S

D EVELOPMENTS IN E XTERNAL S ECTOR D URING 1980’ S

A substantial amount of import savings could be made due to large-scale import

Indicator 1971 197 198 198 199 199 200

Changes in REER .. -2.1 0.8 -4.9 -2.9 -0.8 4.8

Source: Reserve Bank of India.

DEBT POSITION DURING 1990’s

India’s external debt at end-September 1999 stood at US $98.87 billion as against US

External debt management continues as an area of high priority. To consolidate the

CRISIS AND R EFORM IN THE 1990 S

D EVELOPMENTS TO 1991 F OREIGN E XCHANGE C RISIS

By 1990, there was a marked deterioration in India's balance of payments. Although

Furthermore, the economic decline in Eastern Europe led to a contraction of exports

R ESPONSE TO 1991 CRISIS AND ITS EFFECTS

being fixed by politically apprehensive governments. Second, the heavy anti-export

1997 A SIAN CRISIS AND I TS I MPACT

Table 2: Selected Indicators of India’s External Sector (% growth unless noted)

Item/Year 91-92 92-93 93-94 94-95 95-96 96-97 97-98

1. Growth of Exports -1.1 3.3 20.2 18.4 20.3 4.5 2.6

2. Growth of Imports -24.5 15.4 10.0 34.3 21.6 10.1 5.8

3. Exports/Imports 86.7 77.6 84.8 74.8 74.0 70.2 83.3

4. Reserves to Imports 5.3 4.9 8.6 8.4 6.0 6.6 7.0

5. Short-term debt/Reserves 76.7 64.5 18.8 16.9 23.2 25.5 19.8

8. External Debt* 41.0 39.8 35.8 32.3 28.2 25.9 23.8

* As % of GDP Source: Economic Surve

Short-term debt was repeatedly considered as an important risk factor in the

E VOLVING DEBT AND CAPITAL F LOWS S CENARIO T OWARDS 2003

Share in total External Debt

Share in total External Debt

Share in total External Debt

Multilateral 20900 25 28616 31 31898 32 30558 27

An important aspect of India’s external debt has been its concessionality. As of

External Debt- GDP Ratio*

residual/remaining maturity within the component of short-term debt, it still remains

Year Solvency Indicators Liquidity Indicators

199 199 200 200 2002

(12.6) (11.7) (12.5) (10.3) (14.4)

Total External Debt and Foreign Currency Assets