External Debt Management | Management Optional Notes for UPSC PDF Download

Introduction

India's development relies heavily on external capital. External debt, encompassing the total amount a country owes to foreign creditors, can involve the government, corporations, or citizens. This debt encompasses obligations to private banks, other nations, and global financial entities like the International Monetary Fund (IMF) and World Bank. The role of external debt as a tool for fostering economic development has been a prominent subject of discussion among economists.

Debate Among Economists:

• Some economists (neoclassical economists) believe that external debt is essential for a country's development as it provides capital for investment and boosts economic progress.
• However, other economists argue that external debt can hinder economic growth due to various problems associated with it.

Challenges with External Debt:

• Problems include debt accumulation, sustainability issues, and difficulty in meeting debt obligations.
• When a country's external debt is in foreign currency, its real exchange rate depreciates, reducing the purchasing power of domestic output and making it harder to repay debts.

Consequences of Inability to Borrow in Own Currency:

• If a country cannot borrow in its own currency, it may face mismatches, debt intolerance, and capital flight.
• Factors contributing to these problems include the country's level of development, financial credibility, fiscal solvency, and weaknesses in credit markets and contract enforcement.

Main Challenges for Developing Countries:

• Developing countries often struggle to borrow internationally due to their weak macroeconomic environments.
• Issues such as exchange rate regimes and political economy factors also contribute to their borrowing challenges.

Indicators of External Debt Sustainability

1. Indicators for Assessing External Debt:

   • Various indicators help evaluate a country's sustainable external debt level.
   • Economists don't unanimously agree on a single indicator, but ratios comparing different aspects are commonly used.
   • These ratios assist policymakers in managing external debt effectively.

2. Examples of Debt Burden Indicators:

   • Debt to GDP ratio, Foreign debt to exports ratio, and Government debt to current fiscal revenue ratio are examples.
   • Share of foreign debt, short-term debt, and concessional debt in the total debt stock are also considered.

3. Focus on Short-Term Liquidity:

   • Some indicators concentrate on a nation's short-term liquidity needs for servicing its debts.
   • These indicators act as early-warning signals for potential debt service problems.

4. Forward-Looking Indicators:

   • Forward-looking indicators predict how the debt burden may change over time.
   • Dynamic ratios, such as the ratio of average interest rate on outstanding debt to the growth rate of nominal GDP, provide insights into the future debt burden.

5. Economic Policy and External Borrowing:

   • The primary goal of economic policy is to improve living standards through increased investment and rapid economic growth.
   • Developing countries often lack sufficient resources and may need to borrow externally to finance their investment programs.

6. Current Account Deficit and Borrowing:

   • Developing countries, including India, commonly run a current account deficit, leading to external borrowings.
   • External debt is used to finance deficits and promote economic growth when internal resources are insufficient.

7. Definition of Gross External Debt:

   • Gross external debt is the total amount a country owes to non-residents, comprising actual liabilities requiring future payments of principal and/or interest.

The origins of India's External Debt

1. India's Response to the 1980s Debt Crisis:

   • Unlike many developing countries, India was less affected by the debt crisis of the early 1980s due to its low level of private debt.
   • India managed foreign exchange constraints by securing significant loans from the International Monetary Fund (IMF) and Gulf payments, improving its external debt situation.

2. External Debt Policy of India:

   • India's external debt policy focuses on monitoring long-term and short-term debt, securing sovereign loans with longer maturities, and regulating external commercial borrowing.
   • The emphasis is on maintaining manageable levels of external debt.

3. Import Substitution and Foreign Exchange Improvement:

   • India achieved import savings through large-scale import substitution in food, petroleum (after discovering Bombay High), and fertilizer.
   • This, along with multilateral concessional assistance, improved India's foreign exchange situation and helped maintain its credit-worthiness.

4. Trade Liberalization and Economic Growth:

   • Import control liberalization, particularly through Open General License (OGL), facilitated imports necessary for emerging consumer goods industries.
   • However, export growth remained slow due to global trade slowdown, declining commodity prices, and domestic expansionary policies, leading to trade and current account deficits.

5. Financing Deficits and Commercial Loans:

   • India financed deficits by raising commercial loans from Eurocurrency markets, syndicated loans, Eurobonds, and short-term foreign currency deposits from non-resident Indians.

6. Determinants of External Debt:

   • External debt refers to money borrowed by a country from foreign governments, nationals, or international institutions.
   • Borrowing decisions depend on factors like economic returns, cost of borrowing, and savings rates, with external factors also playing a role.

7. Costs and Benefits of External Borrowing:

   • External borrowing should ideally generate returns higher than borrowing costs, but there are costs involved, including debt service burden, liquidity crises, and import substitution costs.

8. Debt Management:

   • Debt management involves issuing and redeeming public securities, administering the national debt, and ensuring timely payment of interest and principal.
   • Effective debt management impacts government revenue, expenditure, and economic stability.