Docstoc

External debt has been one of the key issues addressed by the

Document Sample
External debt has been one of the key issues addressed by the Powered By Docstoc
					VI. EXTERNAL DEBT AND SUSTAINABLE
    DEBT MANAGEMENT


INTRODUCTION

      E    xternal debt has been one of the key issues addressed by the
           International Conferences on Financing for Development.       Re-
cognizing debt financing as an important element for mobilizing resources for
                                                                                                      The external debt
                                                                                                        burden of many
                                                                                                   developing countries
economic development, the Monterrey Consensus of the International Confer-                       continues to be one of
ence on Financing for Development stresses that the national strategies to
                                                                                                   the key impediments
monitor and manage external liabilities should include sound macroeconomic
policies and public resource management in order to reduce the vulnerability                           to economic and
that has risen with rapid globalization in recent years.                                                 social progress


A. RECENT TREND IN EXTERNAL DEBT
      Developing countries resort to external borrowing to fill the gap
between desired expenditure and domestically available resources. In 2003,
net debt flows to developing countries as a whole posted $44.3 billion, after a
marginal outflow in 2001 of $1.2 billion and a modest inflow of $7.3 billion in
2002. Net debt flows to East Asia and the Pacific totalled just $0.5 billion in
2003, after a period of continuous outflow (including a drop of $10.9 billion in
2002), while net lending to South Asia that year registered -$2.3 billion.

      The ratio of total outstanding debt to GDP in the Asian and Pacific
region showed a noticeable improvement in 2003, falling to 26.3 per cent in
East Asia and the Pacific and 22.8 per cent in South Asia. The ratio of total
debt to exports also fell in 2003, for East Asia and the Pacific to 59.6 per
cent and for South Asia, after a modest decline, to 116 per cent.

                       Table VI.1. Resource flows and debt in developing countries
                                                       (Percentage)


                                               All developing              East Asia and
                                                  countries                  the Pacific                 South Asia

                                               1998          2002         1998            2002         1998       2002

 Debt service/exports                         19.07         17.75        12.68        12.07            18.77     14.25
 Reserves/imports(month)                        4.65         5.83         6.82         7.67              4.65     8.24
 Reserves/total debt                          27.66         42.62        46.29        85.75            23.71     50.67
 Short-term debt/total debt                   15.31         13.96        16.12        20.00              4.50     4.28
 Total debt/GNI                               42.00         38.90        40.53        28.00            29.26     26.44
 Total debt/exports                          151.03         98.20       109.15        59.60           188.20    116.70
 Current account balance/GNI                  – 1.96         1.24         4.49         3.44            – 1.76     1.40

     Source: World Bank, Global Development Finance (Washington, DC, World Bank, 2004).



                                                                                                                      107
Implementing the Monterrey Consensus in the Asian and Pacific region: achieving coherence and consistency



However, many                             The share of East Asia and the Pacific and South-Asia in the total
countries in the                   stock of external debt among all developing countries has marginally declined
region have improved               in the post-crisis years, from 32 per cent in 1997 to 28 per cent in 2003.
their external debt
situation                                The shrinking share of debt in the post-crisis period is a result
                                   of several factors: the preference of the corporate sector for borrowing
                                   domestically rather than externally due to perceptions of currency risk, the
                                   development of domestic bond markets in countries such as India, the
                                   Republic of Korea, Indonesia, Malaysia and Turkey, and the vigorous macr-
                                   oeconomic adjustments pursued in the crisis-affected countries that resulted
                                   in reduced demand for external finance. Some of the economies in Asia
                                   have sustained a current account surplus and steadily increased the inflows
                                   of FDI. The total net inflows of FDI to all developing countries reached
                                   $135.2 billion in 2003, of which East Asia accounted for $56.8 billion or 42.8
                                   per cent.

                                   1. UNEVEN PROGRESS IN THE REGION

Countries in the region                   The Asian and Pacific region consists of a heterogeneous group of
are in various stages              countries facing diverse situations. Some countries in the middle-income
of debt restructuring              group have a good track record of private capital market access while others
and structural                     lack access to private capital markets. Most of the countries in Central Asia,
adjustment, but                    South-West Asia and the Pacific are characterized by low savings rates, slow
progress is uneven                 growth and a commodity-dependent economic structure with limited access to
                                   private capital markets, depending on concessionary financial flows.


                  Table VI.2. Classification of countries by level of external indebtedness



          Severely indebted                       Moderately indebted                       Less indebted

 Low-income          Middle-income         Low-income           Middle-income        Low-income      Middle-income

 Bhutan         Turkey                    Cambodia              Kazakhstan           Armenia        China
 Indonesia                                Nepal                 Malaysia             Azerbaijan     Iran (Islamic
 Kyrgyzstan                               Pakistan              Philippines          Bangladesh        Republic of)
 Lao People’s                                                   Russian              India          Maldives
   Democratic                                                     Federation         Viet Nam
   Republic                                                     Samoa
 Myanmar                                                        Sri Lanka
 Papua New Guinea                                               Thailand
 Tajikistan                                                     Turkmenistan

      Source: World Bank, Global Development Finance (Washington, DC, World Bank, 2004).




                                          A number of countries in the Asian and Pacific region have neverthe-
                                   less avoided defaults, although debt situations are critical in some low-
                                   income countries, such as Indonesia, Kazakhstan, Kyrgyzstan, the Lao
                                   People’s Democratic Republic, Myanmar, Pakistan, Papua New Guinea, the
                                   Philippines and Tajikistan. These countries are in various stages of debt
                                   restructuring and are undertaking macroeconomic adjustments, but the out-
                                   come has not been very significant. Aid flows to some of these countries
                                   have declined as donors have placed increasing emphasis on economic
                                   reforms and structural adjustments.

108
                                                                 VI. External debt and sustainable debt management



       The climate of concessional development assistance has not shown
any noticeable improvement in recent years. In fact, the official net resource
flows have fallen and now stand at 0.17 per cent of the GDP of the
advanced economies. Multilateral aid has remained small in relative size
and more constrained than in the past. Moreover, aid flows have become
less responsive to short-term or cyclical phenomena.


B. RESPONSES TO EXTERNAL DEBT PROBLEMS

1. HEAVILY INDEBTED POOR COUNTRIES INITIATIVE

      The Heavily Indebted Poor Countries (HIPC) initiative launched by the               The World Bank and
World Bank and IMF in 1996 was the first comprehensive approach to debt                      IMF launched the
reduction providing relief from multilateral debt. The initiative provided a             Heavily Indebted Poor
framework for supporting a country when its debt level was considered                     Countries debt relief
unsustainable with the net present value (NPV) of its debt-to-export ratio                 initiative, but it has
exceeding 150 per cent, or the NPV of its debt-to-fiscal-revenue ratio                   been slow to produce
remaining above 250 per cent.                                                                             results
         Of the 42 countries qualified as potentially eligible for HIPC debt relief
in September 2004, 27 had received debt service relief of $32 billion in NPV
terms. Several bilateral creditors had responded very favourably to the HIPC
initiative: in November 1999 the Government of Canada announced the
cancellation of 100 per cent of its bilateral debt to HIPC.

        The results of the HIPC initiative have been somewhat slower than
expected, with excessive conditionality and restrictions over eligibility criteria.
In the Asian and Pacific region, the Lao People’s Democratic Republic is
potentially eligible for the HIPC initiative but has not entered the scheme
because it has not yet agreed to the IMF and World Bank structural
adjustment programmes required as a precondition for receiving HIPC debt
relief. The HIPC initiative’s debt sustainability analysis (DSA) has been
criticized for placing too much importance on the role of exports and not
reflecting the true burden of debt on social spending. Moreover, the initiative’s
preoccupation with providing debt relief has excluded a number of developing
countries that have been facing unsustainable debt servicing problems.

         It has been argued that the financial resources pledged under the
initiative should be considered as additional to normal ODA flows to countries
and should not therefore detract from them. If debt relief diverts ODA away
from countries that have succeeded in avoiding a heavy debt burden through
good economic management, it can be viewed as a perverse incentive. The
situation should be avoided where better performers are deprived of their
legitimate ODA grants because of their better performance.

2. SOVEREIGN DEBT RESTRUCTURING MECHANISM

       IMF proposed a sovereign debt restructuring mechanism (SDRM) in                         IMF’s sovereign
the aftermath of the Argentine crisis in 2001, providing a necessary forum for               debt restructuring
dispute resolution. The proposal involves an international bankruptcy court              mechanism received a
for insolvent countries, somewhat similar to the bankruptcy statutes for                   lukewarm response
corporations which are meant to restructure unsustainable private debts in an
orderly manner. Under the proposed system, the national Government would
request the convening of an international panel, which would negotiate with
the private creditors and arrive at a debt restructuring agreement with the
approval of a majority of the creditors. The SDRM proposal aimed at orderly
workouts by providing legal protection for debtors while, at the same time,
having macroeconomic policies in place.

                                                                                                             109
Implementing the Monterrey Consensus in the Asian and Pacific region: achieving coherence and consistency



                                       The proposal was discussed at the IMF-World Bank annual meeting
                                 in April 2003 but received a lukewarm response from the members of
                                 developed as well as developing countries. Private creditors have opposed
                                 the proposal, perceiving possible moral hazard from the borrowing countries.
                                 Moreover, it was noted that IMF would have to create a bankruptcy
                                 resolution mechanism, which would entail a change in the Fund’s articles of
                                 agreement.

                                 3. PRIVATE SECTOR INITIATIVES

A contractual                           The external borrowings of HIPCs and least developed countries have
approach entailing the           come mostly from official sources, while those of middle-income countries
use of collective                have come predominantly from private capital markets where the mechanism
action clauses has               for resolving debt problems has been somewhat limited. The diversity and
been favourably                  anonymity of the investor base in bond markets and the differences in laws
accepted in the market           governing bond issuance have made consensus-building difficult in sovereign
                                 bond restructuring, which carry potentially high costs.

                                        A contractual approach entailing the use of collective action clauses
                                 (CACs) in the bond indentures is being worked out as the legal basis for
                                 collective action by the bond holders. The CACs are intended to permit a
                                 specified super-majority of holders of a particular bond issue to agree to a
                                 restructuring that would be binding on all holders of that issue.        The
                                 approach has been favourably accepted in the marketplace, even though it
                                 provides only a partial solution to the problem. While creditors and debtors
                                 grapple with a suitable mechanism for orderly debt workouts, some countries
                                 have succeeded in agreeing a voluntary exchange of bonds with their
                                 creditors, providing incentives to the creditors to promote greater investor
                                 participation (for example, Pakistan in 1999, Ukraine in 1999 and 2000 and
                                 Argentina in 2001).

                                 4. MARKET-BASED DEBT REDUCTION BY BANKS

The market-based debt                   In the aftermath of the 1982 debt crisis, several commercial debt-
reduction approach               restructuring activities were undertaken in the form of debt buybacks and
taken by banks has               market-based debt reductions. Such market-based debt reduction schemes
not enhanced the                 encouraged banks to retire voluntarily a part of their non-performing debt.
repayment capacity               These schemes included debt-for-equity swaps, the secondary market sale of
of borrowers                     debts, debt buy-backs and the exchange of debts for collateralized securities.
                                 The most commonly used scheme was the use of debt-for-equity swaps that
                                 involved the conversion of external debt into equity investments in the debtor
                                 countries.

                                        Another approach, termed the “Brady Initiative”, involved a variety of
                                 debt conversion instruments, such as debt buyback at a discount and the
                                 exchange of debt for discount bonds at market rates and for par bonds at
                                 below-market interest rates. The initiative had the support of the World Bank
                                 and IMF, which succeeded in completing the conversion of $191 billion of
                                 commercial bank debt involving 13 countries from 1989 to 1995. The
                                 International Development Association (IDA) created a “debt reduction facility”
                                 in 1989 to help low-income countries to buy back their commercial
                                 debt. Since its inception, the facility has completed 22 operations for 21
                                 countries.

                                       The main disincentive for the banks in this debt reduction process
                                 was the heavy discounts that it carried on the face value of the debts.
                                 Nevertheless, the secondary market sale was not intended to enhance

110
                                                              VI. External debt and sustainable debt management



borrowers’ repayment capacity; rather, it helped the banks to adjust their
portfolios and country risks by enabling them to exchange loans with other
investors. Since the exchange was voluntary, there were no common terms
or conditions applied to the countries that engaged in it.


C. EXTERNAL DEBT MANAGEMENT ISSUES

1.   THE FINANCIAL CRISIS OF 1997 AND ITS IMPLICATIONS
     FOR EXTERNAL RESOURCE MANAGEMENT

        The Asian crisis brought several new dimensions to the debt problems
of developing countries. The issue was not so much the aggregate level of
debt as the balance between private and public sector debt, its maturity
structure, the level of contingent liabilities, reserve management and pursu-
ance of macroeconomic policies consistent with external sector objectives.
The contributory factors underlying the financial crisis included the premature
liberalization of capital accounts in many countries. Capital flows from
developed countries have become less countercyclical, with shorter maturities
and greater volatility. These trends have also underscored the importance of
a sound and coherent policy framework for managing and monitoring capital
flows in general and debt management, in particular.

        The debt crisis was shaped by several factors: the nature of capital
flows, the way the current account deficit was being financed and the way
external capital was used. Since the crisis, the structure of external debt
has undergone some changes: maturities have lengthened and the propor-
tion of short-term debt in total debt has fallen. In their desire to prevent a
capital account crisis, many countries in the region have built up large
volumes of international reserves in recent years.        In East Asian and
Pacific countries, foreign exchange reserves reached $544.5 billion in 2003,
more than their combined total external debt of $514.7 billion. In May
2004, the holdings of international reserves posted for China was $463
billion, India $115 billion, the Republic of Korea $166.5 billion, Malaysia $53
billion and Thailand $44 billion. The surge in reserves, however, has
brought to the forefront some new issues in the region’s management of
external resources.

       There are large fiscal costs to holding foreign exchange reserves,             Many countries in the
since monetary authorities need to sterilize the impact of rising reserves by           region have built up
issuing domestic securities at interest rates that are generally higher than               large international
what they can earn by investing these reserves overseas. Some countries                      reserves against
have used their excess holdings of reserves to liquidate their outstanding                  potential liquidity
high-cost debt from international capital markets or even liberalized further         crises and some have
their import and foreign investment regimes. Improved conditions for emerg-                    opted for early
                                                                                         repayment of debts
ing market borrowers, mainly due to lower credit risk assessments by
investors and a lower expectation of the systemic risk associated with
developing countries’ debt, have prompted early debt repayments. India
prematurely repaid sovereign loans, both multilateral and bilateral, amounting
to $6.7 billion during the period from 2002 to 2004, and Thailand proposed to
prepay its public external debt over the coming year. It was reported that
China, in an effort to strengthen its financial system, used $45 billion of its
foreign exchange reserves in the recapitalization of the Bank of China and
China Construction Bank in December 2003.


                                                                                                          111
Implementing the Monterrey Consensus in the Asian and Pacific region: achieving coherence and consistency



                           Table VI.3. Reserves and related ratios at the end of 2003
                                              (Billions of United States dollars)



                                                                                                 Reserve     Reserve
                                                                               Reserve
                                  1996          2003        May 2004            to GDP           to short-   to bank
                                                                                                term debt     deposit
                                                                             (percentage)
                                                                                              (percentage) (percentage)

 China                          107.0           408.2         463.1                 28.9         14.2              ..
 India                           20.2            98.9         115.4                 17.2          6.4           31.1
 Indonesia                       18.3            36.2          34.9                 17.4          1.5           34.4
 Republic of Korea               34.0           155.3         166.5                 25.7          3.4           34.7
 Malaysia                        27.0            44.5          53.6                 43.2          5.4           46.2
 Philippines                     10.0            13.5          13.4                 17.0          1.6           34.5
 Thailand                        38.7            42.1          44.2                 29.5          2.1           32.0

      Source: IMF, Global Financial Stability Report (Washington, DC, IMF, September 2004).




                                    2. CRITICALITY OF PRIVATE SECTOR CORPORATE DEBT

                                           The Asian crisis in 1997-1998 highlighted the need for comprehensive
                                    measures for total external debt management, including both public and
                                    private sector non-guaranteed debt. The increasing role of the private sector
                                    in the development process has been an emerging feature, complemented by
                                    the changing composition of capital flows (for example, the increased impor-
                                    tance of portfolio investment flows and the raising of bonds and loans from a
                                    variety of commercial sources).       These have brought to the fore new
                                    dimensions of the debt problem, such as corporate debt problems, exchange
                                    rate-debt linkages, domestic-external debt linkages and contingent liabilities.

Corporate governance                       Private sector debt, including corporate debt and debt incurred by such
needs further                       financial intermediaries as commercial banks and non-bank financial compa-
improvement                         nies, has the potential to create moral hazard or disrupt the functioning of
                                    financial markets at a time of financial distress. It is well known that
                                    excessive borrowing by private sector banks and corporations in East-Asia
                                    was motivated by several factors, such as low interest rates, pegged
                                    exchange rates, relationship-based business and weak disclosure practices.
                                    This had led to inefficient allocation of resources, particularly into real estate,
                                    as well as to inefficient firms. The weak corporate governance system
                                    resulted in unnecessarily preferential external credit.

                                           The restructuring of distressed private banks and corporations in Asia
                                    and the Pacific has been slow, generally as a result of the ineffectiveness of
                                    formal reorganization procedures, such as bankruptcy and renegotiations.
                                    Judicial efficacy was therefore undermined, and non-performing loans
                                    lingered in the post-crisis period in several countries, such as Indonesia, the
                                    Philippines and Thailand.

                                           However, some countries in the region made significant steps in
                                    restructuring their ailing banks as well as their holdings of corporate debt.
                                    Several countries adopted a policy of bank recapitalization involving legally
                                    binding agreements with the debtors, and set up asset management compa-
                                    nies that were intended to take over the distressed debt of ailing corpora-
                                    tions and facilitate the settlement process.      Those asset management
                                    companies were estimated to have taken over a large amount of debt,
                                    ranging from 10 to 35 per cent of GDP in some of the East Asian countries.

112
                                                                 VI. External debt and sustainable debt management



       The Government of Thailand established a corporate debt restructuring
advisory committee to implement voluntary corporate workouts involving
multiple creditors. The Thai Asset Management Corporation was established
in 2001 and was vested with legal powers to manage and resolve distressed
corporate loans.     The Republic of Korea liberalized regulations on the
participation of foreign investors in mergers and acquisitions involving dis-
tressed corporations. The Indonesian Government created the Indonesian
Debt Restructuring Agency which was expected to provide a guarantee
against exchange risk on renegotiated foreign currency debt. The debtors
were expected to pay the Agency in local currency, and the Agency then
had the obligation to repay creditors in foreign currency.

       Dealing with non-performing assets and restructuring distressed corpo-             A stronger and more
rations in the post-crisis period has proved to be one of the most difficult                  transparent legal
challenges faced by many Asian policy makers. There have been inordinate                     system is needed
delays in bankruptcy proceedings in many countries owing to political pres-
sures and cumbersome regimes. The delays have prompted banks and
firms in some countries to adopt a procedure involving out-of-court restructur-
ing and settlement that lacks transparency. The nexus between corporations
and banks implied that the restructuring process must be adopted simultane-
ously. A transparent and strong legal framework enabling contract enforce-
ment between lenders and borrowers is considered important for financial
sector stability, thereby promoting corporate investment. If the restructuring
of the financial and corporate sectors is to be implemented prudently so as
to minimize the social costs, significant improvements need be made so that
social safety nets can offset the impact of the restructuring exercises on the
poor.

3. ISSUES IN DOMESTIC PUBLIC DEBT

       Debt management policies followed after the 1982 debt crisis were                  Domestic public debt
primarily concerned with the management of external debt, and domestic                            has increased
debt issues were considered part of the budgetary exercise only. However,                 significantly in many
countries have begun to give priority to the management of total public debt,                  countries in the
encompassing both external and domestic debt, while fiscal imbalances with                    region, reflecting
unsustainable domestic debt have begun to cause severe macroeconomic                            increased fiscal
problems. In recent years, domestic public debt has increased significantly                  deficits and rising
in a large number of countries in the region, reflecting increased fiscal                  contingent liabilities
deficits and rising contingent liabilities, notwithstanding the large privatization
programmes undertaken since the 1990s.

       The growth of public debt has important implications for the economy.
The growth of domestic debt leads to an increase in debt servicing costs,
leaving less for investments in economic infrastructure and expenditures on
such vital items as health, education and social security. The expansion of
public borrowing can lead to the crowding out of private investments,
especially when government borrows to cover current consumption spending
and interest payments. Of course, it may not affect overall economic growth
if government expenditure is mostly incurred on capital formation, such as
the creation of infrastructure. Since the build-up of internal debt generally
creates pressure on future inflation and an interest hike, in addition to the
crowding-out effects, it may have an undesirable impact on the economy and
society. An increase in fiscal deficits and public debt places negative
pressure on financial systems and growth prospects, eroding a country’s
creditworthiness.

                                                                                                             113
Implementing the Monterrey Consensus in the Asian and Pacific region: achieving coherence and consistency



                                Figure VI.1. Domestic debt as a percentage of GDP



                                                                                                                                                                 100

                                1996                      2002                                                                                                   90

                                                                                                                                                                 80

                                                                                                                                                                 70

                                                                                                                                                             60

                                                                                                                                                             50

                                                                                                                                                             40

                                                                                                                                                             30

                                                                                                                                                             20

                                                                                                                                                             10

                                                                                                                                                             0
                       1996




                                                                                                                                                    Turkey
                                                                                                                                         Thailand
                                                                                                                     Republic of Korea
                                                                                                       Philippines
                                                                                            Pakistan
                                                                                 Malaysia
                                                                     Indonesia
                                                             India
                                                  china
                                  Bangladesh




      Source: ESCAP calculations based on IMF, International Financial Statistics, November 2004.




                                                      Effective public debt and fiscal management not only has domestic
                                               macroeconomic benefits, but it also enhances the country’s confidence and
                                               credit standing in the eyes of private investors and lenders in international
                                               capital markets. A better credit rating certainly helps to sustain the flow of
                                               external resources into the country and can help to relieve financial constraints.

                                               4. CONTINGENT LIABILITIES

Governments need to                                  External debt sustainability analysis typically focuses on the officially
pay careful attention                          reported claims on the government but often fails to detect possible future
to the implications of                         increases in government debt and payment obligations that could emerge
contingent liabilities                         from explicit or implicit government guarantees.

                                                        Explicit contingent liabilities arise from any contractual arrangement
                                               when the risk of the concerned party is protected in the form of exchange rate
                                               and interest rate risk guarantees and corporate external borrowing guarantees.
                                               Meanwhile, implicit contingent liabilities can arise from a contractual or legal
                                               obligation that is conditional upon certain events, such as systemic solvency of
                                               the banking system. Implicit contingent liabilities are more difficult to assess
                                               than explicit ones owing to the potential moral hazard problem involved. In
                                               the late 1990s, explicit and implicit government guarantees to the domestic
                                               banking sector amounted to over 20 per cent of GDP in the Republic of
                                               Korea, 30 per cent in Thailand and about 50 per cent in Indonesia. These
                                               liabilities carry significant fiscal risks and can constrain a government’s policy
                                               options in times of potential crisis. The extent of such liabilities can swell in
                                               the presence of poor governance and regulatory regimes.

114
                                                                 VI. External debt and sustainable debt management



         Contingent liabilities are often not measured in many countries and are
therefore not covered in the external debt statistics. The Asian economic
crisis exposed the hidden risks of these contingent liabilities that had been
built into the system of pegged exchange rates and the government policy of
bailing out domestic banks. Therefore, debt mangers need to consider
the budget for contingent liabilities, making appropriate stress tests under
abnormal market conditions and estimating the potential costs of such
liabilities in extreme cases.         In order to limit the scope of contingent
liabilities, Governments will need to make the statistics and administration
more transparent to the public.

5. RISK MANAGEMENT

        Foreign-currency-denominated debts are exposed to various risks, such                   As for the risks
as currency and interest rate movements. Frequent commodity price fluctua-              associated with foreign
tions add further risk to the economies that depend on commodity exports by                currency borrowing,
affecting their ability to service the debt. The debt crises of the early 1980s            policy makers in the
show some common elements: oil price hikes leading to a surge in the                      region need to adopt
import bill of non-oil producing countries, a global recession eroding export                   appropriate risk
earnings, rising interest rates and the appreciation of the United States                          management
dollar, adding to the burden of repayment on dollar loans. The crises were                           techniques
also accentuated by the predominance of short-maturity debt contracted at
variable interest rates. These factors placed pressure on developing coun-
tries, affecting their debt servicing negatively. In the event of a currency
crisis, short-maturity foreign exchange borrowings add currency risks to the
liquidity problems.

      In view of the market risks associated with the foreign currency
borrowings, policy makers in developing countries need to adopt appropriate
risk management techniques as well as a policy framework that supports the
development of derivative markets with such instruments as forwards, swaps
and options for risk management. In countries with less developed financial
markets, authorities should consider allowing domestic entities to access
such financial instruments in the overseas markets.

6.   MANAGING EXTERNAL DEBT USING SUSTAINABILITY
     INDICATORS

      External debt management involves balancing resource mobilization                           External debt
and deployment as well as orderly repayment of future obligations. For                       managers need to
sustainable debt management, policy makers need to project accurate debt                          conduct debt
dynamics that are sensitive to the way the current account deficits are                  sustainability analysis
being financed. If borrowed resources are not used productively, external                 on a regular basis to
borrowing can result in severe debt servicing difficulties. Debt management                 check the need for
authorities therefore need to focus on efficient allocations of capital in sectors           debt rescheduling
generating proper returns, and should effect monitoring to determine whether
the borrowed resources are being used to improve the country’s production
capacity so that future obligations are serviced.

       There is no rule of thumb for determining whether a country’s debt
level is sustainable. For an accurate projection on debt sustainability,
several indicators should be assessed simultaneously in a forward-looking
way. It should be noted, also, that debt sustainability analysis has to be
country-specific, with consideration of the country’s debt history, the level of
sovereign ratings and the degree of development in the financial sector and
capital markets.

                                                                                                             115
Implementing the Monterrey Consensus in the Asian and Pacific region: achieving coherence and consistency



                                         A country is said to have unsustainable debt if its level of debt has made
                                  its servicing projection (amortization as well as interest payments) incompatible
                                  with the projection of net capital inflows. Temporary liquidity problems can also
                                  make debt servicing difficult when they are triggered by either a sharp drop in
                                  export earnings, an increase in interest rates, appreciation of the contracted
                                  currency, or increases in the price of imports, such as oil. The currency and
                                  interest rate composition of debt, its maturity structure and the availability of
                                  resources for debt repayments are all important factors that affect the
                                  vulnerability of the economy to external liquidity crises.

                                        Debt sustainability analysis considers the indicators of “solvency” as
                                  well as “liquidity” together. This way of analysing debt sustainability resolves
                                  the issue whether a country needs to reduce its debt, as in the case of
                                  solvency, or to reschedule and restructure debt to make it sustainable. The
                                  common set of solvency indicators has been the ratio of external debt to
                                  exports, external debt to national income, debt service ratio and interest
                                  service ratio. The level of short-term debt has also been considered an
                                  important liquidity risk factor that can precipitate a foreign exchange crisis,
                                  especially when coupled with high or unsustainable current account deficits.
                                  Recent debt sustainability analysis takes into account the ratio of short-term
                                  debt to total outstanding debt and the ratio of international reserves to short-
                                  term debt as common indicators of liquidity.


                                  Table VI.4. Indicators of debt sustainability



 Debt Indicators                                                       Interpretations

                                                       Solvency
 Interest service ratio              Ratio of interest payments to earnings from exports of goods and services
                                     indicates the terms of external debt burden. It also indicates the level of
                                     current earnings needed for the debtor in servicing the debt.
 Debt service ratio                  The ratio of debt-service payments to exports of goods and services indicates
                                     how much of a country’s export revenue will be used up in servicing its debt.
 External debt to exports ratio      The debt to exports ratio provides an indicator of solvency, since an increasing
                                     debt to exports ratio indicates that the country may have problems meeting its
                                     debt obligations in future.
 External debt to GDP ratio          The debt to national income ratio provides some indication of the potential to
                                     service external debt by switching resources from the production of domestic
                                     goods to the production of exports.
 NPV of debt to exports ratio        It compares the debt burden with repayment capacity.
 NPV of debt to fiscal               Since not all export earnings are in the hands of the public sector, this ratio
 revenue ratio                       measures the servicing obligations in relation to government revenues.
                                                        Liquidity
  Reserves to imports ratio          An important indicator of reserve adequacy.
  Reserves to short-term             This ratio can indicate vulnerability to a liquidity crisis in the event of capital
  debt ratio                         flight on account of short-term debt.
  Interest payments to               Measures the interest payments of all debt which could be covered by usable
  reserves ratio                     reserves.
  Short-term debt to total           Measures the relative importance of short-term debt (all debt with residual
  debt ratio                         maturity of less than one year) in total external financing; measures the extent
                                     of vulnerability in the event of a liquidity crisis.



116
                                                                VI. External debt and sustainable debt management



       Of course, there are many constraints in establishing appropriate
frameworks for assessing debt sustainability in developing countries (espe-
cially LDCs and economies in transition) owing to limited data, inaccessibility
of private capital markets, lack of transparency and poor governance issues.
The quality of institutions and the transparency of the governance system are
important in debt analysis as well as management. Sustainability indicators
merely serve as early warning signals and the solutions to the problems
they reveal require suitable macroeconomic policies that correct economic
imbalances.


D. POLICY RECOMMENDATIONS

       Countries should endeavour to make debt finance a positive source of
financing for development. The thrust areas are identified as: (a) the country
level; (b) the bilateral level; (c) the regional level; and (d) the global level.

1. COUNTRY LEVEL

      •   Maintain macroeconomic stability on a sustainable basis with due
          attention to monetary, fiscal and exchange rate policy coherence
          and consistency. In particular, pay careful attention to growing
          public sector fiscal deficits.

      •   Deregulate and liberalize markets carefully to improve productivity
          and, for those that have yet to liberalize, sequence the steps
          required for capital market liberalization appropriately.

      •   Develop the financial system, including domestic bond markets
          and, in particular, the government bond market, by creating an
          environment conducive to the promotion of long-term investments.
          In this regard, development of the derivative market will be also
          needed in emerging markets for risk management.

      •   Avoid excessive dependence on external short-term borrowing and
          secure long-term financing.

      •   Effectively monitor the flows of capital, particularly short-term
          private capital.

      •   Discourage the flow of speculative short-term capital in various              Speculative short-term
          ways, using a different tax structure and caps or maturity restric-                  capital is to be
          tions on certain types of debt in periods of excessive short-term                       discouraged
          capital flows.

      •   Maintain adequate foreign reserves to provide effective insurance
          against external uncertainties.    Effectively manage the foreign
          reserves portfolio, paying attention to the movements of major
          currencies to minimize the foreign exchange risks.

      •   Continuously explore opportunities to reduce the burden of expen-
          sive debt via early retirement (prepayment) and refinancing of
          existing high-cost debt that can be retired without additional costs,
          such as penalties, provided that this does not adversely affect the
          maturity profile.

      •   Efficiently use foreign aid for development purposes to minimize
          the cost of capital.

                                                                                                            117
Implementing the Monterrey Consensus in the Asian and Pacific region: achieving coherence and consistency



                                        •   Monitor debt on a regular basis, using appropriate tools, such as
                                            early warning systems and debt sustainability analysis, to ensure
                                            that the debt burden remains at sustainable levels.

                                        •   Ensure the availability of computerized data on debt, both external
                                            and domestic, both public and private, as well as the contingent
                                            liabilities of the public sector by creating effective institutional
                                            frameworks for the comprehensive and timely flow of information.

                                        •   Ensure greater transparency in debt data in line with international
                                            standards, such as those found in External Debt Statistics: Guide
                                            for Compilers and Users.1

                                        •   Adhere to good governance principles in contracting debt and
                                            using borrowed funds.

                                        •   Promote stronger institutional arrangements for, and strengthen
                                            coordination of, debt management.

                                 2. BILATERAL LEVEL

                                        •   Increase the availability of concessional resources, including grants
                                            to developing countries, particularly those for the LDCs and for the
                                            countries that are commodity-trade-dependent.

                                 3. REGIONAL LEVEL

                                        •   Improve the existing frameworks and arrangements to provide
                                            support for countries facing difficulties in raising capital on interna-
                                            tional markets.

                                        •   Enhance the development of regional bond markets through
                                            increased standardization of issuance and settlement procedures.
Regional cooperation                    •   Improve regional cooperation through more organized arrangements
through more                                in the Asia-Pacific region to enhance debt management capacities,
organized                                   and share experiences in debt management as well as risk man-
arrangements to                             agement. Create an organized resource centre, if needed.
enhance debt
management capacities                   •   Actively explore ways to effectively use the region’s foreign
is important                                exchange reserves.

                                        •   Strengthen the Chiang Mai Initiative (CMI), both in scope and
                                            coverage, to provide an effective mechanism of contingent support
                                            to prevent financial crises.

                                        •   Enhance technical assistance in debt management.

                                 4. GLOBAL LEVEL

                                        •   Implement suitable arrangements for orderly debt workouts, such
                                            as collective action clauses (CACs) and the Sovereign Debt
                                            Restructuring Mechanism (SDRM).


                                     1 IMF, External Debt Statistics: Guide for Compilers and Users, November 2003. The
                                 Guide was prepared by the Inter-Agency Task force on Financial Statisties, which was chaired
                                 by IMF and involved representatives of the Bank for International Settlements, the Common-
                                 wealth Secretariat, the European Central Bank, Eurostat, OECD the Paris Club Secretariat,
                                 UNCTAD and the World Bank.


118
                                                           VI. External debt and sustainable debt management



      •   Improve existing debt management systems, such as the Common-
          wealth Secretariat Debt Recording and Management System (CS-
          DRMS) and the Debt Management and Financial Analysis System
          (DMFAS) of UNCTAD, to ensure that such systems are capable of
          catering to the needs of the changing economic environment and
          responding to capacity-building needs in debt management and
          debt sustainability analysis.

      •   Provide technical support for developing countries whose banking
          sectors are not fully developed.

5. RESPONSE OF ESCAP

      The plan of action for ESCAP would be to (a) identify the countries
that are currently experiencing debt problems and those that are likely to
have problems in near future; (b) provide technical assistance for external
debt management, as highlighted in the Monterrey Consensus; and (c)
provide early warning signals for debt and currency crisis in the region
through regional cooperation.




                                                                                                       119
Implementing the Monterrey Consensus in the Asian and Pacific region: achieving coherence and consistency



                Table VI.5 Recent trends in debt and capital flows to developing countries
                                            (Billions of United States dollars)



                                              1990     1995      1998      1999      2000     2001     2002      2003

                                                                       All developing countries
 Aggregate net resource flows                 97.8     230.3     316.0     261.2    213.5    209.5     175.2     188.2
 Private net resource flows                   43.7     176.3     269.2     216.8    180.0    174.2     153.8     168.2
 FDI, net                                     24.0     105.3     175.6     181.7    162.2    175.0     147.1     135.2
 Official net resource flows                  54.1      53.9      46.9      44.4     33.5     35.3      21.3      20.0
 Total debt stocks                          1351.9    1990.3    2342.1 2374.7 2305.0 2266.7           2338.8    2433.3
 Net flows on debt, total                     54.8     151.3      57.6      13.8     – 9.8    – 1.2      7.3      44.3
                                                                       East Asia and the Pacific
 Aggregate net resource flows                 25.1      87.2       60.5      54.6    42.7     45.1      44.6      52.8
 Private net resource flows                   17.2      74.8       50.4      41.4    34.4     37.2      47.5      58.9
 FDI, net                                     10.5      50.8       57.7      49.9    44.2     48.2      54.8      56.8
 Official net resource flows                   7.9      12.4       10.1      13.2     8.2      7.9     – 2.9      – 6.2
 Total debt stocks                           234.1     455.6     533.2     538.6    497.3   501.3     497.4      514.7
 Net flows on debt, total                     18.6      54.1     – 32.5    – 12.2  – 17.7    – 8.1    – 10.9        0.5
                                                                      Europe and Central Asia
 Aggregate net resource flows                 11.7      37.7      67.4     58.8   51.3     41.9         59.8      50.4
 Private net resource flows                    7.5      26.8      59.9     48.2   42.1     38.9         53.7      45.8
 FDI, net                                      1.2      17.4      26.1     28.4   29.3     31.8         32.9      26.2
 Official net resource flows                   4.2      10.9       7.5     10.6    9.2       3.0         6.1       4.6
 Total debt stocks                           217.2     349.0     485.2    495.6  503.9    498.9        545.8     577.4
 Net flows on debt, total                      1.7      23.4      41.5     16.1   21.0       2.0        24.9      29.5
                                                                  Latin America and the Caribbean
 Aggregate net resource flows                 22.2      72.1     137.9    108.3    82.6     79.5        38.1      46.4
 Private net resource flows                   13.2      59.7     126.4    103.0    80.5     71.5        34.5      44.7
 FDI, net                                      8.2      30.5      73.8     88.0    77.0     69.9        44.7      36.6
 Official net resource flows                   9.0      12.4      11.5      5.3      2.1     8.0          3.6      1.7
 Total debt stocks                           444.2     612.2     748.4    770.2   751.9    729.3       727.9     762.1
 Net flows on debt, total                     18.1      61.2      38.0     12.1    – 9.7     6.3        – 7.9     19.5
                                                                   Middle East and North Africa
 Aggregate net resource flows                 11.8        1.5     13.5      3.4     3.7     9.2           5.2     – 1.6
 Private net resource flows                    2.3        0.5     11.5      3.2     3.2     8.0           5.4     – 3.7
 FDI, net                                      2.6      – 0.7      7.4      2.9     2.4     5.8           2.7       2.0
 Official net resource flows                   9.6        1.0      2.0      0.2     0.5     1.3         – 0.1       2.1
 Total debt stocks                           155.1     186.4     189.3   193.6   180.7    178.4        189.0     188.1
 Net flows on debt, total                      0.9        2.4      7.1    – 1.8   – 6.1     0.9           0.9     – 7.8
                                                                              South Asia
 Aggregate net resource flows                  9.0       9.1      11.5       8.2    13.0      10.1       5.8      11.4
 Private net resource flows                    2.1       6.2       6.7       3.4    10.1        5.1      5.7        9.2
 FDI, net                                      0.5       2.9       3.5       3.1     3.4        5.0      4.2        5.1
 Official net resource flows                   6.9       3.0       4.9       4.8     2.9        5.0      0.1        2.2
 Total debt stocks                           124.4     151.7     157.6     162.0   159.9     156.3     168.3     171.3
 Net flows on debt, total                      8.4       2.5       4.7       0.5     3.4      – 0.7      0.4      – 2.3
                                                                          Sub-Saharan Africa
 Aggregate net resource flows                 18.0      22.6      25.2      27.9    20.1      23.5      21.6      28.8
 Private net resource flows                    1.4       8.4      14.3      17.6      9.6     13.4        7.0     13.3
 FDI, net                                      1.0       4.3        6.9       9.3     5.8     14.3        7.8      8.5
 Official net resource flows                  16.6      14.2      10.9      10.3    10.5      10.2      14.7      15.6
 Total debt stocks                           176.8     235.4     228.4     214.7   211.2     202.6     210.3     219.7
 Net flows on debt, total                      7.1       7.6      – 1.3     – 1.0   – 0.7     – 1.8     – 0.1      4.9

      Source: World Bank, Global Development Finance (Washington, DC, World Bank, 2004).




120
                                                                      VI. External debt and sustainable debt management



                       Table VI.6. Key external debt ratios for developing countries
                                       (Percentage, averages for 2000–2002)



                          Total external Present value      EDT as             PV as        Total debt       Interest
                           debt (EDT)    (PV) of EDT       percentage        percentage     service as     service as
                         to exports of         as           of gross           of GNI       percentage    percentage
                           goods and      percentage        national                         of XGS          of XGS
                            services        of XGS           income
                              (XGS)                           (GNI)

Armenia                        168            109               52                34            11               4
Azerbaijan                      55             44               26                21             7               1
Bangladesh                     182            117               35                22             8               2
Bhutan                         265            244               79                73             5               1
Cambodia                       129            109               86                73             1               0
China                           52             50               15                14             9               2
Fiji                            43             41               12                12             6               2
Georgia                        178            133               56                42            12               4
India                          130            103               22                17            16               5
Indonesia                      191            189               90                89            24               6
Iran (Islamic Republic of)      29             25                9                 7             5               1
Kazakhstan                     159            149               85                80            37               7
Kyrgyzstan                     282            208              126                93            27               4
Lao People’s
   Democratic Republic         522            280              162                87             9               2
Malaysia                        44             44               58                57             7               2
Maldives                        57             42               45                34             5               1
Mongolia                       149            102              100                69             8               2
Myanmar                        241            150                ..                ..            4               1
Nepal                          228            133               53                31             8               2
Pakistan                       256            201               57                45            22               6
Papua New Guinea               117            113               85                82            13               3
Philippines                    130            135               75                77            20               7
Russian Federation             121            122               49                50            12               6
Samoa                          249            178               95                68             8               5
Solomon Islands                139            100               66                47             4               2
Sri Lanka                      129            103               60                48            10               3
Tajikistan                     152            118              113                88            10               2
Thailand                        71             69               50                49            24               3
Turkey                         227            232               75                77            48              10
Viet Nam                        72             61               41                35             6               2

   Source: World Bank, Global Development Finance (Washington, DC, World Bank, 2004).




                                                                                                                     121

				
DOCUMENT INFO