Sustainable External Debt Management

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Sustainable External Debt Management

• Presented by
• Dr Tarun Das
• Economic Adviser
• Ministry of Finance

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Contents

• 1. Definition of external debt
• 2. Conceptual issues
• 3. Different Types of Risk
• 4. Measures for Risk Management
• 5. Sustainability Indicators
• 6. World Bank Classification of Ext debt

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1.1 Definition of external debt

• Gross external debt, at any time, is the
  amount of disbursed and outstanding contractual
  liabilities of residents of a country to
  non-residents to repay the principal with or
  without interest, or to pay interest with or
  without principal.
• Gross external debt
• Contractual obligation
• Disbursed and outstanding
• Principal with or without interest
• Interest with or without principal
• Concept of residency not nationality
• Current not contingent

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1.2 Definition of external debt- Other Issues

• Valuation of external debt
• Present value of debt
• Short-term debt original and residual maturity
• Interest costs- actual / accrued
• Foreign and domestic currency
• Traded and unlisted securities
• Govt and non-govt( monetary authority, banks,
  others)

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2 Conceptual Issueson Sustainable Debt

• Debt Sustainability and Fiscal Deficit
• Debt Sustainability and Current Account Deficit
• Liquidity versus Solvency
• Economy wide models
• Asset Liability framework
• Debt sustainability indicators
•  

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3.1 External Debt Management and Risk Management

• A government should manage its debt in order to
  raise the required amount of resources subject to
  the lowest possible medium/long term cost and
  consistent with a prudent degree of risk
• Poor debt management poses risks for both the
  public and private sectors
• Risks include fiscal crisis change in
  creditworthiness and insolvency (debt
  distress) economic crisis and instability

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3.2 Transparency in Risk Management

• Debt management objectives should be clearly
  defined and publicly disclosed
• The measures of cost and risk that are adopted
  should be explained
• Objectives/preferences of policy
• Rules of the game (institutional and legal
  framework)

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3.3 Basic Principles of Risk Management

• The risks in the structure of government debt
  should be carefully monitored and evaluated
• Risks associated with foreign-currency and
  short-term or floating rate debt
• The risks should be mitigated to the extent
  feasible
• Modify the debt structure, taking into account
  cost of doing so

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3.4 Different types of risk

• Market-Based Risks
• Liquidity risk
• Interest rate risks
• Credit risk
• Currency risk
• Convertibility risk
• Budget/ Fiscal Risk
• Contingent liabilities

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3.5 Different types of risk

• Country specific and Political risks
• a) appropriation of capital,
• b) nationalisation of companies,
• c) no repatriation of capital etc.
• d) no sovereign guarantee
• Operational Risks
• Control system failure risks
• Financial error risk
• Auditing/ Accounting/ Monitoring Risk

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4.1 Debt Management Strategy

• Market risk management involves understanding
  financial characteristics of revenue flows to
  government and matching with liabilities with
  similar characteristics as far as possible
  (asset and liability management)
• Not so feasible in countries without
  well-developed debt markets
• Credit risk management depends on diversification
• Rollover risk can be created by excessive
  short-term or floating rate debt (high potential
  impact)
• Effective cash management is necessary for
  effective risk management (e.g., payment arrears)

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4.2 Risk Management Framework

• A risk management framework should help to
  identify and manage the trade-offs between
  expected cost and risk in the debt portfolio
• Cost includes financial cost and potential cost
  of real economic loss
• Market risk is measured in terms of potential
  increases in debt servicing costs associated with
  changes in interest or exchange rates

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4.3 Assessing Risk

• To assess risk conduct stress tests of the debt
  portfolio based on economic and financial shocks
• Simple scenario models Fund/Bank Debt
  Sustainability Analysis (DSA)
• Project future debt service costs over MT/LT
• List key risk indicators
• Summarize costs and risks of alternative
  strategies

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4.4 Management of liquidity risk

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

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4.5 Management of interest rate risk

• (a) Fix benchmark for ratio of fixed versus
  floating rate debt
• (b) Maintain ratio of short-term versus long-term
  debt
• (c)   Use interest rate swaps

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4.6 Management of credit risk

• (a)      Have credit rating of various scrips
  by international credit rating organizations such
  as SPs, Moodys, JBR etc.
• (b)  Identify key factors that determine
  credit-rating
• (c)  Develop a culture of co-operation and
  consultation among different departments and with
  credit rating organisations
• (d)   Set overall and individual counter-party
  credit limits

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4.7 Management of currency risk

• (a)    Fix benchmark for the ratio of
  domestic and external debt
• (b) Fix ratios of short-term /long-term debt
• (c)   Fix currency mix for external debt
• (d)  Determine single currency and currency
  pool debt
• (e)   Use currency swaps
• (f)  Try to have natural hedge by linking
  dominant currency of exports remittances to the
  currency denomination of debt

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4.8 Convertibility Risk

• (a) Have gradual and cautious approach towards
  capital account convertibility.
• (b) An orderly and sequenced manner in line with
  strengthening domestic financial systems through
  adequate prudential and supervisory regulations.
• (c) Encourage initially non-debt creating
  financial flows followed by long term capital
  flows.
• (d) Short term or volatile capital flows may be
  liberalised only at the end of capital account
  convertibility.

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4.9 Budget Risk

• (a)  Enact a Fiscal Responsibility Act.
• (b)  Put limits on debt outstanding and annual
  borrowing as a percentage of GNP or GDP
• (c ) Use government guarantees and other
  contingent liabilities (such as insurance and
  pensions etc,) judiciously and sparingly.
• (d) Fix limits on contingent liabilities
• (e) Fix targets on fiscal deficit, primary
  deficit
• (f) Fix limits on short term borrowing
• (g) Monitor debt service payments

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4.10 Operational Risk

• (a)      Have stable and sound macro-economic
  policies
• (b)      Have co-ordination among monetary and
  fiscal authorities
• (c)      Allow independence and transparency
  of different offices (such as front, back, middle
  and head offices) dealing with public debt
• (d)      Strengthen capability of different
  offices
•  

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5.1 Solvency Ratio

• (a) Interest service ratio interest payments /
  XGS ratio
• (b)   External debt / GDP ratio
• (c)  External debt / exports ratio
• (d)  External debt / revenue ratio
• (e)  PV of debt services/ GDP ratio
• (f)   PV of debt services / XGS ratio
• (g) PV of debt services / revenue ratio

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5.2 Liquidity monitoring ratio

• (a)  Basic debt service ratio- Ratio of debt
  services on long term debt to XGS ratio
• (b)   Cash-flow ratio for total debt or the total
  debt service ratio (i.e. total debt services to
  XGS ratio
• (c) Interest payments to reserves ratio.
• (d) Ratio of short-term debt to exports of
  goods and services
• (e) Import cover ratio- Ratio of total imports
  to total foreign exchange reserves.
• (f)  Reserves to short-term debt ratio
• (g) Short-term debt to total debt ratio

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5.3 Debt Burden Ratio

• (a) Total external debt to GDP (GNP) ratio
• (b)    Total external debt to XGS ratio
• (c)    Debt services to GDP (GNP) ratio
• (d)     Total public debt to revenue ratio
• (e) Ratio of concessional debt to total debt

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5.4 Debt structure indicators

• (a)    Rollover ratio- ratio of amortization
  (i.e. repayments of principal) to total
  disbursements
• (b)   Ratio of interest payments to total debt
  services
• (c)   Ratio of short-term debt to total debt

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5.5 Public sector indicators

• (a)  Public sector debt to total external debt
• (b)  Public sector debt services to exports
  ratio
• (c)   Public sector debt to GDP ratio
• (d) Public sector debt to revenue ratio
• (e)    Average maturity of non-concessional
  debt
• (f)    Foreign currency debt over total debt

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5.6 Financial sector indicators

• (a)              Open foreign exchange position-
  Foreign currency assets minus liabilities plus
  long term position in foreign currency stemming
  from off-balance sheet transactions
• (b)   Foreign currency maturity mismatch
• (c)   Ratio of foreign currency loans for real
  estate to total debt
• (d)   External sector related contingent
  liabilities
• (e)  Trends of share market prices
• (f)    GDRs and Foreign cur conv bonds issued
• (g)    Inflows of FDI and portfolio investment

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5.7 corporate sector indicators

• (a)   Leverage (debt/ equity ratio)- Normal
  value of debt over equity
• (b)  Interest to cash flow ratio
• (c)  Short-term debt to total debt
• (d)  Return on assets
• (e)  Exports to total output ratio
• (f)   Net foreign currency cash flow
• (g) Net foreign currency debt over equity

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5.8 Dynamic ratios

• (a) Average interest rate/ growth rate of
  exports
• (b) Average interest rate/ growth rate of GDP
• (c) Average interest rate/ growth rate of
  revenue
• (d)  Change of PV of debt service/ change of
  exports
• (e)   Change of PV of debt service/ change of
  GDP
• (f) Change of PV of debt service/ change of
  revenue

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5.9 Standard Stress Tests in the DSA

• Real GDP growth baseline 1 SD
• Export value growth baseline 1 SD
• GDP deflator baseline 1 SD
• Net non-debt creating flows baseline 1 SD
• Primary balance baseline 1 SD
• One-time major nominal or real depreciation
• Combinations (with ½ SD shocks, e.g.)

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5.10 Identifying Debt Distress Episodes

• Debt distress indicated by recourse to any of
  three forms of exceptional finance
• Arrears Years in which principal and interest
  arrears to all creditors is in excess of 5 of
  total debt outstanding
• Paris Club Relief Year of initial Paris Club
  agreement, plus two subsequent years
• Non-Concessional IMF Balance of Payments Support
  Years in which Standby Arrangement or Extended
  Fund Facility are in effect, commitments greater
  than 50 of quota. Normal times are
  non-overlapping periods of five years in which no
  indicators of debt distress are observed

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5.11 Determinants of Debt Distress

• Traditional Debt Indicators
• Present value of debt/exports, debt
  service/exports
• Debt service/current revenues, debt
  service/reserves
• Policy
• CPIA
• KKZ indices of institutional quality (single
  cross-section)
• Shocks
• Real GDP growth
• Real depreciations
• Income effect of changes in terms of trade

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5.12 Implications for Lending Strategies of
Multilateral Concessional Lenders

• Substantial value-added in looking at role of
  institutions/policies and shocks in addition to
  traditional debt burden indicators when assessing
  probability of debt distress
• Using a common debt-burden threshold to assess
  sustainability for all countries is unlikely to
  be appropriate strong tradeoffs between quality
  of institutions/policies and sustainable level of
  debt

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5.13 Indicative Policy-Dependent Debt and
Debt-Service Thresholds ()
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5.14 Debt Distress Classification

• Low riskall indicators well below thresholds
• Moderate riskbaseline ok, but scenarios/shocks
  near thresholds
• High riskbaseline in breach over projection
  period
• In debt distresscurrent breach that is
  sustained/significant

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• Have a Good Day