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Business Commentary/ Bibek Debroy

Despite good macro indicators, perverse expectations can trigger a BoP crisis

Does India have an external debt problem? Difficult question to answer. The ministry of finance brings out a status report on external debt and the next such status report is due in February, more or less at the time when the Economic Survey is published.

The latest figures we have are from the Reserve Bank of India's Report on Currency and Finance, 1997-98 and they state the following for end-March 1998. (The forthcoming status report will probably have figures till September 1998.)

The debt stock is $ 94.4 billion. This is an increase of $ 1 billion over end-March 1997. Debt stock would have increased by $ 3 billion and not $ 1 billion had it not been for the appreciation of the US dollar. This valuation gains result from the phenomenon of converting debt contracted in 23 different currencies into the common numeraire of the dollar.

Global Development Finance 1998 data show that India is the eighth most indebted country in the world today, measured in terms of external debt stock. This is an improvement over the sixth rank in 1997.

The share of concessional debt in total debt stock is 39.2 per cent, down from 42.3 per cent a year ago.

The share of short-term debt in total debt stock, defined as trade credits of between six months to one year and non-resident deposits of up to one year, declined to 5.3 per cent from 7.2 per cent a year ago.

Consider solvency indicators. The debt to gross domestic product ratio is 26.4 per cent, the debt service ratio (defined as debt service of principal payments plus interest as a ratio of current receipts less official transfers) is 19.5 per cent, the interest service ratio is 7.8 per cent and the debt to export ratio is 174.7 per cent. These are well below danger marks and India is a moderately indebted country, not a severely or heavily indebted one.

A solvent country can run into liquidity problems. So consider liquidity indicators. The short-term debt to foreign exchange reserves ratio is 17.2 per cent, the short-term debt to total debt ratio (as mentioned earlier) is 5.3 per cent and the short-term debt in terms of residual maturity (not original maturity) to foreign currency assets (not reserves) ratio is 26.7 per cent.

This substantiates the point that there is no serious debt problem. The issue of external debt management assumes significance in the broader context of managing the Balance of Payments. Successive government documents have advanced the following arguments about why the BoP is unlikely to be under pressure.

The face value of external debt stock is an inadequate indicator of an economy's debt burden. For example, debt may have been contracted on concessional terms at interest rates below market rates. Therefore, one should work out the net present value of debt by discounting the sum of future debt service obligations at market interest rates.

This will reflect the degree of concessionality. If one does this for India, the net present value of debt will be less than four-fifths of the nominal value of debt.

Solvency and liquidity indicators have improved since 1991-92. Increase in government borrowings from multilateral and bilateral creditors, as well as debt to the International Monetary Fund, has slowed down.

Often, apparent increases in debt stock take place because of exchange rate variations or valuation changes. Short-term debt can be volatile and since the BoP crisis of 1990-91, short-term debt as a share of total debt has successfully been brought down.

There is a prudent policy of controlling external commercial borrowings through an annual cap and even in 1998-99, Resurgent India Bonds or the RIBs will not add much to debt because they have substituted for ECBs. The current account deficit as a percentage of GDP has been brought down from the high of 3.2 per cent in 1990-91. It has not exceeded 1.5 per cent of the GDP and in response to policy changes, exports and remittances have both increased.

The coverage ratio of imports by exports has thus improved. To finance the current account deficit, the composition of the capital account surplus has changed from debt creating inflows to non-debt creating inflows, such as the emphasis on foreign direct investments and FDI inflows have gone up.

Foreign exchange reserves have gone up since January 1991 and provide enough import cover. They are more than adequate, if one uses any of the four criteria used by the Tarapore Committee on capital account convertibility to judge the adequacy of foreign exchange reserves.

On the face of it, these arguments are unassailable. There has been some additional interest in debt management because of the east Asian currency crisis.

The currency crisis has been interpreted in at least three ways in India. First, in its limited BoP sense, is a BoP kind of crisis likely to be replicated in India?

Second, there has been competitive devaluation and import contraction in east Asia. What implication does this have for India's exports?

Third, are there any lessons for financial sector reform, perhaps as a prerequisite to liberalising the capital account? So far as the first of these questions is concerned, the above arguments advanced in various "government" type documents are indeed correct.

In its limited BoP sense, an east Asian type currency crisis is unlikely to be replicated in India. However, the currency crisis was also about expectations. In 1996, the macro indicators for most east Asian countries (Thailand, Indonesia, Malaysia, the Philippines and South Korea) were fine.

With the exception of Indonesia, not a single one of these countries had debt service ratios that could be regarded as danger signals. Even in Indonesia, somewhat arguably, the debt service ratio had been brought down from 1989 to 1996. In post-facto rationalisations of the crisis, arguments have been advanced about high current account deficits as a percentage of GDP.

But is there any evidence that a high current account deficit per se is a danger signal? Doesn't the answer have something to do with how the current account deficit is being financed, the nature of the capital account surplus? And doesn't the answer also have something to do with what the current account deficit is being used for, financing investment as opposed to consumption, as in Mexico?

Besides, Thailand and Malaysia were the only two countries where current account deficits were on the high side. And even for these countries, high current account deficits had not propelled them into crises, such as for Thailand in 1990 or Malaysia in 1991. Admittedly, short-term debt was high, but even there, a question mark exists for Malaysia.

The point I am making is a simple one. Even if macro indicators are fine, perverse expectations can trigger a BoP crisis. Consider the Indian BoP. The export growth rate is slowing down, imports (non-oil) are increasing, higher non-factor services are neutralised by lower private transfers and there is a slackening of both FDI and portfolio flows.

Without going into precise figures, this suggests a current account deficit to GDP ratio of around 2.5 per cent in 1998-99, a far cry from the 1.5 per cent. This is dangerously close to 1990-91 levels and extrapolated to 1999-2000, if there isn't a reversal, could very well approach 3 per cent.

Plug in unrealistic exchange rate management and perverse expectations and one is bang in the middle of another BoP crisis, with the reversal of non-resident Indian deposits.

I am not suggesting that this will necessarily happen, as $ 30 billion worth of reserves will take some time to run down. But I am much more concerned about the BoP than standard debt indicators would tend to suggest.

Bibek Debroy

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