Chapter 4 : External Debt

External debt refers to entire foreign currency liability of a country covering government, companies, individuals which is payable in hard currency and thus there is relevance of external debt for economies with weak currency.

Internal debt on the other hand refers to rupee obligation of central government on the borrowings done for making the deficit which is cumulative over past several decades.

Both internal and external debt together constitute public debt or sovereign debt or debt liability of government both in foreign currency and home currency.

External debt + Internal debt = Public debt / Sovereign debt

Another common division of government debt is by duration until repayment is due.

• Short term debt is generally considered to be for one year or less, long term is for more than ten years. Medium term debt falls between these two boundaries.

There are international benchmark for assessing criticality of external debt:-

1. External debt/ GDP : 25-30 % (Should not be grater than 33%)
2. Foreign exchange /external debt > 50%
3. Debt Service ratio = total debt liability/current receipt in BOP : should not be greater than 25%
4. A smaller reserves to short-term debt ratio is associated with a greater incidence and depth of crises.

External debt and reserves affect a country’s external vulnerability through their impact on the country’s ability to discharge external obligations. Inability to discharge obligations may result either from a solvency or a liquidity problem.

Solvency can be defined as the country’s ability to meet the present value of its external obligations. A perceived lack of solvency leads inevitably to an external crisis, as foreign creditors withdraw and domestic residents seek refuge abroad for their assets.

While a solvency problem almost always leads to a liquidity problem, as capital flees the country, it is also possible for a liquidity problem to arise when countries appear to be solvent. Although a (technically) solvent country typically can service its foreign debt under normal circumstances, it can suffer a “run” on its liquidity as uncoordinated creditors rush for the exit.

Post 1991 BoP crisis, India’s prudent external debt policies and management with a focus on sustainability, solvency, and liquidity have helped contain the increase in size of external debt to a moderate level and it is compositionally better with a longer term maturity profile.

EXTERNAL DEBT OF INDIA

 India’s total external debt stock at end-March 2014 stood at US$ 442.3 billion, recording an increase of US$ 32.8 billion (8.0 per cent) over the end-March 2013 level.

• The rise in total external debt during the period was due to long-term debt, particularly NRI deposits.
• A sharp increase in NRI deposits owed to fresh foreign currency non-resident account (banks) [FCNR(B)] deposits mobilized under the swap scheme during September to November 2013 to tide over the external financing needs.
• Long-term external debt  recorded an increase of 12.9 per cent  while short-term debt showed a decline of 7.7 per cent.
• The rise in external debt was on account of higher long-term debt, particularly commercial borrowings and NRI deposits. The maturity profile of India’s external debt indicates the dominance of long-term borrowings.
• long-term debt accounted for 81.1 % of the total external debt
• short-term debt accounted for 18.9 % total external debt 

The currency composition of India’s total external debt

• US dollar= 60.1 %
• Indian rupee = 24.2%
• special drawing rights (SDR) =6.5%
• Japanese yen =4.5 %
• euro =3.0 %

The currency composition of government (sovereign) debt indicates predominance of SDR-denominated debt (33.5 per cent), which is attributable to borrowing from the International Development Association (IDA), i.e. the soft loan window of the World Bank under the multilateral agencies, and SDR allocations by the International Monetary Fund (IMF).

Out of total external debt

• Government (sovereign) external debt accounted for 19.4 % 
• Non-government external debt amounted  80.6 %

Over the years, India’s external debt stock has witnessed structural change in terms of composition.( All data of end- September 2014)

• The proportion of concessional in total debt 9.8 % .
• The dominance of non- government debt in total external debt stood at 80.6 %
• India’s foreign exchange reserves provided a cover of 68.9 % to the total external debt stock .
• The ratio of short-term external debt to foreign exchange reserves was 27.5 %
• The ratio of concessional debt to total external debt declined steadily and stood at 9.8 %
• India’s external debt has remained within manageable limits as indicated by the external debt to GDP ratio of 23.5 per cent and debt service ratio of 5.9 per cent in 2013-14.

The prudent external debt management policy of the Government of India has helped in containing rise in external debt and maintaining a comfortable external debt position. The policy continues to focus on monitoring long- and short-term debt, raising sovereign loans on concessional terms with longer maturities, regulating ECBs through end-use, all-in-cost, and maturity restrictions; and rationalizing interest rates on NRI deposits.

International Comparison

Cross-country comparison of external debt based on the World Bank’s International Debt Statistics 2015, which contains the external debt data for the year 2013, indicates that India continues to be among the less vulnerable countries. India’s key debt indicators compare well with other indebted developing countries.

• The ratio of India’s external debt stock to gross national income at 23.0 per cent was the sixth lowest.
• In terms of the cover provided by foreign exchange reserves to external debt, India’s position was sixth highest at 64.7 per cent 

What is FCNR Account?

FCNR Account stands for Foreign Currency Non Resident Bank Account wherein a Non-Resident Individual of Indian Nationality or Indian Origin can maintain a Fixed Deposit in Foreign Currency and earn regular interest on the same. The following foreign currencies are permissible:-

1. US Dollar
2. British Pound
3. Japanese Yen
4. Australian Dollar
5. Canadian Dollar

As the NRI can maintain his account in the foreign currency, the risk for fluctuations in Currency Conversion is eliminated and the investor can earn a fixed rate of interest on his FCNR deposits which is usually more than the country in which the NRI is residing.

Features of FCNR Account

1. FCNR Account can be opened only by NRI’s or by Person of Indian Origin (PIO)
2. FCNR Account can be opened only in the Foreign Currencies specified above and thus the currency fluctuation risk is eliminated.
3. Regular interest is paid on the FCNR Account.
4. Deposits with a maturity of more than 1 year and less than 5 years can only be opened.
5. FCNR account can be opened jointly with other NRI’s as well as with Resident Indians.
6. Nomination Facility is available and any NRI/PIO/Indian Resident can be made a nominee.
7. Conversion to another designated currency is permitted at a cost to the account holder.
8. Recurring Deposits are not accepted under this scheme
9. Loan Facility against FCNR Account can also be availed of. However, the Loans cannot be used for the purpose of re-lending, carrying on agricultural/plantation activities or for investment in Real Estate Business.

A major advantage of FCNR Account is that the Interest earned on these deposits is not taxable in India and nor is the principal deposited in these accounts taxable under the Wealth Tax.