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Introduction to External Debt Management
EXTERNAL
DEBT

(or foreign debt) is that part of the total debt in a country that is

owed to creditors outside the country. The debtors can be the government, corporations or private households. The debt includes money owed to private commercial banks, other governments, or international financial institutions such as the IMF and World Bank.

D EFINITION
IMF defines it as "Gross external debt, at any given time, is the outstanding amount of those actual current, and not contingent, liabilities that require payment(s) of principal and/or interest by the debtor at some point(s) in the future and that are owed to nonresidents by residents of an economy."

In this definition, IMF defines the key elements as follows:

(a) Outstanding and Actual Current Liabilities: For this purpose, the decisive consideration is whether a creditor owns a claim on the debtor. Here debt liabilities include arrears of both principal and interest.

(b) Principal and Interest: When this cost is paid periodically, as commonly occurs, it is known as an interest payment. All other payments of economic value by the debtor to the creditor that reduce the principal amount outstanding are known as principal payments. However, the definition of external debt does not distinguish between whether the payments that are required are principal or interest, or both. Also, the definition does not specify that the timing of the future payments of principal and/or interest need be known for a liability to be classified as debt.

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(c) Residence: To qualify as external debt, the debt liabilities must be owed by a resident to a nonresident. Residence is determined by where the debtor and creditor have their centers of economic interest - typically, where they are ordinarily located and not by their nationality. d) Current and Not Contingent: Contingent liabilities are not included in the definition of external debt. These are defined as arrangements under which one or more conditions must be fulfilled before a financial transaction takes place. However, from the viewpoint of understanding vulnerability, there is analytical interest in the potential impact of contingent liabilities on an economy and on particular institutional sectors, such as government.

Generally external debt is classified into four heads i.e. (1) public and publicly guaranteed debt, (2) private non-guaranteed credits, (3) central bank deposits, and (4) loans due to the IMF. However the exact treatment varies from country to country. For example, while Egypt maintains this four head classification, in India it is classified in seven heads i.e. (a) multilateral, (b) bilateral, (c) IMF loans, (d) Trade Credit, (e) Commercial Borrowings, (f) NRI Deposits, and (g) Rupee Debt.

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IMPORTANT ASPECTS RELATED TO EXTERNAL DEBT MANAGEMENT
F INANCING T ECHNIQUES

Countries have a limited ability to support external borrowing. At the same time, the supply of finance is also limited. Consequently, borrowers must choose the best combination from the available sources of external finance to suit the needs of individual projects-and of the economy as a whole. The country wishes to minimize the problems in servicing new debt, while making maximum use of grants and foreign loans on concessional terms. These are clearly the cheapest from of financing, but their availability is generally restricted to the poorest developing countries; and even for those countries, they are inadequate to meet needs. A maximum leverage can be obtained from concessional financing by combining it with other types of financing. Other sources of credits are export financing and loans from international commercial banks. Authorities should ensure that credits from financial markets are part of a package that provides the best possible external financing mix for the economy, as well for an individual project. For projects the best mix could mean one with: (1) maximum concessional loans or maximum market finance (2) the maximum capital that can be rolled over easily, or (3) the minimum debt service due in the years before returns materialize. Authorities must also ensure that the aggregate financing package meets national financing priorities, This involves an assessment of such aspects as: the sources of finance ,including the amounts that can be borrowed and the prospects for future supply; the currency composition of foreign borrowing that would minimize exposure to exchange rate fluctuations; the exposure to interest rate fluctuations over the life of the loan; and the impact of new borrowing on the structure of debt service obligations.

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H OW

MUCH TO

B ORROW

The amount that any country ought to borrow is governed by two factors: how much foreign capital the economy can absorb efficiently, and how much debt it can service without risking external payment problems. Each factor will depend on the quality of economic management. Borrowings can be on different terms and in different currencies, which complicates the policy decision. There may be uncertainty too about evolving debt-servicing capacity. Interaction between debt servicing capacities, the type of finance, and the borrowing decision increases in complexity as the number of loans increases.

M ANAGING R ISK

Countries are sometimes exposed to BOP shocks arising from unfavorable changes in the relative prices of exports and imports, suppose that a country’s exports earnings are in dollars and its foreign debts are repayable in yen deterioration in the exchange rate of the dollar vis-a-vis the yen will add to the debt servicing obligation of the borrowing country. Fluctuations in commodity prices, foreign exchange rates and world interest rates are largely beyond the control of countries. It is possible to hedge against this risk. Managing risk is an important part of public debt management.

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K NOWING T HE D EBT

Information on external debt and debt service payments is essential for the day-to-day management of foreign exchange transactions as well as managing debt and for planning foreign borrowing strategies, At the most detailed level, the information enables central authorities to ensure that individual creditors are paid promptly; at more aggregated levels; debt data are needed for assessing current foreign exchange needs, projecting future debt service obligations, evaluating the consequences of further future borrowing and the management of external risk The component of external debt statistics include details of each loan contract and its schedule of future service payments, figures on loan utilization, and the payments of debt service obligations. From these data elements summary figure on foreign borrowing, outstanding debt, and projected debt are assembled. The resulting statistics provide inputs for budget and BOP projections.

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EXTERNAL DEBT AND MACROECONOMIC CONSIDERATIONS
How foreign borrowing affects macroeconomic stability can be best understood in the context of production, consumption, savings, and investment. In a closed economy (no foreign trade), production comprises goods and services for personal consumption (consumer goods), capital goods (buildings, plant and equipment, inventories used by enterprises), and goods and services used by the government, which can be both for consumption (for current use) and for investment. Where there is foreign trade, production also includes goods for export; imports are a supplement to domestic consumption, for investment, for government use or for exports.

There is a relationship between production and income. Put simply production creates incomes equal to the value of output. The government in taxes takes some income; some is taxed; some is saved by the private sector; the balance is spent on consumption. Foreign borrowing is the excess of imports of goods and services over exports and net borrowing creates debt, which can be repaid if exports exceed imports. In the absence of foreign borrowing (exports and imports are equal), private sector investment plus government spending is limited by the level of private sector savings and taxation.

Economic growth, of course, could be accelerated with foreign borrowing, permitting imports to exceed exports and at the same time, investment plus government expenditures to exceed savings plus taxes. There are standard indicators for measuring the burden of external debt: the ratios of the stock of debt to exports and to gross national product, and the ratios of debt service to exports and to government revenue. Although there is widespread acceptance of these ratios as measures of creditworthiness, there are no firm critical levels, which, if exceeded, constitute a danger for the indebted country.
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However, the World Bank Staff has proposed a set of parameters, which it uses to demarcate “moderately” and “severely” indebted countries. Countries with a rapid export growth can support higher debt relative to exports and output. Heavily indebted, however, are vulnerable to severe macroeconomics shocks-sharply higher interest rates in the lending countries, for instance, or simply lenders cutting back on their commitments. Faced with these pressures, countries must then adjust by cutting private investment, decreasing government expenditures and or increasing government revenues. After this lets have a look at external debt sustainability in detail in Chapter 2.

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External Debt Sustainability
Sustainable debt is the level of debt which allows a debtor country to meet its current and future debt service obligations in full, without recourse to further debt relief or rescheduling, avoiding accumulation of arrears, while allowing an acceptable level of economic growth. (UNCTAD/UNDP, 1996)

External-debt-sustainability analysis is generally conducted in the context of mediumterm scenarios. These scenarios are numerical evaluations that take account of expectations of the behavior of economic variables and other factors to determine the conditions under which debt and other indicators would stabilize at reasonable levels, the major risks to the economy, and the need and scope for policy adjustment. In these analysis, macroeconomic uncertainties, such as the outlook for the current account, and policy uncertainties, such as for fiscal policy, tend to dominate the medium-term outlook.

World Bank and IMF hold that “a country can be said to achieve external debt sustainability if it can meet its current and future external debt service obligations in full, without recourse to debt rescheduling or the accumulation of arrears and without compromising growth.” According to these two institutions, external debt sustainability can be obtained by a country “by bringing the net present value (NPV) of external public debt down to about 150 percent of a country’s exports or 250 percent of a country’s revenues.”

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I NDICATORS

OF

E XTERNAL D EBT S USTAINABILITY

There are various indicators for determining a sustainable level of external debt. While each has its own advantage and peculiarity to deal with particular situations, there is no unanimous opinion amongst economists as to one sole indicator. These indicators are primarily in the nature of ratios i.e. comparison between two heads and the relation thereon and thus facilitate the policy makers in their external debt management exercise.

These indicators can be thought of as measures of the country’s “solvency” in that they consider the stock of debt at certain time in relation to the country’s ability to generate resources to repay the outstanding balance.

Examples of debt burden indicators include the (a) debt to GDP ratio, (b) foreign debt to exports ratio, (c) government debt to current fiscal revenue ratio etc. This set of indicators also covers the structure of the outstanding debt including the (d) share of foreign debt, (e) short-term debt, and (f) concessional debt in the total debt stock.

A second set of indicators focuses on the short-term liquidity requirements of the country with respect to its debt service obligations. These indicators are not only useful early-warning signs of debt service problems, but also highlight the impact of the inter-temporal trade-offs arising from past borrowing decisions. The final indicators are more forward looking as they point out how the debt burden will evolve over time, given the current stock of data and average interest rate. The dynamic ratios show how the debt burden ratios would change in the absence of repayments or new disbursements, indicating the stability of the debt burden. An example of a

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dynamic ratio is the ratio of the average interest rate on outstanding debt to the growth rate of nominal GDP. These were certain aspects of external debt in the next chapter we will see how the external debt was managed by various countries of the world at the time of economic crisis.

Debt Management Strategy - A Global Overview
The design of an adequate strategy for public debt management should include proper consideration of a number of questions. Among them, several come to mind: (a) how much public debt should be issued in domestic markets and how much in foreign capital markets? (b) What should be the currency denomination of new public debt issues? (c) What is the optimal maturity structure of public debt? (d) Should governments consider redeeming in advance some issues and refinance them on different terms? (e) Should public debt be issued at fixed or variable rates and (f) should public debt issues be directed to a particular segment of the market (financial institutions, other institutional investors, corporate sector, etc).Most of these choices entail a trade-off between the level and the variance of debt costs and are highly dependent on both the domestic macroeconomic context and conditions in international markets. Nonetheless, the debt management strategy has important implications for the economy as a whole. Good liability management should result in lower borrowing costs and unobstructed access to international capital markets, while minimizing any crowding-out effects on private sector borrowing. The choice of the specific characteristics of the debt portfolio involves difficult decisions. While on a pure costbased analysis it is tempting to choose short-term over long-term debt, the latter might Brady bond spreads for different emerging market economies have behaved similarly, though at different levels, in the midst of financial crises or increased uncertainty. Thus, the liquidity of emerging markets’ securities and the collective behavior of institutional investors make the financial authorities’ tasks more difficult, particularly since systemic risk may rise swiftly. Over the past decade, capital mobility has
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increased many times over and its main features have also changed, especially those related to the allocation between foreign investment and traditional lending. Mexico, as a recipient economy, has witnessed those events. Total capital inflows to Mexico grew from a yearly average of US$ 2 billion in 1987– 88 to $36 billion in 1993. The 1994 crisis caused an important reduction of these flows, to $23 billion in 1995. For 1996–97 capital inflows were on average $10 billion per year.. That is, foreign investment more than compensated for the decline in indebtedness. For 1998–99 capital inflows are estimated to have averaged $16 billion per year. Foreign direct investment grew from $4 billion in 1993 to $11 billion in 1994 and has kept a stable level of around $10 billion per year since then. On the other hand, portfolio investment has shown more erratic behavior. Having reached a peak of $29 billion in 1993, it turned negative in 1995 (–$10 billion) and for 1996–99 has averaged under $1 billion per year. The important reduction in the flows of foreign portfolio investment to Mexico since the crisis of 1994–95 is primarily explained by the adoption of a floating exchange rate regime. This regime has proved to be extremely helpful in inhibiting short-term foreign investments by reducing their expected return, once adjustment is made for exchange rate risk. Without the implicit guarantee to portfolio investment provided by the semifixed exchange rate regime, foreign direct investment started to play a more dominant role in financing Mexico’s current account deficit blurred. The Exchange Stabilization Fund prevented the liquidity crisis from turning into a solvency crisis, whose repercussions would have been far more devastating. Prior to 1994, both debtors and the banking system in general were in a fragile situation. Past due loans had increased substantially, and the lack of proper provisioning started to erode banks’ capital. In addition, some commercial banks faced severe problems that were not revealed in their financial statements, and, in some instances, banks disregarded existing regulations and proper banking practices (Mancera (1997)). In this environment, the effect of the currency depreciation, rising inflation and higher interest rates on the
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credit service burden seriously jeopardized the Mexican financial system. At that time, the materialization of systemic risk and its impact on the economy were major concerns. Faced with this situation, the government and the central bank implemented a comprehensive programme to deal with the banking sector crisis, without derailing monetary policy from its main task of procuring the reduction of inflation. The successful mix of policies ensured the consistency of Mexico’s macroeconomic framework and allowed the economy to recover and rapidly return to international markets. An important element of the overall strategy was to provide liquidity to commercial banks to comply with their external obligations. To this end, a dollar facility was made available to them by the central bank. Thus, Banco de México played the role of lender of last resort for commercial banks at a time of distress, making foreign exchange available to banks through a specially designed credit window. These dollar-denominated loans were channeled through the Fund for the Protection of Savings (FOBAPROA).At the beginning of April 1995, the dollardenominated credits granted through FOBAPROA reached a maximum of US$ 3.8 billion. However, the high level of interest rates purposely charged on such credits induced a rapid amortization, as banks sought other sources of financing. By 6 September 1995, the 17 commercial banks that had participated in this scheme had already repaid their credits. In this sense, the programme achieved its stated purpose, namely that of providing temporary assistance. Once international markets were reopened to Mexican agents (July 1995), the main objectives for the immediate future included the refinancing of the Exchange Stabilization Fund in the market, have a smaller refunding risk and thus be preferable in the end. That is, a better schedule of amortizations lowers country risk and finance costs over the medium term, both for the government and for the private sector. Likewise, borrowing domestically may turn out to be more expensive than in external markets. Yet borrowing in domestic markets could trigger a rapid development of these markets and pave the way for a solid corporate domestic market in the future. In sum, a good liability management strategy is one that helps minimize the cost of borrowing
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over the medium and long term. The objective is certainly not to save the last basis point in each transaction, but rather to bring down the overall borrowing cost. Thus, a smooth debt amortization profile is crucial. There is no doubt that emerging economies have to work hard to ensure desirable characteristics in the debt profile, even if initially costly. At the end of 1994, Mexico faced a liquidity crisis accompanied by a very high refinancing risk.

This forced the country to seek support from the international community to confront the heavy short-term debt burden. Economic policy was oriented towards rapidly reestablishing macroeconomic stability. This was the only way to stop capital flight and gradually restore Mexico’s access to international financial markets. To deal with the scenario just described, a comprehensive package of policy measures was put together. The stabilization programme was built upon restrictive fiscal and monetary policies and was reinforced by the financial package (Exchange Stabilization Fund) assembled by the US financial authorities and multilateral organizations. The rescue package amounted to more than US$ 52 billion: $17.8 billion committed by the IMF, $20 billion by the United States government, $10 billion by the Bank for International Settlements, $3 billion by commercial banks and $1.5 billion by the Bank of Canada. It is worth mentioning, however, that in 1995 Mexico’s drawings amounted to only $24.9 billion. A solvent government might still face liquidity problems that limit its ability to service its debt. For instance, an overly pessimistic view about the future of the economy might lead lenders to curtail the amount of financing temporarily even if the country is in fact solvent. Eventually, liquidity problems might escalate, negatively affecting the government’s access to international capital markets. At the same time; the private pension fund system has continued to grow, making long-term resources more widely available. Today, Mexico’s foreign debt amortization schedule is light and well distributed over time. The overall debt burden, including domestic and external debt, diminished from levels above 450/0 of GDP in 1990 to approximately 280/0 in 1998. This trend is thought to have continued in 1999.The country’s solvency and liquidity indicators compare favorably to those of other countries: external debt as a share of GDP amounted to 170/0 in early 1999,
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while the ratio of total exports to external debt was 1.7. An example of Mexico’s strategy to ensure external financing when conditions in international capital markets turn adverse is the credit line secured with international financial institutions in November 1997. After having a look at the global scenario of external debt lets understand the debt management in India .

External Debt Development and Management
SOME REFLECTIONS ON INDIA INTRODUCTION
In 1990-91 when India got into a severe foreign exchange crisis her outstanding level of external debt was $ 83. 8 billion. The level of debt was about 40 per cent of Gross Domestic Product and the debt service payment was about 30 per cent of exports of goods and services. Several destabilizing forces acting on the Indian foreign exchange markets were a downgrade of India’s sovereign credit ratings to non-investment grade, reversal of capital flows, exacerbated the foreign exchange crisis and withdrawal of the foreign currency deposits held by non-resident Indians. One can best describe the severity of the situation by quoting from the then Finance Minister of India Dr Manmohan Singh’s Budget 1992-93 speech to the Parliament:

"When the new Government assumed office (June 1991) we inherited an economy on the verge of collapse. Inflation was accelerating rapidly. The balance of payments was in serious trouble. The foreign exchange reserves were barely enough for two weeks of imports. Foreign commercial banks had stopped lending to India. Nonresident Indians were withdrawing their deposits. Shortages of foreign exchange had forced a massive import squeeze, which had halted the rapid industrial growth of earlier years and had produced negative growth rates from May 1991 onwards".
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With this background a study on India’s external debt would obviously raise certain questions such as: how did India manage historically with a very low volume of external capital inflows; how is that the third world debt crisis of early 80s had a little impact; how is it then that India got into a massive foreign exchange crisis in 1990-91; how was India spared from the contagious currency crisis of 1997; and how did India managed to improve her rank from what was third debtor after Brazil and Mexico in 1991 to eighth in 2002 in the list of the top fifteen debtor countries(as per the Global Development Finance report 2004 published by the World Bank). Still more notable is the fact that India never defaulted to international lenders in her entire credit history (except one or two instances of corporate rescheduling).

Although the level of debt has increased to $ 112.1 billion by end-December 2003, the magnitude of debt is no longer an issue at present. The economic reforms and debt management policies pursued since 1991 have helped to bring down the share of external debt in GDP to 20.2 per cent and the debt service ratio to 15.8 percent by end-December 2003. The reforms involving trade and capital account liberalization have changed the nature and composition of capital flows into Indian economy. The gradual opening of the capital account and improved credit standing internationally, supported by the prudent macroeconomic policies, have established investors’ confidence.

The above scenario although presupposes several accomplishments underlying the country’s external debt management history, the Indian economy nevertheless displayed several episodes of imbalances in her debt, capital flows and external sector. India’s external debt management in the light of the development in her overall macroeconomic policies and draws lessons for countries in the region. It needs to be mentioned here that the trends in debt need to be reviewed along with the developments in external sector and capital flows, because the overall trade regime, involving trade restrictions, export subsidisation and exchange controls would govern to a large extent the behaviour of external debt.
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B URDEN

OF

E XTERNAL D EBT IN INDIA

It is a source of some comfort that India's external debt continues to be at a stable level. According to the status paper prepared by the Union Finance Ministry, the stock of foreign debt stood at $98.4 billion at the end of December 2001. After a substantial increase of $16 billion between 1991 and 1995, partly on account of fresh loans and partly on account of exchange rate movements, the total debt has fluctuated between $93 billion and $99 billion since 1995. Going by a number of indicators, India's external debt situation is far better today than it was during the balance of payments (Bop) crisis of 1991. While the absolute size of foreign debt is important, more relevant is the weight this debt imposes on the economy. And, on that count, the burden has become lighter and lighter, even as the stock of outstanding has remained more or less constant. Annual repayments of loans and interest as a percentage of current receipts — the debt service ratio, which was as high as 35 per cent in 1990-91, has fallen to 13 per cent today. Debt as a percentage of the gross domestic product has nearly halved since the early 1990s. And the short-term debt to GDP ratio, which crossed 10 per cent in 1990-91 and precipitated the Bop crisis of that year, has been held under 3 per cent. Overall, India is now classified by the World Bank as a "less" indebted country, which is two rungs below the extreme category of "severely" indebted countries, which is where Brazil, Argentina and Indonesia now belong. In absolute terms as well, India's position has improved globally. In the mid-1990s, India was the third largest debtor in
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the world; today it is ranked ninth. All this has taken place in spite of the fact that new loans are increasingly being raised on commercial rather than concessional terms, as was the practice for decades.

CAUSES FOR INCREASE IN EXTERNAL DEBT
The important causes for the sharp increase in India’s external debt were the following:

Increase in Trade Deficit
The enormous increase in trade deficit has been a very important reason for the sharp increase in India’s external debt. the poor export performance of India has also been responsible for the large trade deficit. The impact of oil price hike has already been pointed out earlier.

Decline in the Net Invisibles
During the 1980s, there was a gradual decline in invisibles surplus. Invisibles surpluses had traditionally financed a large part of India’s deficit. There was a steep fall in this since the beginning of the eighties. Net invisibles financed nearly 73% of the trade deficit in 1980-81. During the sixth plan (1980-85), on an average it financed more than 60% of the trade deficit. By 1990-91 it dropped to 13%, compelling the nation to take increasing recourse to external source for meeting the payment obligation. This falling trend in the net invisibles had been caused by the adverse trends in invisible payments on the one hand and invisibles receipts on the other.
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Change in the Composition of the Debt
One important source of the BOP problem in the 1980s and afterwards is the change in the source of financing the large current account deficit. In the earlier period, i.e. until the beginning of the 1980s, almost the entire deficit was financed through inflows of concessional assistance, which kept the debt-service burden low. As against this, the eighties were marked by a reduction in flows of concessional assistance to India, particularly from the World Bank Group. The credits from the IDA on soft terms declined, while loans from the World Bank on market terms increased sharply. As a result, the average interest rate on India’s official debt increased from 2.4% in 1980 to 6.1% in 1982. The debt service payments on multilateral loans tripled from $371 million in 1984 to $1106 million in 1989. Further, the average maturity of loans declined from 40.8 years in 1980 to 24.4 years in 1989. Between 1980 and 1989, the debt to private creditors, including commercial banks and non-residents increased almost ten-fold, from $2.3 billion to $22.8 billion. The debt service as a percentage of export earnings nearly tripled during this period, from 9.1% to 26.3%.

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E XTERNAL D EBT M ANAGEMENT P OLICY
India’s Debt-GDP ratio which shows the magnitude of external debt to domestic output had declined from 38.7 % at the end of March 1992 to 22.3% at end March 2001.Similarly the debt service ratio that measures the ability to serve debt obligations has declined from 35.3% of current receipts in 1990-91 to 16.3% in 2000-01. This improvement in external debt should be attributed both to a cautious policy on foreign borrowings (which includes annual caps on commercial loans which would not have been possible if the rupee was fully convertible) and to the steady growth in current receipts in the BOP. There are, however, enough areas of concern, which should prevent complacency and persuade the Government to go slow on capital account convertibility. The first is that while the short-term debt to GDP ratio was only 2.8 per cent at the end of 2001, the more accurate measure of immediate repayments— total debt of a residual maturity of one year — was 9 per cent of GDP in December 2001. This is still not a very heavy burden, but it is not something to be taken lightly.

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The second concern should be that the estimate of debt servicing in the years ahead (based on past borrowings) shows that there are going to be two major humps round the corner. In 2003-04 and 2005-06, repayments of the expensive Resurgent India Bonds and India Millennium Deposits fall due. Debt service in both years will then cross $12 billion. This will be the largest since 1995-96, though the Government hopes that not all the repayments will be repatriated. The third concern should be the impact of the Government's decision to make even the existing non-repatriable bank deposits by non-resident Indians fully payable in foreign exchange. As a consequence, two such schemes were discontinued last April and outstandings transferred to repatriable accounts where they will be held till maturity. The stock of deposits in one of these schemes was itself over $7 billion. This means that if these deposits are taken out of the country when they mature they will add to India's debt service burden. And if they are renewed they will add substantially to India's external debt burden. Either way, the Government's decision is going to have a negative impact on the Bop.

Problems of External Debt Management In India

Borrowing costs are not limited to interest costs. First, there is the dependency syndrome, which leads to the development of constituencies at the various levels of government to keep the borrowing momentum in full swing, actively supported by the multilateral development agencies. Second, there is an element of uncertainty in regard to whether the loans will be available when most needed, with the uncertainty increasing in the event of any demonstration of national self-reliance in area unacceptable to the stockholders of the lending agencies. Third, neither the civil servants negotiating the loans nor their political bosses have a direct responsibility for loan repayment, with the result that there is bound to be a relatively high degree of laxity in ensuring the best and most productive use of the borrowed funds. Fourth, there is hardly any evidence to indicate that countries with heavy indebtedness really can ever develop to such an extent that they will be free from such indebtedness.

E XTERNAL D EBT D EVELOPMENT U NTIL 1970’ S
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Looking at historically one observes that external capital played a very insignificant role in India’s development process. The industrialisation strategy adopted since the 1950s emulated an import substituting trade regime, with both imports and exports being strictly regulated through quota and duties. The level of current account deficit was as low as 1.2 per cent in 1970, matching the availability of external finance, most of which were contracted from the official creditors and at concessional interest rates. Private commercial borrowings from the international capital markets were nil. The total external debt outstanding at $ 8.4 billion was just about 13.3 per cent of GDP for the year 1970.

India responded very well to the first oil shock of 1973, with prudent macroeconomic management. The deflationary stance of macroeconomic policies coupled with massive inflows of inward remittances from Gulf led to even a surplus on current account in 1976-77, which helped to build up the reserve level. Imports were virtually restricted to the level of exports, and thus the entire inflows of worker's remittances and net aid inflows (after adjusting the gross flows for debt service) were ploughed back to build up the reserves.

It was no surprise, therefore, to find that during this period gross aid inflows were sharply reduced by the donors, as these were only going to swell further the reserves. By 1978-79, the reserve level reached about 9 months of import requirements. There was strong opinion in some quarters as to whether India could take advantage of this comfortable foreign exchange situation to relax the severity of the import control regime. To some extent imports were liberalised in 1976-77 and 1977-78 through the introduction of Open General License (OGL), but the persistence of almost total protection of the Indian industrial sector prevented any significant loosening of import.
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The second oil shock had a major impact on India’s balance of payments, however, with the prices of POL more than doubling during the course of 1979. The oil imports accounted for almost 58 percent of total imports and 46 percent in terms of export earnings. The primary focus of balance of payment management after the second shock was to finance the deficit, rather to control it through deflationary stance of the first oil shock-type.

D EVELOPMENTS

IN

E XTERNAL S ECTOR D URING 1980’ S

India remained unaffected by the debt crisis of early eighties facing many developing countries, due to her insignificant level of private debt. The foreign exchange constraints in the aftermath of second oil shock could be relieved by drawing substantial amount of loans from the International Monetary Fund: SDR 266 million under Compensatory Financing Facility (CFF) in 1980, SDR 529.01 million under Trust Fund Loan (TFL) in 1980-81 and SDR 5 billion under Extended Fund Facility (EFF) during 1981-84 (of which India used only SDR 3.9 billion). The foreign exchange situation also improved dramatically due to the inflow of remittances from the Gulf.

A substantial amount of import savings could be made due to large-scale import substitution in the areas of food, petroleum (after the discovery of Bombay High) and fertilizer. Thus, an improved foreign exchange scenario, which along with the available multilateral concessional assistance helped India to retain her creditworthiness and avoid a possible liquidity crisis of the Latin American type in early
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1980s. In fact taking the advantage of the improved foreign exchange scenario Indian policy makers attempted to relax the severity of the controlled trade regime in the 80s. The liberalization of the import control regime, particularly the category of Open General License (OGL) and export-related licenses, opened up a variety of imports that were required by a wider range of emerging consumer goods industries. Export growth remained sluggish during the eighties, due to the slowdown in the growth of world trade, decline in primary commodity prices in the global market, and the expansionary policy at home, as the later might have reduced the exportable surplus to some extent. Indeed the trade deficits went up from $ 5.9 billion in 1984-85 to $ 7.9 billion in 1990-91 (with $ 9.1 billion in 1988-89) and the current account deficits from $ 2.4 billion to $ 8.9 billion during the same period (based on RBI data).

With the near stability in the inflows of concessional assistance, financing of deficits were made by raising commercial loans from the Eurocurrency markets in the form of syndicated loans and Eurobonds as well as accepting short term foreign currency deposits from the non-resident Indians.
Table 1: Indicators of Current Account Sustainability for India (Per cent)

Indicator

1971 1975

197 6198 0
-1.4 0.2 -5.0 4.7 12.8* .. ..

198 1198 5
-2.5 -1.5 -6.8 3.8 13.2* .. ..

198 6199 0
-2.1 -2.2 -8.1 4.8 15.8* 10.0 6.0

199 1199 5
-1.2 -1.3 -5.7 7.3 33.9 6.7 27.1

199 6200 0
-2.5 -1.3 -5.1 6.6 24.3 5.3 49.3

200 1200 3
-2.2 0.2 -5.9 9.9 21.2 3.6 94.8

Trade Deficit/ GDP Current Account Deficit/GDP Gross Fiscal Deficit/GDP Private Sector: SI Gap External Debt/GDP Short-term Debt/Total Debt Non-Debt Capital Flows/Total Capital Flows Debt Servicing

-0.9 -0.4 -3.3 2.7 15.3* .. ..

..

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..

30.2

28.9

19.7

15.3

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Changes in REER Import Cover (Months)

.. 4.3

-2.1 7.4

0.8 4.2

-4.9 3.3

-2.9 5.9

-0.8 7.2

4.8 11.2

* Comprising of external assistance, commercial borrowings and IMF loans only. Thus, the external debt-GDP ratio for these periods is not comparable with the subsequent period. SI Gap: Saving Investment Gap

Source: Reserve Bank of India.

The imbalances in the external sector coincided with the macroeconomic imbalances in the economy, particularly in the form of increasing domestic money supply and budget deficits (see Table 1). The expansionary monetary and fiscal policies did not take into account the likely repercussion in the form of spill over effects on balance of payments. In fact, the generation of the excess liquidity that accompanied the liberalised import structure swelled the level of current account deficit.

The principal mode of balance of payment adjustments in India during the second half of the eighties was the managed depreciation of the rupee. Between 1985-90, the NEER of the rupee depreciated by almost 50 per cent and the REER by 30 per cent. It is clear that in a situation where the balance of payment problem was basically due to the macroeconomic imbalances, which arose primarily from the expansionary macroeconomic policies and the liberalised import structure, the expenditure switching effects of devaluation did not work.

The debt management policies in 1970’s and 1980’s was not helping India develop and there arised a need to make changes in the policies.

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DEBT POSITION DURING 1990’s
India’s external debt at end-September 1999 stood at US $98.87 billion as against US $97.68 billion at end-March 1999. Despite the increase in debt stock, there has been considerable improvement in major debt indicators, which reflects an over all improvement in the external debt scenario of the country. In this regard, it is noteworthy that the Debt-GDP ratio improved from 41.0 per cent in 1991-92 to 23.5 per cent in 1998-99 (Table 6.12). The debt service payments as ratio of current receipts continued to improve steadily from 30.2 per cent in 1991-92 to 18 per cent in 1998-99. Short-term debt (i.e., debt with an original maturity of up to one-year) declined from US $ 8.54 billion at end-March 1991 to US $ 4.61 billion at end September 1999. The share of short term to total debt fell from 10.2 per cent at end March 1991 to 4.7 per cent at end- September 1999 (Figure 6.5).

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Simultaneously, the ratio of short term debt to foreign currency assets has continued to improve from the high of 382.1 per cent at the end March 1991 to 15.1 per cent at end September 1999. (Table 6.12). The share of concessional debt to total external debt was 38.7 per cent at the end September 1999 as against around 45 per cent during first half of the decade. The share has been declining gradually since the mid-nineties showing signs of structural change in the composition of external debt.

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India has been among the top ten developing country debtors. However, its comparative indebtedness position has improved over the years. India ranked as the third largest debtor country after Brazil and Mexico in 1991 while in 1997 it ranked eighth after Brazil, Mexico, China, Korea, Indonesia, the Russian Federation and Argentina.Table 6.13 gives comparative indebtedness position for the top 15 debtor countries. India has the most favorable short term to total debt ratio. Since India has a high proportion of concessional debt, its Present Value (PV) of debt is low, and it ranks tenth on this count (as against eighth position in terms of total indebtedness).

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External debt management continues as an area of high priority. To consolidate the gains already made, the focus of external debt management policy would be continued stress on high growth rate of exports, keeping the maturity structure as well as the total amount of commercial debt under manageable limits and encouraging non-debt creating flows of foreign investment

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CRISIS AND R EFORM IN THE 1990 S
The foreign exchange crisis opened up several internal conflicts of an inward looking economy. The policy makers considered the unsustainable balance of payment situation as the symptom and the disease was inherent in the trade and industrial policy that protected the Indian economy from both internal and external competition. The shrinking share of India's exports in the global trade was considered as the reflection of the receding exports competitiveness and the absence of a right kind of commodity mix in India's export basket. The inefficiency of the trade regime had much to do with the prohibitive tariffs and a pervasive system of import controls. The entire regime of discretionary management of foreign exchange had constrained growth, proliferated black markets in foreign exchange and created avenues for considerable rent-seeking activities.

India’s approach to the 1990-91 crises was not to default on her external obligations, rather to pursue macroeconomic reforms, and remain current on debt servicing by borrowing from multilateral sources. As part of the overall macroeconomic reforms, sweeping changes were introduced in the areas of trade and exchange rate policies.

The Congress led government, which assumed office at the Centre in June 1991, accepted the medium term structural adjustment programme of the IMF. 1991 the rupee was devalued at two stages, from £ 1 Rs.34.36 to Rs.41.59. This was followed by a plethora of trade policy reform measures, beginning August 1991, by slashing cash subsidies for the export sector and relieving the economy from the QR and tariff regimes adopted since fifties. An immediate fall out of this programme was the sharp devaluation of the rupee. In July

India’s reform efforts since 1990s had led to a resumption of growth, decline in inflation, improved fiscal deficit, and a sustainable balance of payments. As we shall
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see later this had remarkably reduced the external debt burden and brought several beneficial changes in the composition of capital flows in years to come.

D EVELOPMENTS

TO

1991 F OREIGN E XCHANGE C RISIS

By 1990, there was a marked deterioration in India's balance of payments. Although there was satisfactory growth in exports, it was overshadowed by growth in imports, stagnant flows in invisibles such as tourism and private transfers, and mounting debt service burden. The current account deficits which were sustained mainly by borrowing from commercial sources and NRI deposits, with short maturities and variable interest rates, resulted in a ballooning of repayment burden towards 1990. The size of external debt reached $ 83 billion in March 1991, 45 percent of which was contracted from private creditors and at variable interest rates.

The debt service payments had reached 30 percent of export earnings by March 1991, which was close to some of the heavily indebted countries such as Indonesia (31 per cent), Mexico (28 per cent), and Turkey (28 per cent).

Interest components alone were about $ 4 billion, comprising some 50 per cent of the total current account deficits and 21 per cent of the total merchandise exports. The growth of exports in US dollar terms was not sufficient even to pay for the interests for each of the three years to 1990-91 and India had to make for amortization payments by resorting to fresh borrowing.

The foreign exchange crisis was exacerbated by the Gulf war that began in August 1990, causing shortfall in exports to West Asia, loss of remittances from Kuwait and Iraq, huge foreign exchange costs of emergency repatriation from the region and, most importantly, additional cost of oil imports due to the oil price increase. The Gulf crisis coincided with recessionary trends in the West that had depressed the demand for India’s exports.

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Furthermore, the economic decline in Eastern Europe led to a contraction of exports to these markets.

The uncertain political climate at home along with the precarious balance of payments situation led to the erosion of India's credit ratings abroad. The Moody's downgraded India's status to BB in 1990, which was the highest speculative grade for long-term debt.

There were indications that the net resource transfer on account of official and private credit had become negative in 1990-91 i.e. the fresh inflows were not even adequate to meet the obligations on account of amortization and interest payments. The level of foreign exchange reserves fell to just $ 1 billion in 1990-91. This desperate situation led the Reserve Bank of India to sell 20 tonnes of gold in May 1991 and pledge another 46.91 tonnes in July 1991, for meeting the urgent foreign exchange needs and financing current account deficits. An imminent foreign exchange crisis loomed large before the Indian economy, with unsustainable external debt burden.

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R ESPONSE

TO

1991

CRISIS AND ITS EFFECTS

Ten years ago India was in the midst of a full-blown balance of payments crisis. We have come a long way since those dark days of collapsing confidence, thanks mainly to sound economic policy and partly to good luck. It’s a story of successful economic reform. To begin with, it’s worth recalling just how bad our external economic position had had become in 1991. By March the current account deficit in the BoP had cumulated to a record level of nearly 10 billion dollars or over 3 per cent of GDP. Exports were falling. The foreign borrowing spree had taken the ratio of short-term external debt to foreign currency reserves to an astronomical 380 per cent. Foreign currency reserves skated close to a pitiful billion dollars throughout the spring and summer of the year. NRI deposits were bleeding away. Access to commercial external credit was becoming extremely costly and difficult. Even the normally sober government Economic Survey for the year admitted “A default on payments, for the first time in out history had become a serious possibility in June 1991”. Faced with this prospect, the new Government (with Manmohan Singh as finance minister) undertook emergency measures to restore external and domestic confidence in the economy and its management. The rupee was devalued, the fiscal deficit was cut and special balance of payments financing mobilized from the IMF and World Bank. The government also launched an array of long overdue and wide-ranging economic reforms. Aside from various measures of domestic liberalization, the strategy for restoring external sector health embraced six key planks. First, and most importantly, the exchange rate was made market-dominated after a two year transition. It improved greatly the incentives to exporters and to NRIs remitting funds to India through official channels. Correspondingly the rupee cost of importing became higher. Most important, the price of foreign exchange stopped
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being fixed by politically apprehensive governments. Second, the heavy anti-export bias (and pro high-cost import substitution bias) was reduced through phased cuts in our extraordinarily high customs tariffs. Third, almost all the economic (and not so economic) evils of the import licensepermit raj were gradually phased out. Fourth, there was a decisive opening up to foreign direct and portfolio investment. Fifth, short term foreign debts were reduced and strictly controlled; medium term commercial borrowing was also made subject to prudential caps and minimum maturities. Finally, there was a deliberate policy to build up foreign exchange reserves to provide more insurance against external stresses and uncertainties. The fruits of these policy thrusts soon came in bountiful measure. Export growth zoomed up to 20 per cent in 1993/94 and the two years thereafter. Inward remittances by NRIs quadrupled from two billion dollars in 1990/91 to eight billion in 1994/95 and rose further to exceed twelve billion in 1996/97. The current account deficit in the BoP never again exceeded two per cent of GDP and averaged only about one per cent for the ten years after 1990/91. Foreign investment soared from a negligible hundred million dollars in 1990/91 to over 6 billion dollars in 1996/97. Foreign exchange reserves climbed steeply from the precarious levels of 1991 to over $ 26 billion by the end of 1996/97. The debt service ratio was halved over the decade. The critical ratio of short-term foreign debt to forex reserves (proven critical again in the recent Asian Crisis) plummeted down from the stratospheric heights of 1991 to a very safe 20 per cent in March 1995. It would be hard to find more convincing evidence of success of the external sector reforms. But more evidence was soon forthcoming as the gales of contagion swept through Asia in 1997/98. India’s external policies of flexible exchange rates, strict control of short-term borrowing and ample forex reserves, backed by timely monetary policy, passed this rigorous test with high marks. With many key performance indicators (such as overall economic growth and fiscal deficit), the year 1996/97 seems to mark a turning point. Export growth dropped sharply that year and has averaged below 10 per cent in the last 5 years despite of a
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good recovery in 2000/01. Foreign investment has actually fallen since the peak of 1996/97 and totaled only $3.4 billion in 2000/01. External debt indicators have continued to improve but not decisively. Remittance inflows have plateaued after 1996/97.True, the current account deficit has remained low but this mainly reflects the stagnation of non-oil imports because of a sluggish industrial economy. Only software exports have bucked the lackluster trend of recent years. What’s amiss and what should we do? First, we should draw the right lessons from our earlier success. The most important and most encouraging lesson is that when we pursue good economic policies we quickly get the rewards in the form of strong economic performance. Second, the strength our external sector depends crucially on the productivity and competitiveness of our producers in agriculture, industry and services. Rigid labour laws and reservation of products of small scale industry handicap our competitiveness. The sooner the budget speech promises on these are implemented, the better. Our infrastructure sectors of power, roads, ports and railways are notoriously inefficient compared to our international competitors. The sooner we reform them, the more competitive our producers will become. Our customs tariffs are usually high and have changed a little after the sizable reductions between 1991 and 1997. protection reduces efficiency and productivity. Here too, budget speech intentions await fulfillment. Third, foreign direct investments (FDI) could play a big role in boosting output, exports and employment, as it has in China which is host to almost 20 times the amount of FDI each year than we are. The same factors of poor infrastructure, rigid labour laws, high government borrowings and weak export orientation that deter domestic investment also inhibit FDI. Over the past year the world economy has slowed and India (like everyone else) faces a tougher external economic environment. The disastrously wrong response to this would be to turn more inward. Our painfully slow economic progress in the three decades up to 1980 provides ample testimony to bankruptcy of inward-looking development strategies. The correct response is to improve productivity and complete harder. That means implementing the policy priorities, noted above, with even greater vigour and consistency. Only good economic policies will yield more growth, less
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poverty and a stronger external sector. We have seen that before and we must ensure it in our future.

1997 A SIAN CRISIS AND I TS I MPACT
The Southeast Asian crises had several common elements: speculative attack on the currencies (with sharp depreciation); the authorities being forced to defend the plummeting currency by depleting large volumes of international reserves; banking crisis compelling the governments to extend massive financial assistance to banks through budgetary support to prevent a collapse.

Another distinguishing feature of the crisis was the effect of contagion; crisis in one country spreading into several others in the region. The contagion impact depended on the degree of financial markets integration as well as the existing state of the economy.

The speculative attacks were on those countries’ currencies that were competing in the same world markets for goods and capital.

The Asian crisis had only a marginal impact on India, with negligible impact on her foreign exchange markets, the level of reserves and the banking system. It has been observed that the macroeconomic fundamentals prevailing at the time coupled with the flexible exchange rate management and control on short-term capital flows helped India to withstand the currency crisis.

The crises demonstrated that the major objective of sound debt management policy could be to achieve or maintain debt sustainability, while meeting key economic macroeconomic goals.

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At the time of currency crisis India’s balance of payments situation had become sustainable due both to a reduction in the current account deficit and to a substantial increase in net capital inflows. The current account deficit had fallen from its peak level of $ 9.8 billion in 1990- 91 to US $3.7 billion in 1997-98; the later was estimated at 1.5% of the GDP.

The 1997 level of current account deficit as per cent of GDP was 7.9% in Thailand, 4.9% in Korea and Malaysia, 3.3% in Indonesia and 4.7% in Philippines. India’s external debt at the end of 1997-98 was $92.9 billion or 23.8 per cent of GDP. The debt-GDP ratio was very high for the affected Southeast Asian countries: Thailand (56.8%), Indonesia (67%), Philippines (54%) and Malaysia (49%).

Table 2: Selected Indicators of India’s External Sector (% growth unless noted) Item/Year 91-92 92-93 93-94 94-95 95-96 96-97 97-98

1. Growth of Exports 2. Growth of Imports 3. Exports/Imports 4. Reserves to Imports -24.5

-1.1 15.4

3.3 10.0 84.8 8.6 64.5 25.6 -0.4 39.8 3.3

20.2 34.3 74.8 8.4 18.8 26.2 -1.1 35.8 3.6

18.4 21.6 74.0 6.0 16.9 24.3 -1.8 32.3 3.6

20.3 10.1 70.2 6.6 23.2 21.4 -1.0 28.2 3.3

4.5 5.8 83.3 7.0 25.5 18.3 -1.5 25.9 2.8

2.6

86.7 77.6 5.3 4.9 76.7 27.5 -1.8 41.0 3.3 3.3

5. Short-term debt/Reserves 6. Debt service Ratio 30.2

19.8

7. Current account balance* -0.4 8. External Debt* 9. Debt service payments* * As % of GDP

23.8

Source: Economic Surve

The level of international reserves, which was just $ 5.5 billion in 1991-92, increased to $29.4 billion 1997-98, providing about 7 months of imports cover. Nevertheless, exports continued to finance over 80% of India’ imports, thus making the trade account near self-sustaining. By the end of March 1998, the combined level of
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portfolio flows and short-term debt constituted about 75 per cent of the country’s foreign exchange reserves.

Indeed, the entire volatile inflows were said to have been added to reserves that had given sufficient leeway for stabilizing speculations in the foreign exchange markets. The net capital inflows into India increased from $4.7 billion in 1991-92 to $9.5 billion in 1996-97, which came down marginally to $8.2 billion in 1997-98, because of the uncertain domestic and international environment (mainly arising out of sanctions from the US). In the aggregate, there was already a shift towards non-debt creating flows, by way of foreign institutional investors (FII) into India’s debt and equity markets, euro equity issues by Indian companies, which had reached at $5.5 billion in 1997-98.

Debt flows (to cover aid, commercial borrowings, NRI deposits, drawings from IMF) in contrast was actually coming down significantly, reaching about $3.0 billion in 1997-98.

Short-term debt was repeatedly considered as an important risk factor in the precipitation of foreign exchange crisis, especially when coupled with high or unsustainable current account deficits. The share of short-term debt in the total debt was just 6% in India at the time of crisis, which compares with 41% in Thailand, 25% in Indonesia, 28% in Malaysia and 19% in Philippines. By the end of March 1998, the combined level of portfolio flows and short-term debt constituted about 75 per cent of the country’s foreign exchange reserves. Indeed, the entire volatile inflows was said to have been added to reserves that had given sufficient leeway for stabilizing speculations in the foreign exchange markets. It needs to be recognized that the short term flows also have provided the necessarily liquidity to an otherwise thin currency market in India.

The Asian crisis had therefore important policy lessons, and particularly in the context of external debt management and capital flows. It is by now abundantly clear that the
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crisis was not just because of the high current account deficit but much to do with the way the current account deficit was financed, the nature of capital flows (such as debt vs non-debt creating flows), and finally the way external capital being used for (such as financing investment as opposed to consumption or non tradable). The relative immunity to the crisis had also much to do with the structure of capital flows.

Although the Indian rupee was fully convertible on the current account, convertibility on the capital account front was rather asymmetric, with somewhat more restrictions on capital outflows than on inflows. With controls on trade, foreign exchange transactions and short-term capital flows, it was therefore possible to insulate the Indian economy from external shocks.

Exchange rate was considered the most important variable affecting the currency crisis. After a devaluation of about 22% in July 1991 India shifted to a system flexible exchange rate management based on “partial convertibility” in March 1992 and finally to “market determined” exchange rate system in March 1993. The market driven exchange rate also had obliged the policy makers to have lower inflation, disciplined fiscal and monetary policies, and stable real exchange rate for attaining sustainable balance of payments.

Under the circumstances the Reserve Bank retained the necessary flexibility in managing the currency, by quoting its own reference rate and actively intervening at that rate from time to time. pegged exchange rate regime. In fact, the existence of exchange risks has discouraged some of the more speculative short-term capital flows in to India, thereby reducing the need for policy interventions. The conduct of exchange rate policy had also stabilizing impact on the currency and capital flows pursued with appropriate mechanisms of intervention and sterilization. Looking from the experience, one noticed some kind of self-balancing mechanisms to have worked in the Indian foreign exchange markets. At a time of exchange market
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In addition the market driven exchange rate also

prevented excessive risk-taking by agents that would have occurred a fixed or a

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pressure, the policy seemed to have been not to defend the currency fully by spending reserves and, thereby, offering the speculators an easy target. In addition the market driven exchange rate also prevented excessive risk-taking by agents that would have occurred a fixed or a pegged exchange rate regime. In fact, the existence of exchange risks have discouraged some of the more speculative short-term capital flows into India, thereby reducing the need for policy interventions.

E VOLVING DEBT AND CAPITAL F LOWS S CENARIO T OWARDS 2003
India’s external $ 112.1 billion stood at the end of December 2003, which increased from $ 83.8 billion in March 1991(Table 3). The growth rate during the period was at an annual average rate of 2 per cent per annum. Some of the increase has been due to valuation changes, resulting from the weakening of US dollar vis -a- vis other currencies (for example, $ 5.7 billion out of $6.8 billion increase in external debt during 2002-03 was due to such valuation changes).

In terms of the level of outstanding debt India ranked as eighth in 2002 from among the top fifteen debtor countries in the world, coming after Brazil, China, Russian Federation, Mexico, Argentina, Indonesia and Turkey. This implied a marked improvement in her debtor position since 1991 foreign exchange crisis, when her rank was third from among the top fifteen debtor countries, i.e. coming after the two most heavily indebted countries such as Brazil and Mexico.
Table 3: India's External Debt Share in total External Debt Share in total External Debt Share in total External Debt Share in total External Debt End-March 1991 End-March 1996 End-March 2001 End-Dec 2003 (US $ mn.)

(US $ mn.)

(US $ mn.)

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(US $ mn.)

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External Debt Management

Multilateral Bilateral IMF Export Credit Commercial Borrowing NRI Deposits* Rupee Debt Short-term Debt Total External debt Share Concessional of Debt

20900 14168 2623 4301 10209 10209 12847 8544 83801

25 17 3 5 12 12 15 10 100 44.8

28616 19213 2374 5376 13873 11011 8233 5034 93730 42.3

31 20 3 6 15 12 9 5 100

31898 15323 0 5368 23227 17154 3042 2745 98757 36.0

32 16 0 5 24 17 3 3 100

30558 17942 0 4773 20582 29867 2635 5773 112130 36.4

27 16 0 4 18 27 2 5 100

to Total Debt Source: India’s External Debt: A Status Report, Government of India, 2003.

An important aspect of India’s external debt has been its concessionality. As of December 2003 about 36. 4 per cent of the overall debt portfolio was characterized by concessional debt, contracted mainly from multilateral and bilateral institutions. Due to the concessional nature of indebtedness the present value concept becomes the appropriate measure, obtained by discounting the future debt service payments for individual loans by appropriate discount rates and aggregating such present values. The present values India’s external debt stood at $ 82.9 billion in the year 2002 which is 80 per cent of the total outstanding debt. According to Global development Finance, the present value of external debt in the year 2002 was 17 per cent of GNP, lowest within the top fifteen debtor countries except China (with 14 per cent in 2002).

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45 40 35 30 t 25 n e c r 20 e P 15 10 5 0
28.7 38.7 37.5

External Debt- GDP Ratio*

33.8 30.8 27 24.5 24.3 23.6 2 2.1 22.6 21.1

20.2

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

The effectiveness of debt management policy should be judged in terms of the debt serving capacity, which can be gauged by indicators measuring solvency as well as liquidity. In Table 4 we analyze the most commonly used indicators debt sustainability: debt service ratio, interest service ratio, debt to gross domestic product ratio, short-term debt to total debt and short term debt to foreign exchange reserves. As seen from Table there is remarkable improvement in all the ratios during 19902003. The stock of external debt to GDP ratio declined from its peak of 38.7 per cent in 1991-91 to 20 percent in 2002-03. The debt service ratio which reached a record level of over 35 per cent in 1990-91, declined steadily to 14.7 per cent in 2002-03.

The most notable outcome of external debt management during 1990s has been the control over short-term debt. The level of short-term debt amounted to only US $5.0 billion by December 2003. The share of short term debt to total debt declined significantly from over 10 per cent in 1990-91 to 4.4 per cent in 2002-03, which actually was the lowest for India from among the top 15 debtor countries.

The volume of short-term debt, which was 146 per cent of foreign exchange reserves in 1990-91, declined to just 6 per cent in 2002-03. By taking into account the
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residual/remaining maturity within the component of short-term debt, it still remains modest at $ 12. 7 billion or 11.7 per cent of total external debt by end-December 2003(Table 5). Table 4: Indicators of Debt Sustainability for India Year
1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 s1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03

Solvency Indicators DSR
35.3 30.2 27.5 25.4 26.2 24.3 21.2 19.0 17.8 16.2 17.2 13.9 14.7

Liquidity Indicators STD/TD
10.2 8.3 7.0 3.9 4.3 5.4 7.2 5.4 4.4 4.0 3.6 2.8 4.4

ISR
15.5 13.0 12.5 10.5 9.7 8.8 7.3 7.5 7.8 7.3 6.6 5.4 4.1

DGDP
28.7 38.7 37.5 33.8 30.8 27.0 24.5 24.3 23.6 22.1 22.4 21.0 20.3

STD/FER
146.5 76.7 64.5 18.8 16.9 23.2 25.5 17.2 13.2 10.3 8.6 5.1 6.1

DSR = Debt Service Ratio; ISR = Interest Service Ratio; DGDP = Debt to Gross Domestic Product Ratio; STD = Short-Term Debt; TD = Total Debt; FER = Foreign Exchange Reserves. Source: Reserve Bank of India

Table 5: India’s Short Term External Debt by Residual Maturity (US $ million) 199 8 Short-term maturity (5.4) Long-term debt maturing within one yr (7.2) Total Short-term debt by 11,76 9 Page | 42 residual maturity (7.3) (8.5) (6.7) (11.6) 6,723 (4.4) 7,059 (4.0) 8,359 (3.6) 6,767 (2.8) 11,465 debt by original 5,046 199 9 4,274 200 0 3,936 200 1 3,628 2,745 2002

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(12.6)

(11.7)

(12.5)

(10.3)

(14.4)

Note: Figures in the bracket represent per cent to total external debt. Source: India’s External Debt: A Status Report, June 2003.

120 100 80 n o i l l i 60 B $ S U 40 20 0

Total External Debt and Foreign Currency Assets

En d End End End End End End End End End End End End E nd End Mar 91Mar 92Mar 93Mar 94Mar 95Mar 96Mar 97Mar 98Mar 99Mar 00Mar 01Mar 02Dec 02Mar 03Dec 03

To tal Extern al Debt Fo reig n Curren cy Asset s

Table 5: Reserve Indicators for India Year Import Cover of Reserves (months) 2.5 5.3 4.9 8.6 8.4 6.0 6.5 6.9 8.2 8.2 Page | 43 Reserves to External Debt 7.0 10.8 10.9 20.8 25.4 23.1 28.3 31.4 33.5 38.7 Reserves to Short Term debt 68.3 130.4 155.1 530.9 590.0 430.8 392.8 582.0 760.2 966.4

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00

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2000-01 2001-02 2002-03 Source: Reserve Bank of India

8.6 11.3 13.8

41.8 54.8 72.0

1,165.4 1,971.1 1,650.9

The level of foreign exchange reserves went up from just 2.5 months of import cover during 1990-91 is currently sufficient for over a year imports. The buildup reserves were an outcome of the capital account opening in India as well as official policy keeping in view the factors such as the level of current account deficit; the size of short-term liabilities, debt servicing, the possible variability in portfolio investments and other types of capital flows; unanticipated pressures on the balance of payments arising out of external shocks such as oil price hikes. Looking at the sectoral composition of external debt one finds that the share of government and government guaranteed debt account for about 48 per cent of total external debt in December 2003. Debt contracted by the corporate sector, which also include government owned public sector undertakings, are showing an increasing trend.

Table 6: Government Guaranteed External Debt ($ Millions) 1994 1 2 4 3 Govt. Debt Non-Got Debt Total External Debt(1+2) of which with Govt. Guarantee*: ( a+b+c ) a. Financial Sector b. Public Sector 5 6 c.Private Sector Govt. Debt and Guaranteed Debt(1+3) Percent of Govt. Debt and Guaranteed Debt to Total External Page | 44 5594 3 3675 2 9269 5 1056 8 1709 8533 326 6651 1 71.8 1098 7070 377 6164 0 65.8 2323 4605 341 5378 9 57.5 2496 4363 315 5331 1 55.0 49.8 1429 4639 247 50342 1761 5070 191 5064 1 51.3 46.8 1807 4985 59 52498 1996 5309 5 4063 5 9373 0 8545 1998 4652 0 4701 1 9353 1 7269 1999 4613 7 5074 9 9688 6 7174 10113 2 6315 2001 44027 57105 2002 4361 9 5513 8 9875 7 7022 11213 0 6851 2003 45647 66483

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Debt(5/4) 7 Percent of Govt. Guaranteed Debt to Non- Govt Debt(3/2) 28.8 21.0 15.5 14.1 11.1 12.7 11.0

Comparing the external debt indicators of the top 15 debtor countries for the years 1990 and 2001 one observes very comfortable situation for India (Table 7). India’s debt had grown at 18 per cent as compared to over 300 percent rise in Korea, China, Malaysia and Russian Federation and over 200 per cent rise in Argentina, Brazil, Chile, Colombia, Indonesia and Turkey. Most of the solvency indicators for India have shown perceptible improvement during the decade and fare well from among the top fifteen indebted countries: level of external debt to exports of goods and services, external debt to GNP, debt service ratio and interest service ratio, etc all show considerable improvement during the decade. The adjustments in the debt indicators are far better for India as compared to all other debt countries, particularly in the post Asian crisis years.

COMPOSITION OF CAPITAL FLOWS
The pattern of capital flows into India reveals a shift in its composition, from debt to non-debt creating flows with decreasing importance of short-term flows such as foreign currency deposits and short term debt, and an increasing share of foreign direct and portfolio investment flows(Table 8). The share of non-debt flows in total capital flows have increased to 46.6 per cent during 2002-03. Portfolio investments flows from FIIs are allowed since 1993, the cumulative investment of which was $ 19 billion in 2003 with about 10 per cent of the total market capitalization of the Indian stock market.

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Table 7: Comparison of External Debt Indicators of Top Fifteen Debtor Countries

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Country

Debt

Concessional PPG to Total Debt 1990 75.3 73.2 54.2 82.3 85.2 2001 75.1 41.3 14.5 53.9 59.3 Debt (%) 1990 0.8 2.5 1.9 17.6 5.7 2001 1.0 1.2 0.9 15.4 2.4

External Debt to External debt Current receipts 1990 373.7 325.5 179.6 91.4 181.0 2001 373.7 314.4 162.6 54.9 210.6 to national Income 1990 46.0 26.5 67.3 15.2 45.1 2001 52.5 46.9 60.0 15.0 46.2

Debt Service Interest Service Ratio 1990 37.0 22.2 25.9 11.7 40.9 2001 66.3 75.4 28.1 7.8 36.1 Ratio 1990 16.3 6.1 16.7 5.4 17.9 2001 29.9 23.6 8.3 2.5 15.3

Short Term Debt to Total Debt 1990 16.8 19.8 17.6 16.8 8.4 2001 14.6 12.5 6.7 25.8 10.2

Short Term Debt to Reserves 1990 228.1 318.7 55.7 31.5 31.1 2001 137.4 79.1 17.8 20.4 36.8

Outstanding Debt to Total ($ billion) Years 1990 2001 Argentina 62.2 136.7 Brazil Chile China 120.0 226.4 19.2 38.4

55.3 170.1 36.7

Colombia 17.2

India

83.8 98.8

45.9 36.0 84.9
26.4 12.6 14.6 0.8 20.0 7.7 0.0 15.2 15.1 20.7 0.3 7.3 0.7 21.3 9.9 0.0 12.6 3.5 68.7 53.7 75.6 72.7 78.6 79.5 80.1 44.4 78.6

85.0
50.4 30.6 55.5 54.5 65.3 39.8 66.8 39.2 48.6

328.9
233.9 45.6 44.4 191.4 230.1 251.3 .. 89.8 196.1

121.6
205.9 58.5 41.6 85.5 125.1 113.5 128.0 84.2 205.7

28.7
64.0 13.8 36.4 41.1 69.4 88.8 10.3 33.3 32.5

21.0
97.2 26.1 54.4 26.2 69.2 35.7 50.9 60.4 78.8

35.3
33.3 10.8 12.6 20.7 27.0 4.9 .. 16.9 29.4

13.9
23.6 13.8 6.0 26.1 18.6 28.0 14.5 25.1 40.0

15.5
13.3 3.4 3.4 13.4 13.3 1.7 .. 6.5 13.5

5.4
8.9 2.8 2.1 6.9 6.7 5.0 6.6 4.1 11.1

10.2
15.9 30.9 12.4 15.4 14.5 19.4 19.9 29.6 19.2

2.8
16.1 31.9 11.8 11.4 11.6 11.2 13.7 19.6 14.2

365.4
149.3 73.0 19.5 163.1 479.1 213.6 .. 62.6 157.0

5.4
80.0 34.2 16.7 40.2 45.0 27.2 64.4 40.9 86.6

Indonesia 69.9 135.7 Korea, Rep. 35.0 110.1 Malaysia Mexico 15.3 43.4

104.4 158.3 52.4 62.4

Philippines 30.6 Poland 49.4

Russian Fed 59.3 152.6 Thailand Turkey 28.1 67.4 49.4 115.1

Table 9: Composition of Capital Inflows to India

Types of Flows
Total Net Capital Inflows($ bn) PERCENT Non-debt Creating Inflows a) FDI b) Portfolio Investment Debt Creating Inflows a) External Assistance

199091
7.1

199596
4.1

199798
9.8

199900
10.4

200001
10.0

200102
10.6

200203
12.1

1.5 1.4 0.1 83.3 31.3

117.5 52.4 65.1 57.7 21.6

54.8 36.2 18.6 52.4 9.2

49.7 20.7 29.0 23.1 8.6

67.8 40.2 27.6 59.4 4.3

77.1 58.0 19.1 9.2 11.4

46.6 38.5 8.1 -10.6 -20.0

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b) ECB # c) Short- term Credits d) NRI Deposits e) Rupee Debt Service Other Capital @ Total (1 to 3) Memo: Excluding b & c*

31.9 15.2 21.8 -16.9 15.2 100.0 84.7

31.2 1.2 27.0 -23.3 -75.2 100.0 33.7

40.6 -1.0 11.4 -7.8 -7.2 100.0 82.4

3.0 3.6 14.7 -6.8 27.2 100.0 67.4

37.2 1.0 23.1 -6.2 -27.2 100.0 71.4

-14.9 -8.4 26.0 -4.9 13.7 100.0 89.3

-19.4 8.1 24.6 -3.9 64.0 100.0 83.8

# refers to medium and long-term borrowings Source: Reserve Bank of India.

GDRs/ADR Table 10: Portfolio Investment in India (US $ Million) 199293 199394 199495 199596 199697 199798 199899 199900 200001 200102 200203 600 477 831 768 270 645 1,366 683 2,082 1,520 s# 240

FIIs * 1 1,66 5 1,50 3 2,00 9 1,92 6 979 -390 2,13 5

Offshore funds 3 382 239 56 20 204 59 123 82 39 2

Tot al 244 3,567 3,824 2,748 3,312 1,828 -61 3,026 2,760 2,021 979

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#: Represents the amount raised by Indian corporates through Global Depository Receipts (GDRs) and American Depository Receipts (ADRs). *: Represents fresh inflow of funds by Foreign Institutional Investors. Source: Reserve Bank of India

SPECIAL PURPOSE EXTERNAL COMMERCIAL BORROWING
The Indian Government had obtained external borrowing using special provisions three times since 1991: India Development Bonds (IDBs), 1991; Resurgent India Bonds (RIBs), 1998; and, India Millennium Deposits (IMDs), 2000. These borrowings were used only to meet the unfavorable external circumstances, and served as alternative to sovereign borrowings. The maturity of these issuances were about five years, mostly subscribed by non-resident Indians,
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with redemption only at maturity and offering reasonable spread over comparable government bond yields. These instruments were considered as substitutes for foreign currency deposits, which extended the duration of the country’s debt profile.
Table 11: Special Borrowings by India since 1991

Type of Borrowings

Amount(US $ Million)

Interest Rate (%)

5-Year Government Bond Yield

Sprea d (Col 3-4)

India Millennium Deposits, 2000 Mobilization in US Dollar Mobilization in Pound Sterling Mobilization in Euro Resurgent India Bonds, 1998 Mobilization in US Dollar Mobilization in Pound Sterling Mobilization in Euro India Development Bonds, 1991 Mobilization in US Dollar Mobilization in Pound Sterling

5,520 5,182 258 80 4,230 3,987 180 63 1,627 1,307 320 9.50 13.25 7.86 9.92 1.64 3.33 7.75 8.00 6.25 5.26 5.45 2.49 2.55 8.50 7.85 6.85 5.57 4.63 2.93 3.22

Source: India’s External Debt: A Status Report, Government of India, October 2001.

FOREIGN CURRENCY DEPOSITS
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Many countries allow foreign currency deposits from expatriates as a source for balance of payments financing. Such schemes were introduced in India in 1970 allowing non-Resident Indians/Overseas Corporate Bodies to place deposits denominated in foreign currency as well as local currency with the Indian banks, with interest rate fixed and exchange rate guaranteed by the Reserve Bank of India. The two oil shocks of 1970s brought substantial amount of US dollar deposits from the gulf countries. By the end of March 1990, the total NRI deposits were to the extent of $ 12 billion. However these short-term deposits have proved to be very volatile, responding to macroeconomic instability as well as political risks. The external payments difficulties of 1990-91 demonstrated the vulnerability associated with these deposits.

Considering the huge fiscal costs of exchange guarantee and higher interest rates offered on such deposits as compared to international rates, the policy later years withdrew the exchange rate guarantee and reduced considerably the interest rate spread. A scheme called Non-resident NonComposition of External Debt introduced in 2003 repatriable Rupee Deposit (NRNRRD) was alsoas at End Decorder to avoid the reversibility (Share in %) character of the deposits, but was later withdrawn in April 2002.

Composition of External Debt as at End Dec 2003 (Share in %)
Rupee Debt 2% NRI Deposit 27% Short term Debt 5%

Multilateral 27%
Short term Debt 5%

Rupee Debt 2%

Commercial Debt Bilateral 19% NRI Deposit Export Credit 16% 4% 27% Multilateral 27%

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Commercial Debt Bilateral 19% Export Credit 16% 4%

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EndMarch
1975 1980 1985 1990 1995 1996 1997 1998 1999 2000 2001 2002 2003

NR(E) RA
40 856 2,304 3,777 4,556 3,916 4,983 5,637 6,045 6,758 7,147 8,449 14,923

FCNR( A)*
– 188 770 8,638 7,051 4,255 2,306 1 – – – – –

FCNR( B)
– – – – 3,063 5,720 7,496 8,467 7,835 8,172 9,076 9,673 10,199

NR(NR)R D**
– – – – 2,486 3,542 5,604 6,262 6,618 6,754 6,849 7,052 3,407

FC(O) N
– – – – 10 13 4 2 – – – – –

Tot al
40 1,044 3,074 12,415 17,166 17,446 20,393 20,369 20,498 21,684 23,072 25,174 28,529

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* **

: Withdrawn effective August 1994. : Withdrawn effective April 2002.

Source: Reserve Bank of India.

Let us view the financial highlights of the fiscal 2007-08 in form of charts and tables in the next chapter.

India’s External Debt as at the end of March 2008
The external debt data are compiled and released by the Reserve Bank/Government of India on a quarterly basis with a lag of one quarter. As per current practice, India’s external debt statistics for the quarters ending March and June are compiled and released by the Reserve Bank, while the external debt data for quarters ending September and December are compiled and released by the Ministry of Finance, Government of India. The data on India’s external debt for end-March 2008, which was released by the Reserve Bank on June 30, 2008, are presented below:

CURRENT SCENARIO

India’s total external debt is placed at US $ 221.2 billion at the end of March 2008. At this level, the external debt stock increased by about US $ 51.5 billion or over 30.4% over
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the end-March 2007 level.(Table 1 & Chart 1). The increase was mainly due to external commercial borrowings (ECBs) that contributed around 39.5% of the increase in total external debt, followed by short-term debt (contribution being 34.8%).

The valuation effect, on account of appreciation of the US dollar against other major international currencies, has had a moderating impact on the stock of external debt.

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Out of increase in US $ 51.5 billion in external debt during the year 2007-08, valuation effect reflecting the depreciation of the US dollar against other major international currencies and Indian rupee accounted for US $9.9 billion of the increase. This would imply that excluding the valuation effects, the stock of external debt as at end-March 2008 increased by about US $41.6 billion over the end-March 2007 level.

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Among the various components of debt, NRI deposit, trade credit and multilateral debt have risen during the year (Table 2). External Commercial Borrowings (ECBs) (including FCCBs) at US $62.0 billion recorded the maximum increase of US $20.4 billion (48.9 per cent) during the year (Table 2) expansion. (Chart 2). This was mainly due to the rising financing requirements of the Indian companies on account of their ongoing technological upgradation and capacity

The data on short term debt now includes supplier’s credit up to 180 days with effect from end-March 2005. Short term debt also recorded an increase of US $17.9 billion during 2007-08. Under short term debt, while trade related credits rose significantly by
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around US $17.7 billion in line with the rising imports, FII debt investment in government papers rose by about US $254 million.

All other components of external debt also recorded an increase during 2007-08: multilateral debt (US $4.0 billion), bilateral debt (US $3.6 billion), export credit above one year maturity (US $3.2 billion) and NRI deposits (US $2.4 billion). Rupee debt recorded a marginal rise of US $69 million.

The US dollar continues to remain the predominant currency accounting for 57.1% of the total external debt stock as at the end of March 2008, followed by the Indian rupee (14.5%), Japanese yen (12.1%) and SDR (10.2%). (Table 4 & Chart 3).

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I NDICATORS

OF

D EBT S USTAINABILITY

There has been a perceptible improvement in external debt indicators over the years reflecting the growing sustainability of external debt of India.

External debt to GDP has risen to 18.8 per cent at end-March 2008 from 17.8 per cent at end-March 2007. This ratio was 30.8 per cent at end-March 1995.

The debt service ratio was placed at 5.4% during 2007-08 as against a double digit figure till 2003-04.

Reflecting the rise in short term debt during 2007-08, the ratio of short-term to total debt and short term debt to reserves rose to 20.0 per cent and 14.3 per cent, respectively.

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The share of concessional debt in total external debt declined to 19.9 per cent at endMarch 2008 from 23.3 per cent at end-March 2007 reflecting the continuing increase in the non-concessional private debt in India’s external debt stock.

India’s foreign exchange reserves exceeded the external debt by US $ 88.5 billion providing a cover of 140.0 per cent to the external debt stock at the end of March 2008 (Chart 4)

Comparing the cross country online data on external debt provided by the World Bank up to 2006 for the top twenty debtor countries of the developing world reveal the following (Table 6):

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• • • •

India’s position was fifth in 2006 in terms of external debt stock. In terms of the ratio of external debt to Gross National Product (GNP). India’s position was second lowest, with China having the lowest ratio of external debt to GNP. India’s debt service ratio was third lowest with China and Malaysia having first and second lowest debt service ratio, respectively. The element of concessionality in India’s external debt portfolio was the second highest after Indonesia. In terms of reserves to total debt, India’s position was fifth China, Malaysia, Thailand and Russia.

A detailed account of India’s external debt as at end-March 2008 in US dollar is presented in Statement below:
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India's external debt - GDP ratio down at 15.8 per cent: Chidambaram

news

Mumbai: India's total external debt has declined from 21.1 per cent of GDP in 2001-02 to 15.8 per cent of GDP in 2005-06, finance minister P Chidambaram informed the Sabha during question hour. Around 36.4 per cent of the country's total external debt comprised of loans raised by Indian corporates through external borrowings, export credit and short-term credits, the finance minister said. The share of government debt in total external debt was 33.4 per cent, while non-government debt accounted for the remaining portion in December last year, he said. He said the government was pursuing a ''prudent'' external debt management policy by raising funds on concessional terms and from less expensive sources with longer maturities, among other things. This has forced the Reserve Bank of India (RBI) to keep in abeyance measures announced in October for greater liberalization of external commercial borrowings (ECBs). In its review of the credit policy in October 2006, the RBI had said it would allow banks to borrow through the ECB route up to 50 per cent of their Tier-I capital, subject to a cap of $10 million, but this would include borrowing for export credit. Earlier, banks were allowed to borrow 25 per cent of their Tier-I capital, excluding any loans taken for on-lending to exporters.
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A day ahead of the presentation of the monetary policy, the RBI said, "In view of the prevailing market conditions and likely impact on liquidity, it has been decided to keep the operationalisation of the policy announcement in abeyance." Loans raised by the private sector from international capital markets with maturities of more than three years are classified as ECBs. The latest external debt data released by the government show that commercial borrowings from global sources have risen by 11 per cent to $35.98 billion in December 2006 from $32.46 billion in September 2006. Commercial borrowing accounted for 25.2 per cent of India's $ 142.7 billion external debt in December 2006. In the previous quarter, commercial borrowings represented 23.8 per cent of the total external debt of $136.5 billion. During fiscal 2006-07, the government had put a $22 billion ceiling on external commercial borrowings (ECBs), with a $500 million cap on individual company borrowings. Long-term debt outstanding increased over the quarter by $6.798 billion to $132.641 billion, while short-term debt declined by $610 million (5.7 per cent) to $10.015 billion as on Decemberend 2006. With domestic interest rate firming up, deposits by non-resident Indians have also gone up by Rs1,867 crore ( 5.1 per cent) to Rs38,382 crore at December-end 2006. Inflationary pressures in the last few weeks have led to a rise in the value of the rupee. The rupee touched a nine-year high against the dollar on Monday. The RBI is likely to continue tough measures to check liquidity growth and prevent a further rupee rise. The RBI has identified ECBs as one of the "major contributors to capital inflows". "Higher recourse to ECBs was enabled by lower spreads on external borrowings and rising financing requirements for capacity expansion domestically," the RBI has pointed out.
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Policy Perspectives on External Debt Management
The debt management policy following the balance of payments crisis evolved into a multipronged strategy. This evolving policy regime was based broadly on the recommendations of the Rangarajan Committee (1993) which implied (i) the continuation of an annual cap, minimum maturity restrictions and prioritizing the use of ECBs; (ii) LIBOR based ceilings on interest rates and minimum maturity requirements on NRI deposits to discourage the volatile component of such deposits; (iii) containment of short-term debt together with controls to prevent its undue increase in future; (iv) retiring/ restructuring/ refinancing of more expensive external debt; (v) measures to encourage non-debt creating financial flows such as foreign direct and portfolio investments; (vi) incentives and schemes to promote exports and other current receipts; and (vii) conscious build-up of foreign exchange reserves to provide effective insurance against external sector uncertainties.

These policies pursued with varying intensity yielded good results in making a turnaround in India’s external debt scenario, which is reflected in the sustained improvement in her key debt indicators. A transparent policy on external commercial borrowings with the stated objectives of prudent debt management seems to have emerged in recent years. India began considering the need for a Public Debt Management Office in 2000. Attention was focused on building up of the institutional capability for debt analysis for effective public debt management and an appropriate institutional structure for it in the public sector.

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The institutional arrangement of debt reporting is shared between the Ministry of Finance (MOF) and the Reserve Bank of India (RBI), with the External Debt Management Unit (EDMU) in the Ministry of Finance serving as the apex unit for monitoring, computerization and management related decisions. The majority of the country’s total external debt data relating to external assistance and external commercial borrowings have been computerized on the Commonwealth Secretariat Debt Recording and Management System(CS : DRMS).

The ECB guidelines issued by the Ministry of Finance from time to time put a cap on the overall amounts that can be borrowed in a financial year, allowing a longer maturity for larger borrowing, caps on borrowing cost and restrictions on end-use (See the Appendix). These restrictions have proved to be helpful in avoiding debt-servicing difficulties. The annual review of a cap on ECB is fixed considering the requirement of different sectors and the medium term balance of payments scenario. ECB approvals are monitored regularly to ensure that the total debt is maintained within the limits of debt management.

The ECB guidelines in a way impose restrictions on the leveraging capabilities of Indian companies in terms of the amounts and the periods for which the borrowings can be made. Corporate access external commercial borrowings for expansion of existing capacities as well as for fresh investment. At the moment different rules apply for different forms of financing which therefore restricts the choice of financing available.

In this way, to a large extent, funding depends upon the government rules rather than the characteristics of the projects. There are no sovereign guarantees; corporate today access oversees capital markets based on the strength of their balance-sheet and their brand. The government has relaxed recently to prepay external debt, thus the possibilities for lowering the interest costs due to falling interest rate environment.

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The concern is gradually shifting towards managing corporate borrowing, as the volume of external debt on the government account has been decreasing. Corporate can also undertake liability management for hedging the interest and exchange rate risks on their underlying foreign currency exposures without prior approval of the Ministry of Finance or the Reserve Bank of India.

The policy gives greater priority for projects in the infrastructure, core and export sectors. The regulatory structure has been evolving to influence the activities that would be financed through external borrowings, thereby restricting the funds from recycling into financial markets as well as real estate. To lengthen the maturity profile of external debt, commercial borrowings of eight years and above are kept outside the ceiling.

Keeping in view the volatility the short term capital flows are monitored and restricted mostly for trade related purposes. As regards the foreign currency and local currency denominated deposits, from the non-resident Indians, there has been a significant change in terms of the removal of exchange guarantees provided by banks, gradual shift in policy in favor of local currency denominated deposits, promotion of non-repatriable deposits, and aligning interest rates to international rates such as LIBOR.

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External Commercial Borrowings Policy Guidelines
External Commercial Borrowings (ECB) refer to commercial loans availed from non-resident lenders with minimum average maturity of 3 years. Borrowers can raise ECB from internationally recognized sources such as (i) international banks, international capital markets, multilateral financial institutions (such as IFC, ADB) (ii) export credit agencies and (iii) suppliers of equipment, foreign collaborators and foreign equity holders.

A. A CCESS M ECHANISM
Under the present framework, ECB can be raised through two routes viz. (i) Automatic Route and (ii) Approval Route.
(i) (ii) Automatic Route Eligible Borrowers: Corporates registered under the Companies Act except financial intermediaries (such as banks, financial institutions’ (Fis), housing finance companies and NBFCs) are eligible. Cases considered:

(i)
(ii)

Up to USD 20 million or equivalent with minimum average maturity of 3 years.
Above USD 20 million and up to USD 500 million or equivalent with minimum maturity of 5 years.

Eligible Borrowers:

a) Financial Institution dealing exclusively with infrastructure or export finance will be considered on a case by case basis.

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b) Banks and Financial Institutions which have participated in the textile or steel sector restructuring packages approved by the Government will also be permitted to the extent of their investment in the package and assessment by RBI based on prudential norms. Cases considered: cases falling outside the purview of the automatic route limits and maturity period mentioned earlier. Such cases falling under the Approval Route will be considered by an Empowered Committee of the RBI.

B. G ENERAL
All-in-cost ceilings

TERMS AND

CONDITIONS:

The present all-in-cost ceilings for ECB are as follows:
Maturity i) 3 years and up to 5 years ii) More than 5 years All-in-cots ceiling* over 6 month LIBOR 200 basis points 350 basis points

* All-in-cost ceiling includes rate of interest, other fees and expenses in foreign currency except commitment fee, prepayment fee, and fees payable in Indian rupees. Also, payment of withholding tax is excluded for calculating the all-in-cost.

END-USE
(i) ECB can be raised only for investment (such as import of capital goods, new projects, modernization/expansion of existing production units) in the real sector-industrial sector including small and medium enterprises and infrastructure sector in India. (ii) Utilization of ECB proceeds is permitted in the first stage acquisition of shares in the disinvestments process and in the mandatory second stage offer to the public under the disinvestments programme of PSU shares. (iii) Utilization of ECB proceeds is not permitted for on-lending or investment in capital market by corporates.
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(iv)

Utilization of ECB proceeds is not permitted in real estate. ‘Real Estate’ excludes development of integrated townships as per provisions of Press Note No. 3 (2002 series) dated 4.1.2002 of the D/O Industrial Policy & Promotion.

(v)

End-uses of ECB for working capital, general corporate purpose and repayment of existing rupee loans are not permitted.

C.

P AYMENTS

Prepayment of ECB up to USD 100 million is permitted without prior approval of RBI, subject to compliance with stipulated minimum average maturity period as applicable for the loan. Refinance of existing ECB

Refinancing of existing ECB by raising fresh loans at lower cost is permitted, subject to the condition that the outstanding maturity of the original loan is maintained.

E.

Foreign Currency Convertible Bonds (FCCB)

The liberalization norms applicable to ECB are also extended to FCCB in all respects.

Source: India’s External Debt: A Status Report, Government of India, 2003.

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Politics of External Debt Management
There has been overall jubilation on the performance of the Indian economy on the external front. The country's foreign currency debt has gone up to $105 billion, up from the $100 billion the previous year, but few are worried as this rise is being attributed to revaluation gains and to the discontinuation of a rupee deposit window open to non-resident Indians (NRIs). The country's foreign exchange reserves have crossed the $80-billion mark and the Reserve Bank of India is facing the tough task of trying to check the inflows to manage inflation and take the sustained pressure off the rupee. The burgeoning foreign currency cushion has made it possible for the country to retire its multilateral dollar debts amounting to about $2.8 billion last year, and a similar amount is to be prepaid this year.
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The Finance Ministry has further made statements that it no longer wants small aid packages and it proposes to prune its bilateral donor list to just six strategic countries, including Britain, the EU, Germany, Japan, the US and Russia. The net result is that 22 donor countries have received the axe, including such long-time bilateral lenders as Canada, conveying the overall impression that India views itself as the big brother amongst nations, of course with the exception of the big six. Such rhetoric would go down well with the Swadeshi lobby, and could generally be considered harmless, provided it does not contain the seeds of economic de-stability over a longer period of time. Yet, the measures taken by the BJP Government on the external debt management front are not that reassuring, if one looks at the manner in which the external debt portfolio is being restructured. Here, one gets the impression that the Government is paying a high price to score a few political brownie points. To illustrate the point, take the case of the Resurgent India Bonds (RIBs). The Centre raised about $5.5 billion in the post-Pokhran period. The sum was raised not because it was needed but more to cock-a-snook at the international community for threatening it with sanctions. The Government claimed that its credit worthiness was high among the wealthy NRIs in the US, the UK and West Asia; though it did take the precaution of setting a high rate of return on the offering to ensure it was fully subscribed. The offering mopped up an unexpected $5.5 billion and the rates were subsequently justified as being on a par with the paper issued by the Brazilian government at that time. However, the RIBs were undoubtedly high cost funds, when viewed against the background that India did not need the funds in the first place. Five years down the line, these bonds are now coming up for repayment. Given the rates, the burgeoning foreign exchange reserve and the lack of dependence on these funds, one would assume that the Government would jump at the opportunity of retiring these bonds. Instead, the

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State Bank of India (SBI), which raised the loans on behalf of the Government, plans to roll them over. A conversion of the dollar debt into a rupee loan is being worked into the rollover option, which could be an advantage, if one did not have the funds to prepay them. However, availability of funds is not an issue and a financial cushion against sanctions is no longer necessary, it is not clear why a rollover option is being considered at all. Some could argue that India's reserves are not comparable with China's $217.9 billion, next only to Japan's $399.3 billion in 2001, but they are closer to Republic of Korea's $103 billion, Taiwan's $123 billion and Singapore's $76.2 billion during the same period. Besides, the sum involved in retiring the RIBs is miniscule in proportion to the reserve accumulated thus far, which would earn only moderate returns in a global falling interest rate regime. The story of the poor external debt management does not end there. Take, for instance, the Government's decision to retire foreign currency multilateral loans amounting to $2.8 billion last year, with an equal sum being retired this fiscal, and its decision to do away with small aid packages. The net result is that concessional loans are being repaid and the list of donors is now set to be pruned by 22 countries, including long-time donors, limiting the donor list to just six. Since Russia stands included in this list, apart from Britain and the US, one can assume that India nurtures certain geopolitical aspirations by positioning itself as a big brother among the economically smaller nations. That by itself is acceptable, provided that this goal is achieved by following the basic fiscal prudence of replacing high-cost loans with low-cost debt. In the past, the `anti' feelings against multilateral loans have been strong and retirement of this class of debt could be justified on the grounds that it is necessary to maintain the suzerainty of the nation. In that case, the cost and pain involved in the retirement are not a parameter. However, this rationale fails when one looks at India's approach to bilateral aid management. Here, the Government wants to continue to borrow from those countries, which could wield significant influence on its sovereignty, while it has chosen to axe donors who would least affect its economic and political decision-making.
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The buzz today is that the aim of the whole exercise is not economic but political: The Government wants to show up nations that had criticised it for the Gujarat carnage. If that is indeed so, then this is one lesson, which is being taught at an extremely high cost for Indians

The Future
“The best way to predict the future is to invent it” - Alan Kay

Given the sustainable level of current account and foreign exchange reserves in India, it is very unlikely that the foreign exchange situation becomes critical again. It also seems unlikely that international investors will substantially reduce their exposure, given the strong fundamentals of the Indian economy. External debt management will continue to be an area of high priority in the context of overall management of the Indian economy. To consolidate the gains already made, the focus of external debt management policy should stress on high growth rate of exports,
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keeping the maturity structure as well as the total amount of commercial debt under manageable limits, tight control on short-term debt, and encouraging non-debt creating foreign investments flows. These combined with the policy efforts aimed at achieving a commensurate growth in current receipts to service the existing debt will help retain the sustainability status in the long run.

Articles
India’s external debt increases to Rs.632, 051 crore (US$142.7 billion)

India's external debt stock increased by US$6.2 billion to US$142.7 billion (Rs.632,051 crore) as at the end of December 2006 from US$136.5 (Rs. 627,112 crore) billion at end-September 2006 (Table 1). The rise in external debt outstanding at end-December 2006 was due to an increase in

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multilateral debt, external commercial borrowings and NRI deposits, offset by a marginal decline in short-term debt.

While long-term debt outstanding increased over the quarter by US$6,798 million to US$132,641 million, short-term debt declined by US $610 million (5.7 per cent) to US$10,015 million at end-December 2006. Under long-term debt, all the components showed an increase over the quarter. The largest increase was recorded by commercial borrowings; an increase of 11.0 per cent over the quarter taking the amount outstanding to US$ 35,980 million. While multilateral debt rose by US$975 million, bilateral debt showed an increase of US$ 36 million. Export credit outstanding rose by US$299 million. While Rupee debt remained broadly at the same level as at the end of previous quarter, NRI deposits rose by US$1,867 million to US$38,382 million.

Non-Resident deposits continued to account for the largest share of 26.9 per cent in the total debt outstanding at end-December 2006, followed by commercial borrowings at 25.2 per cent and multilateral debt at 24.2 per cent. The share of bilateral debt was 11.1 per cent. Export credit and Rupee debt accounted for 4.2 per cent and 1.4 per cent, respectively. The share of short-term debt was 7.0 per cent as compared to 7.8 per cent at end-September 2006.

India’s foreign currency reserves (foreign currency assets of the RBI, gold, SDRs and Reserve Tranche Position) in the International Monetary Fund was US$177.3 billion at end-December 2006. Foreign currency assets of the RBI stood at US$170.2 billion as on December 31, 2006 providing a cover of around 119 per cent to total external debt stock.

US dollar continued to be the major currency of composition in India’s external debt portfolio. The share of US dollar in the debt stock of the country which increased from 45.4 per cent at
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end-March 2006 to 46.7 per cent in the quarter ended September 2006, had marginally come down to 46.3 per cent at end-December 2006.

Government continued to pursue prudent external debt management policies to maintain external debt within manageable limits. These include emphasis on raising funds under Government borrowing on concessional terms and from less expensive sources with longer maturities, monitoring of short-term debt, prepaying high cost loans, rationalizing interest rates on NRI deposits, restricting end-use of external commercial borrowings, limiting trade credits and encouraging non-debt creating capital flows

Source: Press Information Bureau Posted On: 3/30/2007

External borrowings becoming more expensive Bangalore June 21, With global interest rates showing signs of hardening, external commercial borrowings (ECBs) are beginning to become more expensive.

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Bankers said they have already cautioned some of the intending external commercial borrowers to hedge their open positions. Most international borrowings are currently linked to the London Inter Bank Offered Rate (LIBOR). Six-month LIBOR is currently 5.5 per cent. Inclusive of swap and hedging costs, the effective rates were currently in the region of about 9 per cent. This was assuming that corporates were borrowing at rates of about 100 basis points over LIBOR. The bankers said that indications of a potential hardening of rates were available from the recent hardening of US Treasury yields. The 10-year US Treasury has moved up to 5.2 per cent now from 4.6 per cent in March end, a 0.6 percentage point increase. They said that this trend was likely to continue. Firming of international dollar yields was triggered by China's sale of US Treasuries as a move to reshuffle its $1.2-billion dollar holdings of exchange reserves. China's international reserves are mostly invested in US Treasuries, and long-term bonds. According to data from the US Treasury Department, China and Hong Kong together sold close to about $7 billion between March and April this year. India's holdings of US Treasuries on the other hand remained constant at $20 billion for the same period, according to the data. This sell off was leading to a hardening of dollar yields, the bankers said. The rising yields notwithstanding, India Inc's interest in ECBs stemmed from the advantageous interest rate situation, the bankers said. Currently, ECBs despite rising yields were still cheaper than comparable domestic borrowings by at least 2.5 to 3 per cent. Domestic corporates as a result had borrowed a little over $5 billion to fund their rupee expenditure till March 2007. The ECB flows have continued well into this year and medium rung companies have also begun exploring the option of tapping foreign currency borrowings.
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External commercial borrowings decline in Jan 30 Mar, 2008 MUMBAI: Overseas corporate borrowings by the India Inc declined in January as compared to the preceding two months despite softening interest rates globally as the Central government has put curb on overseas debt. The total overseas borrowings raised by 52 companies through External commercial borrowings (ECBs) and foreign currency convertible bonds declined to 1.18 billion dollars in January from 2.26 billion dollars in December and 2.21 billion dollars in November, according to latest figures released by the Reserve Bank. The Centre has been tightening the norms for ECBs as huge inflows of capital are appreciating rupee and in turn hurting exports. It has announced that not more than USD 20 million raised through ECBs can be brought back to India for rupee expenditure purposes. To remit even USD 20 million, prior approval of the RBI is needed. The ECB data for January showed that most of the overseas debts were used for importing capital goods with NTPC borrowing USD 380 million, followed by Delhi International Airport at USD 200 million and Ashok Leyland at USD 200 million. Jet Airways borrowed USD 231 million, however, for financial lease. Similarly, December also saw the import of capital goods as the prime reason of these borrowings. While Reliance Telecom Infrastructure borrowed the highest amount USD 500 million for the import of capital goods and telecommunications, Shipping Corporation of India raised USD 339 million for capital goods. In November, National Aviation Company of India was the highest borrower at USD 601 million
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for financial lease, followed by Firstsource Solutions which mopped up USD 275 million for overseas acquisitions.

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