samoa-external debt management by tarun das-part-1-text

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Sustainable External Debt Management-International Best Practices and Lessons for Samoa

Dr. Tarun Das*,

Economic Adviser, Ministry of Finance, India

And Resource Person, ESCAP, United Nations, Bangkok.

September 2005

_______________________________________________________________________

* This report expresses personal views of the author and should not be attributed to theviews of either the Ministry of Finance, Government of India or the UN-ESCAP. Theauthor would like to express his gratitude to the UN-ESCAP and the Ministry of Finance,Government of Samoa to provide an opportunity to prepare this report and the Ministryof Finance, Government of India to grant necessary permission for that.

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Sustainable External Debt Management-International Best Practices and Lessons for Samoa

Dr. Tarun Das, Economic Adviser, Ministry of Finance, India

And Resource Person, ESCAP, United Nations, Bangkok.

Contents

1. Conceptual Issues

1.1 Definition of external debt1.2 Debt Sustainability and Fiscal Deficit1.3 Debt Sustainability and Current Account Deficit1.4 Liquidity versus Solvency

2. Debt Sustainability Measurements2.1 Economy wide model in ALM framework2.2 Different Types of Risk2.3 Risk Management2.4 Sustainability Indicators2.5 World Bank Classification of External debt

3. Inter Country Comparisons

3.1 Top ten debtor countries3.2 Selected countries in Asia and Pacific3.3 South Asia, and East Asia & Pacific

4. International Best Practices

4.1 New Zealand4.2 Australia4.3 Ireland4.4 European Union4.5 Fund-Bank Conditionality4.6 HIPC Initiatives4.7 Sovereign Debt Management

5. Management of External Debt in India

5.1 External debt situation in India5.2 External debt management policies5.3 Organisational structure5.4 Contingent liabilities5.5 Fiscal Responsibility and Budget Management Act 20035.6 Monitoring and Dissemination of data5.7 Capacity building5.8 Trends of external debt indicators

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6. Management of external debt in Samoa

6.1 Public external debt in Samoa6.2 Overall external debt in Samoa

6.3 Lessons from international best practices(a) External Debt Management Policies(b) Capacity Building

Selected References

Statistical Tables:

Annex-1: Economic size of selected economies in 2003Annex-2-A: Debt Indicators for top ten debtor countries in 2003Annex-2-B: Indebtedness Classification of top ten debtor countries in 2003

Annex-3: Key indebtedness indicators for selected countries in 2001-2003Annex-4: Key external debt sustainability indicators for selected countries in 2003Annex-5: Further external debt sustainability indicators for these countries in 2003Annex-6: Classification of selected ESCAP countries by levels of external debt andper capita income in 2003Annex-7: External debt in Samoa

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1. Conceptual Issues

Debt sustainability basically implies the ability of a country to service all debts internaland external on both public and private accounts- on a continuous basis without affectingadversely its prospects for growth and overall economic development. It is linked to thecredit rating and the creditworthiness of a country. However, there is no simple answer tothe question- what should be the sustainable or optimal level of debt for a country?Before discussing various measures for sustainable debt management, it is useful toclarify certain basic concepts regarding measurement of external debt.

1.1 Definition of external debt

The Guide on external debt statistics jointly produced by the Bank for International

Settlements (BIS), Commonwealth Secretariat (CS), Eurostat, International MonetaryFund (IMF), Organisation for Economic Co-operation and Development (OECD), ParisClub Secretariat, United Nations Conference on Trade and Development (UNCTAD) andthe World Bank and published by the IMF (2003) defines Gross external debt, at anytime, as the amount of disbursed and outstanding contractual liabilities of residents of a

country to non-residents to repay the principal with or without interest, or to pay interestwith or without principal.

This definition is crucial for collection of data and analysis of external debt:

1. First, it talks of gross external debt, which is directly related to the problem of

debt service, and not net debt.

2. Second, for a liability to be included in external debt it must exist and must beoutstanding. It takes into account the part of the loan, which has been disbursedand remains outstanding, and does not consider the sanctioned debt, which is yetto be disbursed, or the part of the debt, which has already been repaid.

3. Third, it links debt with contractual agreements and thereby excludes equityparticipation by the non-residents, which does not contain any liability to makespecified payments.

4. Fourth, the concept of residence rather than nationality is used to define adebt transaction hereby excluding debt transaction between foreign-owned anddomestic entity within the geographical boundary of an economy. Besides, whileborrowing of overseas branches of domestic entities including banks would beexcluded from external debt, borrowing from such overseas branches by domesticentities would b included as part of external debt.

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5. Fifth, it talks of contractual agreements, and excludes contingent liabilities. For aliability to be included in external debt, it must exist at present and must havecontractual agreement.

6. Finally, the words principal with or without interest include interest free loans

as these involve contractual repayment liabilities, and the words interest with orwithout principal include loans with infinite maturity such as recently popularperpetual bonds as these have contractual interest payments liabilities.

Two other concepts- one relating to interest payments and another relating to short-termdebt need some clarification. While calculating interest, in general an accrual methodrather than the actual cash-flow method is used. In general, short-term debt is defined asdebt having original maturity of less than one year. However, Southeast Asian crisishighlighted the necessity to monitor debt by residual maturity. Short-term debt byresidual maturity comprises all outstanding debt having residual maturity of less than oneyear, irrespective of the length of the original maturity. Residual maturity concept is

distinctly superior to original maturity concept.

1.2 Debt Sustainability and Fiscal Deficit

Debt sustainability is closely related to the fiscal deficit, particularly to the primarydeficit (i.e. fiscal deficit less interest payments). Sustainability requires that there shouldbe a surplus on primary account. It also requires that the real economic growth should behigher than the real interest rate. Countries with high primary deficit, low growth andhigh real interest rates are likely to fall into debt trap.

1.3 Debt Sustainability and Current Account Deficit

Economic theory states that high fiscal deficit spills over current account deficit of thebalance of payments. Persistent and high levels of current account deficit is an indicationof the balance of payments crisis and needs to be tackled by encouraging exports andnon-debt creating financial inflows.

1.4 Liquidity versus Solvency

One important conceptual issue relates to the distinction between debt service problemsdue to liquidity crunch and those due to insolvency. These concepts are borrowed fromthe financial analysis of corporate bodies, but there are distinctions between firms andcountries (Raj Kumar 1999). If a firm has positive net worth but faces difficulty to meetthe obligations of debt service, it is considered to be solvent but to have liquidityproblem. When it has negative net worth, it is insolvent.

There is difficulty to apply these concepts to a country, as it is difficult to value all theassets of a country such as natural resources, wild life, antics in museum, heritagebuildings and monuments. Besides, firms can disappear due to insolvency problems, buta country cannot become bankrupt nor disappear nor are overtaken or merged purely on

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account of financial problems. So we need to consider medium and long term prospectsof a country in terms of growth and balance of payments.

2 Debt Sustainability Measurements

There are broadly two approaches to determine debt sustainability of a country. One is todevelop a comprehensive macroeconomic model for the medium term particularlyemphasizing fiscal and balance of payments problems, and another is to assess variousrisks associated with debt and to monitor various debt sustainability ratios over time.

2.1 Economy wide model in ALM framework

Economy wide model in general is constructed in the Asset and Liability Management(ALM) Framework and is aimed at minimizing cost of borrowing subject to specifiedrisks or to minimize risk subject to specified cost. Benefits of such models are quiteobvious in the sense that the model can be used not only for debt management but also

for determination of optimal growth, fiscal profiles, medium term balance of paymentsetc. However, building up such models requires not only huge data but also expertise onthe part of modelers for which there may be constraints in developing countries.

2.2 Different Types of Risk

There should be a framework that identifies and assesses the financial and operationalrisks for the management of external debt. Risks can be grouped in three broad heads viz.

(A) External market based risks which include

Liquidity risk

Interest rate risk

Credit risk

Currency risk

Convertibility risk

Budget/ Fiscal risk

(B) Operational and Management Risks which include

Operational risk

Control systems failure

Financial error risk, and

(C) Country specific and political risks.Box-1 provides a brief discussion the nature and implications of these risks.

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Box 1. Risks for Management of External Debt

(A) External Market-Based Risks

(A1) Liquidity risk. The pledging of reserves as collateral with foreign financial institutions as

support for loans to either domestic entities, or foreign subsidiaries of the reserve managemententity, renders reserves illiquid until the loans are repaid. Liquidity risks also arise from thedirect lending of reserves to projects (particularly in real estate and share markets) with returnsin domestic currency or to enterprises, which are subject to shocks in external and domesticmarkets and are unable to repay their liabilities in time.

In fact, one of the major factors leading to East Asian financial crisis in 1997-1998 was thatshort-term external borrowing was invested in protected or illiquid sectors having low return andlong gestation period (real estate and petrochemicals in Indonesia, Thailand, Malaysia), sectorswith high or excess capacity having low or negative returns ( steel, ships, semiconductors,automobiles in Korea), non-tradable (such as land, office blocks and condominiums in Thailand)that generate return in domestic currency and did not generate foreign exchange; in

automobiles and electronics with inadequate attention to profitability, andspeculative and unproductive lending in share markets. This created liquidityproblem due to maturity mismatch between assets and liabilities of thefinancial intermediaries.

(A2) Interest rate risks. While fixed interest rate has the advantage of having fixed obligationsof interest payments over time, there may be a substantial loss in a regime of falling interestrates and global trends of soft interest rates. Solution lies to have a proper mix of variable andfixed interest rates.

Losses may also arise on assets from variations in market yields that reduce the value ofmarketable investments below their acquisition cost. Losses may also arise from operations

involving derivative financial instruments.

(A3) Credit risk. Losses may arise from the investment of reserves in high-yielding assets thatare made without due regard to the credit risk associated with the asset. Lending of reserves bythe Central Bank to domestic banks and overseas subsidiaries of reserve management entities,may also expose reserve management entities to credit risk.

(A4) Currency risk. Some element of currency risk is unavoidable with external debt. But,there are instances to denominate debt in a few currencies in anticipation of favorable exchangerates. Subsequent adverse exchange rate movements may lead to large losses.

(A5) Convertibility risk: Easy convertibility of domestic currency may lead to flight of capital

at the slight anticipation of crisis.

(A6) Budget/ Fiscal Risk: Fiscal risk may arise from unanticipated shortfalls in revenue orexpenditure overruns. Government should consider both budget and off-budget liabilities and try

to minimise contingent liabilities, which may represent a significant balance sheet risk for agovernment and are a potential source of future fiscal imbalances. Sound public policyrequires that a government needs to carefully manage and control the risks of theircontingent liabilities. The most important aspect of this is to establish clear criteria as to

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when government guarantees will be used and to use them sparingly.Experience in the industrialised countries suggests that more complete disclosure, betterrisk sharing arrangements, improved governance structures for state-owned entities andsound economic policies can lead to substantial reductions in the governments exposureto contingent liabilities.

(B) Operational and Management Risks

(B1) Operational Risk is the risk that arises from improper management systems resulting infinancial loss. It is due to improper back office functions including inadequate book keeping andmaintenance of records, lack of basic internal controls, inexperienced personnel, and computerfailures. Probability of default is high with inadequate operational and management systems.

(B2) Control system failure risks arise due to outright fraud and money laundering because ofweak or missing control procedures, inadequate skills, and poor separation of duties.

(B3) Financial error risk. Incorrect measurement and accounting may lead to large and

unintended risks and losses.

(c) Country specific and political risks influence multinational companies choicebetween exports and investments, and act as deterrents for foreign investment, whereasscale economies, lower wages, fiscal incentives, high yields, trade openness andagglomeration effects stimulate non-debt creating financial flows. Foreign capital isattracted by countries which allow free repatriation of capital and profits, and donotinsist on appropriation of private capital in public interest.

2.3 Risk Management

Although there is no unique solution to tackle various types of risk, general riskmanagement practices of the government aim at minimizing risk for government bodiesand public enterprises. These include development of ideal benchmarks for public debtand monitor and manage credit risk exposures. Typical risk management policies aresummarized in Table-1.

Table-1 Policies for Risk Management

Type of Risk Risk Management Policies

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

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(i) Develop liquidity benchmarks

2. Interest rate risk (j) Fix benchmark for ratio of fixed versus floating rate debt(k) Maintain ratio of short-term versus long-term debt(l) Use interest rate swaps

3. Credit risk (m) Have credit rating of various scrips by major credit ratingorganizations such as S&Ps, Moodys, Japan Bond Research

Institute etc.(n) Identify key factors that determine credit-rating(o) Develop a culture of co-operation and consultation among different

departments and with credit rating organisations(p) Set overall and individual counter-party credit limits

4. Currency risk (q) Fix benchmark for the ratio of domestic and external debt(r) Fix ratios of short-term and long-term debt(s) Fix composition of currencies for external debt(t) Fix single currency and currency pool debt(u) Use currency swaps and have policies for use of market derivatives(v) Try to have natural hedge by linking dominant currency of exports

and remittances to the currency denomination of debt

5. Convertibility risk (w) It is better to have gradual and cautious approach towards capitalaccount convertibility.

(x) The liberalisation of capital accounts should be donein an orderly manner in line with the strengthening ofdomestic financial systems through adequateprudential and supervisory regulations.

(y) The golden rule is to encourage initially non-debtcreating financial flows (such as foreign directinvestment and portfolio equity investment) followedby long term capital flows.

(z) Short term or volatile capital flows may be liberalisedonly at the end of capital account convertibility.

6. Budget Risk (aa) Enact a Fiscal Responsibility Act.(bb) Put limits on debt outstanding and annual borrowing as a

percentage of GNP or GDP(cc) Use government guarantees and other contingent liabilities (such

as insurance and pensions etc.) judiciously and sparingly(dd) Fix limits on contingent liabilities(ee) Fix targets on fiscal deficit and primary deficit(ff) Fix limits on short term borrowing(gg) Monitor debt service payments

7. Operational risks (hh)Allow independence and transparency of different offices(such as front, back, middle and head offices) dealing withpublic debt

(ii) Strengthen capability of different offices(jj) Try to achieve general political consensus in policy

formulations.

8. Country specificand political risk

(kk) Have stable and sound macro-economic policies(ll) Have co-ordination among monetary and fiscal authorities

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(mm)Try to achieve general political consensus for policyformulation.

2.4 Sustainability Indicators

Debt sustainability indicators are the most widely used ratios for debt management. Theseindicators express outstanding external debt and debt services as a percentage of grossdomestic product or other variables indicating the strength of the economy. Somecommonly used debt sustainability indicators are given in Table-2.

Table-2: Debt Sustainability Indicators

Purpose Indicators

1. Solvency ratios (a) Interest service ratio the ratio of interest payments to

exports of goods and services.(b) External debt to GDP ratio(c) External debt to exports ratio(d) External debt to revenue ratio(e) Present value of debt services to GDP ratio(f) Present value of debt services to exports ratio(g) Present value of debt services to revenue ratio

2. Liquiditymonitoring ratios

(h) Basic debt service ratio- Ratio of debt services (bothinterest payments and repayments of principal) on longterm debt to exports of goods and services.

(i) Cash-flow ratio for total debt or the total debt service

ratio (i.e. the ratio of total debt services to exports ofgoods and services)(j) Interest payments to reserves ratio.(k) Ratio of short-term debt to exports of goods and services(l) Import cover ratio- Ratio of total imports to total foreign

exchange reserves.(m) International reserves to short-term debt ratio(n) Short-term debt to total debt ratio

3. Debt burden ratio (o) Total external debt outstanding to GDP (or GNP) ratio(p) Total external debt outstanding to exports of goods and

services ratio(q) Debt services to GDP (or GNP) ratio(r) Total public debt to budget revenue ratio(s) Ratio of concessional debt to total debt

4. Debt structureindicators

(t) Rollover ratio- ratio of amortization (i.e. repayments ofprincipal) to total disbursements

(u) Ratio of interest payments to total debt services(v) Ratio of short-term debt to total debt

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5. Public sectorindicators

(w) Public sector debt to total external debt(x) Public sector debt services to exports ratio(y) Public sector debt to GDP ratio(z) Public sector debt to revenue ratio

(aa) Average maturity of non-concessional debt(bb) Foreign currency debt over total debt

6. Financial sectorindicators

(cc) Open foreign exchange position- Foreign currency assetsminus liabilities plus long term position in foreigncurrency stemming from off-balance sheet transactions

(dd) Foreign currency maturity mismatch(ee) Ratio of foreign currency loans for real estate to total

credits given by the commercial banks(ff) External sector related contingent liabilities(gg) Trends of share market prices

(hh) GDRs and Foreign currency convertible bonds issued(ii) Inflows of foreign direct investment and portfolioinvestment

7. Corporate sectorindicators

(jj) Leverage (debt/ equity ratio)- Ratio of normal value ofdebt over equity

(kk) Interest to cash flow ratio(ll) Short-term debt to total debt(mm) Return on assets(nn) Exports to total output ratio(oo) Net foreign currency cash flow

(pp) Net foreign currency debt over equity

8. Dynamic ratios (qq) Average interest rate/ growth rate of exports(rr) Average interest rate/ growth rate of GDP(ss) Average interest rate/ growth rate of revenue(tt) Change of PV of debt service/ change of exports(uu) Change of PV of debt service/ change of GDP(vv) Change of PV of debt service/ change of revenue

Source: Raj Kumar (1999) and IMF (2003)

2.5 World Bank Classification of External debt

On the basis of ratio of PV to GNI and PV to XGS (exports of goods and services), theWorld Bank in their report on Global Development Finance 2005 has classified countriesinto three categories viz. low indebted, moderately indebted, and severely indebtedcountries as indicated in Table-3. While PV takes into account all debt servicingobligations over the life span of debt, GNI indicates countrys total potentials and XGS

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indicates foreign exchange earnings reflecting debt-servicing ability. Countries are alsoclassified into low and middle income depending on the level of per capita income.

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Table-4: Classification of selected countries in ESCAP by levels of external indebtedness

And per capita income in 2003

Severely indebted Moderately indebted Less indebted

Low income Middle income Low income Middle income Low income Middle income

SILI SIMI MILI MIMI LILI LIMI

BhutanKyrgyz RepLao PDRMyanmarTajikistan

IndonesiaKazakhstanMaldivesSamoaTurkey

CambodiaMongoliaPakistanPN GuineaSolomon IslandUzbekistan

MalaysiaPhilippinesRussian FedSri LankaTurkmenistan

BangladeshIndiaNepalVietnam

ArmeniaAzerbaijanChinaFijiIran Ism RepThailandTongaVanuatu

3.3 South Asia, and East Asia & Pacific

Table-5 indicates that despite severe foreign exchange and financial crisis at the end of

1990s, East Asia and Pacific countries as a group achieved significant improvement in theexternal debt burden in 1990-2004. South Asian countries as a group also improved theirdebt situation. South Asia has higher shares of multilateral and concessional debt thanthose in East Asia and Pacific. On the other hand, the ratio of reserves as a percentage ofexternal debt is much higher in East Asia and Pacific than in South Asia despitesignificant improvement in the ratio in South Asia over the period.

Table-5 : Trends of Key Debt Indicators

Key external debt indicators East Asia and Pacific South Asia

1980 1990 2000 2004 1980 1990 2000 2004

EDT/XGS (%) 179 132 78 49 154 303 155 113EDT/GNI (%) 17 36 32 24 16 31 27 23TDS/XGS (%) 27 18 11 8 12 28 15 10INT/XGS (%) 14 7 4 2 5 15 6 4INT/GNI (%) 1 2 2 1 1 2 1 1RES/EDT (%) 51 31 57 141 40 7 30 78RES/MGS (months) 9 5 6 8 6 2 5 10

Short-term/ EDT (%) 23 16 13 27 7 10 4 4

Concessional/ EDT (%) 19 29 21 21 73 55 50 52

Multilateral/ EDT (%) 9 15 13 12 25 31 38 36

Notes: EDT = External debt outstanding, GNI = Gross national incomeTDS = Total debt services, INT = Interest paymentsXGS = Exports of goods and services, MGS = Imports of goods and servicesRES = Foreign exchange reserves, Short term = Short term debtConcessional = Concessonal debt, Multilateral = Multilateral debt

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3.3.1.1.1.1.1.1 International Best Practices

3.4 New Zealand

The New Zealand Debt Management Office (NZDMO) is responsible for themanagement of public debt since the separation of debt management policy frommonetary policy in 1988. Although NZDMO is placed in a division in Treasury, itmaintains some degree of autonomy from the rest of the government and has its ownadvisory board. The board meets at least four times a year and consists of a seniormember of the Treasury and experts in risk management. The board provides advice andoversight on wide range of issues relating to operational risk management and promotestransparency in debt management policies and supervision.

The treasurer or the head of the NZDMO recommends benchmarks for sovereign debt in

terms of currency mix and interest rate sensitivity, and trading limits imposed on theportfolio manager. The basic objective of the NZDMO is to identify a low risk portfolioof net liabilities consistent with the governments aversion to risk and expected costs forrisk reduction. In order to minimize the net risk exposure, the NZDMO has set theduration and currency profile of the liabilities to match its assets. As most of thegovernment assets are denominated in New Zealand dollars, the strategy has entailedgradual elimination of net foreign currency debt (which was achieved in September 1996)and lengthening maturity of domestic debt. Assets and liabilities are monitored on dailybasis and the model also incorporates private sector debt management practices. Theactual performance of portfolio managers is evaluated against the benchmark portfolio ondaily basis.

Over these years NZDMO has undertaken considerable amount of works relating toanalysis and management of the government liabilities within an Asset and LiabilityManagement (ALM) framework (Anderson 1999). It has developed both economy widemodels and specific models for the management of public debt. In the wider model, basicobjective is to construct a debt portfolio, which aims at hedging the economy as a wholeagainst shocks to national income or net worth. It requires information on the nature anddegree of private hedging mechanisms, which are highly dispersed and very expensive tocollect. Therefore, NZDMO concentrates on the management of the government assetsand liabilities. It has improved accounting principals and has adopted generally acceptedaccounting and auditing practices.

In recent times, focus has been on maximizing returns and minimizing costs of assets andliabilities using the modern portfolio theory. In contrast to earlier works, it does notinclude physical assets that do not directly produce returns. The model estimates therelationship between the values of various asserts classes (e.g. equities, real estate etc,)and various government liabilities (e.g. debt and the undefended pension liabilities). Toreflect the Crowns total portfolio, the model also includes the measures of the Crownsfuture tax revenues and future social expenditure liability.

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ALM relates essentially to the management of market risk and derivatives are used toachieve desired outcomes. On the basis of ALM modeling, NZDMO specifiesbenchmarks for various sustainability indicators such as ratio of domestic and externaldebt, ratio between debts with floating and fixed interest rates, currency mix, maturity

mix, limits on short term debt, interest rates etc.

Like many sovereign debt management agencies the NZDMO is committed to the principles of transparency, neutrality and even-handedness in its activities. Theexperience of NZDMO (Anderson 2000) leads to the following conclusions:

(a) ALM framework is conceptually appealing but requires huge data.(b) It is relatively easy to include all financial assets and liabilities.(c) The extension of ALM to physical assets and non-traded sovereign

instruments raises a number of issues and practical difficulties.(d) ALM framework is only one component of prudent debt management.

Measures to manage other risks, particularly refinancing, liquidity, andoperational risks need to be established. However, gains in riskmanagement and cost reduction are considerable.

3.5 Australia

The Australian Office of Financial Management (AOFM) established on July 1, 1999 isan independent agency within Treasury and a specialised office to manage Australiangovernments debt position (McCray 2000). However, it has important practical linkageswith the parent departments. Its major task is to identify, measure, monitor and analyzeall kinds of risk, particularly market risk, funding/ liquidity risk, credit risk, operationalrisk etc.

AOFM recognizes that capital account convertibility and liberalisation of trade andfinancial flows present both opportunities and challenges for debt management.Opportunities lie in accessing a truly global and expanded market for debt withpotentially low cost. However, risks arise due to increased financial market volatility andinternationally mobile creditors and investors leading to vulnerability of debt servicecosts, market exposures of debt portfolio and balance sheet net worth.

Australian government introduced accrual budgeting and accounting systems to tacklerisks and contingent liabilities. There is an increasing emphasis on outcomes-orientedapproach to performance reporting, public sector transparency and accountability, andfocus on net worth and risks to net worth.

A comprehensive risk management framework encompassing funding, market, credit,liquidity and operational risks provide the basis for a coherent and objective planning fordebt. A unique feature of the Australian debt management is that the basic organisationalstructure, staffing numbers, skill net, financial resourcing, delegation powers and

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accountability arrangements within AOFM had practically remained unchanged since itsinception.

3.6 Ireland

The National Treasury Management Agency (NTMA) in Ireland is an independent publicdebt office and is in charge of management of all public debt- either internal or externaland also all contingent liabilities (such as savings schemes of the government, pension, provident and insurance funds). The benchmarks are designed in consistent with theannual debt-service budget within which the NTMA has to operate. As such the review ofthe benchmark is annual and matches the budget cycle.

At the beginning of the year, NTMA signs a Memorandum of Understanding (MOU)with the Finance Minister and specifies benchmarks for various parameters such as extentof internal and external loan, currency mix, maturity mix, interest rare mix etc. Thesebenchmarks are developed after careful examination and measurement of various risks

such as liquidity, debt refinancing, maturity of debt etc. MOF does not interfere with theday-to-day working of the NTMA, which has distinct front, back, middle and headoffices and dealing rooms.

The NTMA attempts to beat the benchmark both by funding at different dates than thebenchmark stipulations in order to take advantage of favourable market conditions, andby issuing at different maturities within the broad guidelines regarding proportions offoreign currency and floating rate debt. The performance of the NTMA is evaluated at theend of the year in terms of actual and benchmark portfolios and costs. If NTMA performsbetter than the benchmarks agreed in the MOU, it retains the profits of debt management.Over the years, NTMA has emerged as a highly technical, efficient and profitableorganisation in debt management.

3.7 European Union

The Maastricht Treaty of the European Union set up the framework for the EuropeanMonetary Union, which includes introduction of common currency the Euro. TheTreaty also sets out four convergence criteria to achieve price stability, fiscal prudenceand debt sustainability. These include the following:

(1) Average consumer price inflation should be sustainable and, in the year prior toexamination, should not be more than 1.5 percentage points over that of, at most,the three best performing countries.

(2) The country should not have an excessive deficit. Prima facie a governmentsbudget deficit should not exceed 3% of GDP, and

(3) Its debt should not be more than 60% of GDP.(4) Average nominal long-term interest rates should not exceed, by more than two

percentage points the long-term interest rates of, at most, the three bestperforming member states in terms of price stability.

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Individual countries within European Union have developed independent debtmanagement systems and procedures within these broad principles. Several countrieshave developed benchmarks for currency composition and maturity mix of external debt.Institutional constraints that limit influence the benchmarks include limiting currency

composition of foreign debt to that of reserves portfolio (e.g. United Kingdom) andmaintaining a fixed percentage of foreign exchange in a specific currency such as theECU to develop debt market of that currency (e.g. France and Italy).

In Sweden, the benchmark serves as the limit within which the foreign currency debt maybe exposed to currency and interest rate risks. The Sweden debt Office (SNDO) laysdown the risk limits and takes position in the foreign exchange and bond markets to bringthe long-term cost of the debt below that of benchmark portfolio. The currencycomposition of the benchmark primarily matches the weights of the currencies in theECU basket while US dollar and Japanese Yen are included in the portfolio fordiversification. The SNDO may deviate from the currency mix benchmark by 3

percentage points, and that for duration benchmark by 0.5 percentage points. The interestrate structure of the benchmark is based on diversified borrowing along the yield curve toreduce shocks to specific parts of the yield curve and to reduce bunching of debtpayments over time.

In Denmark, benchmarks for various indicators and the maximum level of deviationsfrom the benchmarks are specified.

In Hungary, the debt management office located in the Ministry of Finance is responsiblefor servicing the cost of the net sovereign external debt. The authorities align the currencycomposition of the external debt through hedging operations with that of the currencybasket to which the national currency is pegged. Emphasis is placed on lengthening thematuring of the debt, maintaining more than three quarters of the debt in fixed rateinstruments, and evenly spreading debt redemptions to avoid rollover risks.

3.8 Fund-Bank Conditionality

Countries seeking finances from the multilateral financial institutions like the IMF,IBRD, ADB and others have to satisfy certain conditionalities in terms of fiscal prudence,monetary discipline, sustained debt and balance of payments situation and price stability.For instance the Funds Structural Adjustment Facility (SAF), the Enhanced StructuralAdjustment Facility (ESAF) and Stand-by Arrangement specifically provide limits on theextent of borrowing that countries can contract within any year and specify the types ofborrowing a country can resort to. Non-compliance of these limits or performance criteriawill usually result in withholding of further disbursement.

In many cases, conditionalities imposed by the multilateral organizations helped debtorcountries to implement structural reforms and stabilization policies, which were long overdue. India is a case of successful reforms. Since June 1991 India had undertaken crediblereforms in trade, industry, investment, fiscal and financial sectors, which were not

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possible in tranquil economic situation. In fact, conditions agreed to external donors afterthe Gulf crisis in 1990 helped India to come out of a severe balance of payments crisisand to avoid default on external debt payments. Major conditionalities includeddevaluation of Indian rupee, full convertibility on current account, partial convertibilityon capital account, reduction of fiscal deficit, reduction of customs duties, rationalization

of user charges for public goods and services, downsizing the government, privatization,decentralization, deli censing, deregulation and anti-corruption strategies. India was ableto come out of the crisis without debt write-off or rescheduling of external debt. At thesame time, India moved on a higher growth path with less inflation, less poverty, moreemployment and higher real wages.

Fund-Bank in association with other international financial organizations are attemptingto implement a new financial architecture to tackle volatile financial flows and to preventmoney laundering. India along with other developing countries welcomed theestablishment and implementation of internationally accepted standards and codes topromote financial stability, but urged that there should be a clear prioritization among the

proliferating population of standards and that the acceptance by developing countriesshould remain voluntary and should not form a part of IMF conditionalities.

3.9 Heavily Indebted Poor Country (HIPC) Initiatives

The HIPC Initiative was launched by the World Bank and the IMF in 1996 (and latterenhanced in 1999) as a comprehensive effort to eliminate unsustainable debt in theworlds poorest and heavily indebted countries. The initiative was designed to help theHIPCs that show a strong track record of economic reforms and adjustment, to achieve asustainable debt position in the medium term through the provision of debt relief to thesecountries. It was perceived that an efficient management of public debt was the mostimportant factor leading to unsustainable debt position. Together with soundmacroeconomic policies, prudent debt management in the HIPCs remains central toensuring durable exit from the unsustainable debt burden.

A recent survey by the staff of the World Bank and the IMF revealed that there areseveral weaknesses in key aspects of debt management in the HIPCs, particularly in thedesign of their legal and institutional framework and coordination among severalorganizations for performing basic debt management functions (IMF and World Bank2003). Institutional weakness is due to insufficient human, technical and financialresources, which need urgent corrections. In addition, transparency and accountability indebt management, including public access to debt information, requires strengthening.

3.10Sovereign Debt Management

While organizing the Second Forum on Sovereign Debt Management in November 1999,World Bank conducted a survey on sovereign debt management in the countriesparticipating in the Forum. The results of the survey summarised in Table-6 are revealingand self-explanatory.

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Table-6 World Bank Survey on Second Sovereign Debt Management Forum

Items Percentagein total

respondents

1. Debt management objectives and priorities

(a) Minimise financial costs and risks 38(b) Funding management 26

(c) Management of debt 15

(d) Development of financial markets 9

(e) Others 13

2. Establishment of benchmarks for risk management

(a) Countries establishing guidelines for risk management 45

(b) Countries establishing benchmarks for foreign currency debt 24

(c) Countries establishing benchmarks for portfolio performance 21

(d) Countries establishing benchmarks for domestic currency debt 13

3. Risk management guidelines(a) Limit currency risk 35

(b) Avoid excessive short-term debt / to smooth maturity profile 29

(c) Debt in least volatile currency 24

(d) Limit on debt with floating interest rate 18

(e) Debt matching reserves 12

(f) Others 18

4. Analytical techniques for undertaking risk analysis

(a) Not using any analytical techniques 32

(b) Value-at-Risk (VAR)/ Cost-at-Risk (CAR) 23

(c) Debt sustainability indicators 16

(d) Others 295. Constraints for establishing benchmarks

(a) Lack of debt management policy 23

(b) Lack of debt management expertise 23

(c) No access to financial markets 13

(d) Lack of debt monitoring 10

(e) Difficult economic environment 10

(f) Others 21

6. Use of derivatives to hedge currency and interest rate risks

(a) Currency swaps 31

(b) Interest rate swaps 24

(c) Use of exchange commodity futures and options 77. Constraints for using derivatives

(a) Lack of technical knowledge 71

(b) Undeveloped financial markets 17

(c) Legal constraints 12

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Items Percentagein total

respondents

8. Institutions managing the foreign currency debt

(a) Ministry of Finance 51

(b) Jointly by the Ministry of Finance and the Central Bank 30

(c) Central Bank 11

(d) Independent Debt Office 9

9. Coordination of both public and public debt

(a) Ministry of Finance 35

(b) Jointly by the Ministry of Finance (MOF) and the Central Bank (CB) 24

(c) Partly by MOF and partly and independently by the CB 24

(d) Debt Management Committee 18

10. Highest authority for approval of foreign currency debt Dom.debt Ext.debt

(a) Finance minister/ Governor of the Central Bank 72 49

(b) Parliament 6 21(c) Interministerial board 8 12

(d) President/ Prime Minister 6 9

(e) DG of independent authority 8 9

11. Average time taken for approval of external debt

(a) One day or less 10

(b) Less than a week 13

(c) More than a week, but less than three months 65

(d) More than three months 13

12. Management of Contingent liabilities

(a) Subnational entities are allowed to raise their own funding abroad 69

(b) Central govt provides explicit guarantees for IBRD loans 68(c) Central govt bears fully the exchange rate risk for IBRD loans 41

(d) Central govt shares partially the exchange rate risk 11

13. Efficiency of Middle Office

(a) Use of Market Information system (MIS) 76

(b) Access to internet 91

(c) No Middle Office Unit 43

(d) Distinct Middle Office Unit 43

(e) Middle Office placed under the direction of the Front Office 3

14. Main constraints for external debt management

(a) Lack of proper organisational structure 31

(b) Macroeconomic risk 14(c) Lack of technical staff in the middle office 12

(d) Lack of technical staff in the back office 6

(e) Lack of legal framework 6

(f) Limited local debt market 6Source: Fred Jensen (2000) as given in World Bank (2000)

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5. Management of External Debt in India

5.1 External Debt Situation in India

Although Indias external debt increased from US$83.8 billion at end-March 1991 to

US$123.3 billion at end-March 2005, as percentage to GDP it declined from 28.7 per centto 16.7 per cent over the period (Table-7). External debt is predominantly long-term. Theshare of short-term debt in total debt declined from 10.2 per cent in 1990-91 to 5.7 percent in 2004-05.

Official creditors and official borrowers

Shares of official debtors, official creditors and concessional loans in total external debtdeclined substantially during 1990 to 2005 (Table-7 and Table-8) implying inflows ofmore private and commercial debt. This must have enhanced the cost of externalborrowing.

Table-7: Trends of external debt of IndiaYearEnd

Total ExtDebt

As % ofGDP

Shortterm

OfficialCreditors

OfficialDebtors

Conce-ssional

(US$ Bln) Per cent Per cent Per cent Per cent Per cent

1990-91 83.8 28.7 10.2 64 60 461995-96 93.7 27.0 5.4 64 57 452000-01 101.3 22.6 3.6 51 43 352001-02 98.4 21.2 2.8 52 44 362002-03 105.0 20.3 4.4 48 42 372003-04 111.7 17.8 4.0 45 40 362004-05 123.3 16.7 5.7 43 39 34

Table-8 Creditors and Debtors Composition of External debt of India (per cent)Creditor Composition (per cent) Debtor composition (per cent)

Creditors March1991

March2005

Debtors March1998

March2005

Multilateral 28 26 Government 50 39

Bilateral 36 17 Non-government 50 61

Non-resident Indians 17 26 -- Financial Sec 22 34

Others 23 34 -- Public sector 10 17

-- Private sector 13 4

-- Short-term 5 6

Total 100 100 Total 100 100

Currency composition

US dollar is the most important currency in the currency composition of Indias externaldebt (Table-9). Other important currencies are SDR, Indian rupees, Japanese Yen, Poundsterling and Euro which together accounted for 55 per cent of the outstanding externaldebt at the end of March 2005.

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Government guaranteed external debt

Government of India raises external loans on its own account under external assistance program and also provides guarantees to external borrowings by the public sectorenterprises, developmental financial institutions and a few private sector companies

under the BOT schemes for infrastructure development. All loans taken by the non-government sectors from multilateral and bilateral creditors involve guarantees by thegovernment. Such guarantees given by the government form part of sovereign liability asthe guarantees could be invoked in the case of default by the borrower. Thus, guaranteestantamount to contingent liability of the government. However, share of guaranteed loansin total external debt has declined continuously over the years and now accounts for only5.5% of total external debt.

Table-9 Currency composition of Indias external debtCurrency March 1996 March 2005

US dollar 41 45

SDR 15 16

Indian Rupees 15 19

Japanese Yen 14 11

Euro 9* 5

Pound sterling 3 3

Others 3 1

Total 100 100

* DM, French Franc, Netherlands Guild

Table-10 Total contingent liabilities (i.e. government guaranteed debt)

Year As per centto GDP

As per cent tototal external debt

1994 4.3 13.11995 3.7 12.52000 1.3 7.3

2002 1.5 7.12003 1.3 6.22004 1.0 5.8

2005 1.0 5.5

5.2 External Debt Management Policies

India has been able to manage its external debt situation despite serious balance of payments problems at the beginning of 1990s on account of gulf war leading todisruptions of Indian exports and remittances by non-resident Indians living in the gulf.Policy emphasis has been on resorting to concessional and less expensive fund sources,preference for longer maturity profiles, monitoring short-term debt, pre-payment of highcost debt and encouraging exports and non-debt creating financial flows.

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Careful management of external debt allowed India to retain policy-making sovereigntyand not to be wholly influenced by the conditionalities imposed by the multilateralfunding agencies. In fact, in recent years India prepaid a part of more expensive debtfrom the World Bank, the Asian Development Bank and some bilateral countries. Theyinsisted for substantial reduction of food and fertilizer subsidies and overall fiscal deficit,

which were not politically feasible for a coalition government. Effective public debtmanagement also helped government to adopt a step-by-step approach to liberalizationand to adopt effective safety nets for the weaker and vulnerable sections of the society byexpanding and strengthening various anti-poverty and poverty alleviation programs.

India adopted a cautious, gradual and step-by-step approach towards capital accountconvertibility. Initially non-debt creating financial flows (such as FDI and portfolioequity) were liberalized followed by liberalization of long-term debt flows and partialliberalization of medium term external commercial borrowing. There was tight control onshort-term external debt and close watch on the size of the current account deficit. Capitalaccount restrictions for residents and short-term debt helped India to insulate from the

East Asian economic crisis during 1997-2000. There was high share (80% at the end ofMarch 2000) of concessional debt in government accounting and there was nogovernment borrowing from external commercial sources and no short-term external debton government account. Maturity of government debt concentrated towards long-end forthe debt portfolio (GOI-MOF 2005).

5.3 Organisational structure

The organisational structure for sovereign external debt management consists of thefollowing offices:

(a) Front offices, which are responsible for negotiating new loans. Variousdivisions in the Ministry of Finance (MOF) such as Fund-Bank, ADB, EEC,Japan, America, ECB divisions, and the Reserve Bank of India (for IMF loans)act as front offices.

(b) Office of Controller of Aid, Accounts and Audit in the MOF acts as the BackOffice, which is responsible for auditing, accounting, data consolidation and thedealing office functions for debt servicing.

(c) External Debt Management Unit (EDMU) in the MOF acts as the MiddleOffice, which is responsible for identification, measurement and monitoring ofdebt and risk, dissemination of data and policy formulation for both short andmedium term.

(d) The Finance Minister acts as the Head Office and accords final approval forboth internal and external debt.

Under the Indian constitutional provisions, States cannot borrow directly from externalsources and the Central government has to intermediate external borrowings and bearexchange rate risk for the states. Currently, external assistance is passed on to the stateson the same terms and conditions as for normal central assistance for state plans i.e. in90:10 mix of grant and loan to the hilly and backward states (the so-called special

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category states) and 30:70 mix of grant and loan to other states. Loans carry an interestrate of 11.5% with maturity of 20 years including moratorium of 5 years. The systeminvolves certain amount of concession provided to the states.

Recently, on considering the high transactions cost of large number of low value projects,

tied assistance, and strict conditionalities, government has taken a policy decision toprune the number of bilateral creditors from over 18 to only six namely Japan, UnitedKingdom, Germany, USA, European Commission and Russian Federation. Governmenthas also decided to pre-pay outstanding bilateral debt except to Japan, Germany, USAand France. The decision was also partly influenced by the substantial build up of foreignexchange reserves and low interest rates in the domestic countries.

Those bilateral countries, from which it has been decided not to receive developmentassistance on government account, have been advised to provide their developmentassistance to non-governmental organisations and the Universities etc. Accordingly,countries like Australia, Belgium, Canada, Denmark, France, Italy, Netherlands, Norway,

Sweden, Switzerland and others are now providing assistance directly to the NGOs forprimary education, urban water supply and sanitation, HIV/AIDS prevention and care,strengthening environment institutions and poverty alleviation program.

India provides technical assistance under the Technical and Economic Cooperation(ITEC) Program and the Special Commonwealth African Assistance plan (SCAAP) to141 developing countries in Asia, Africa, Latin America, Eastern Europe and the Pacific.India is also participating actively in the international initiative for economicdevelopment of HIPC (Heavily Indebted Poor Countries) and other developing countries.Under the HIPC, India is providing credit lines to seven eligible HIPC countries viz.Mozambique, Tanzania, Zambia, Ghana, Guyana, Nicaragua and Uganda. Thegovernment has waived the outstanding dues from these countries. In addition, Indiaprovides credit lines to a number of developing countries.

An effective system is in place to measure and monitor the level and indicators of debt.Some of the important sustainability and liquidity indicators include external debt to GDPratio, debt service ratio, maturity and present value of debt, short-term debt by originaland residual maturity, ratios of debt to other indicators such as exports of goods andservices, and foreign exchange reserves. Statistical improvement and technologicalupgradation have been done to monitor these parameters on real time basis.

5.4 Contingent liabilities

As discussed earlier, in addition to direct liabilities for external debt, government of Indiahas various contingent liabilities in terms of government guarantees for the loans takenby the public enterprises, exchange rate risk and guarantees given to the first track large power projects by the independent power producers. During 1990s, as percentage ofGDP, there was a steady decline of the contingent liabilities of the central government(from 7.8% to 4.2%), but an increase in the liabilities of the states (5.7% to 7%) (Das,Bisen, Nair and Kumar 2001). Many states initiated measures to contain the growth of

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Greater transparency in the budgetary process, rules, accounting standards and

policies having bearing on fiscal indicators.

Quarterly review of the fiscal situation

5.6 Monitoring and dissemination of data

100% government debt data and 78% of total external debt data are computerized on thebasis of Commonwealth Secretariat DRMS. The Ministry of Finance has undertakenprojects to computerise fully NRI deposits and short term debt, which account for theresidual 22% of total external debt.

Historical trends and future projections of debt stock and debt services are available foranalysis, scenario building and as MIS inputs. Debt Data are updated quarterly for March,June, September, December. June 2005 debt data are now under compilation. Data byboth Creditors and Debtors classification and by currency, maturity and interest mix are

available. Data cross-classified by institutions and instruments are also available.

Time lag for data update: is 8 weeks, which is well below the IMF benchmark set underthe Special Data Dissemination Standard (SDDS). A Status Report on External Debt ispresented by the Finance Minister to the Parliament every year. The report is also postedon the MOF homepage (www.nic.in/finmin/miscellaneous).

5.7 Capacity Building

World Bank provided a Grant under the Institutional Development Fund (IDF) forstrengthening capacity building and policymaking process for management of Indian

external debt. The Grant yielded rich dividends and involved all stakeholders in thepolicy of policymaking and helped in bridging research and policy. The IDF Grant helpedto computerise the database and disbursements and payments system for external publicdebt on real time basis and reduced transactions cost significantly. Under the IDF grantthe Ministry of Finance organized three international seminars and one workshop withactive participation by the World Bank, RBI, academicians and all stakeholdersconcerned with external debt and non-debt creating financial flows. The executiveagencies published three Books on papers and proceedings (CRISIL 1999 and 2001 andRBI 1999). These seminars recommended various reforms for external sectors. Most ofthe policy recommendations were accepted by the government.

Ministry of Finance also set up various working groups comprising members from thegovernment, RBI, financial institutions, private and public corporate bodies and professionals having expertise and the experience on the selected subjects. Membersvisited foreign countries to understand international best practices for management ofexternal debt. These countries included Australia, Ireland, New Zealand, UK and USA.Expert Groups submitted the following reports:

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(1) Report on Monitoring of Non-Resident Indian Deposits.(2) Report on Monitoring of Short-term External Debt.(3) Report on Monitoring of non-debt financial flows.(4) Report on Measurement of External Sector Related Contingent liabilities.

(5) Report on Modeling Sovereign External Debt and External Debt Sustainability.(6) Report on Middle Office for Public Debt(7) Report for the Establishment of the Centre of Excellence for Training.

5.8 Trends of External Debt Indicators

All these measures paid rich dividends. There has been a significant improvement in theexternal sector. India overcame a severe balance of payments crisis without any debtwrite-off. Subsequently, India was able to prepay $7.2 billion of external debt to themultilateral funding agencies and bilateral countries during 2002-03 and 2003-04.

Total foreign exchange reserves increased from US$1 billion, equivalent to two weeksimports in June 1991 to US$142 billion equivalent to 20 months of imports in March2005. The current account balance, which recorded a deficit of 3.1 percent of GDP in1990-91, had a surplus since 2001-02. Foreign investment inflows improved from total ofUS$1 billion in 1980s to $40 billion in 1990s due to stability of the exchange rate,continual reforms in infrastructure and liberalisation of foreign investment policies.

External debt indicators also showed steady improvement. In terms of stock of externaldebt, Indias position improved from the third rank after Brazil and Mexico in 1990 to theeighth rank after Brazil, China, Argentina, Russian Federation, Mexico, Turkey andIndonesia in 2003 (Annex-2-A). The debt-to-GDP ratio declined continuously from 38 %in 1991 to 20 % in 2003 and further to 18 % in 2004. The debt-service ratio (i.e. the ratioof total debt services to gross receipts on the current account of the external sector) alsodeclined continuously from 35 % in 1990 to 16 % in 2003-2004 and further to 6 % in2005. The World Bank now classifies India as a low indebted country.

Table-11 Debt sustainability indicators for India during 1990-2005 (per cent)Year Debt

serviceratio

Debt/GDPratio

Debt/CurrentReceiptsratio

Concessionaldebt toTotal debt ratio

ShortTerm toTotal debtratio

ShortTerm toForexreserves

Shortterm debtto GDPratio

Interest tocurrentreceiptsratio

1990-91 35.3 28.7 329 46 10 382 3.0 16

1991-92 30.2 38.7 312 45 8 126 3.2 13

1995-96 26.2 27.0 189 45 5 30 1.4 9

2000-01 16.2 20.3 110 37 4 9 0.8 62003-04 16.2 17.8 99 36 4 4 0.7 4

2004-05 6.1 16.7 95 35 6 5 0.6 2

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6. Management of External debt in Samoa

6.1 Public external debt in Samoa

The Ministry of Finance of the government of Samoa is in charge of the management andrecording of both domestic debt and external debt of the government, while the CentralBank of Samoa is in charge of the management and recording of the private external debt.Within the Ministry of Finance, two independent divisions viz. the Aid Co-ordinationDivision and the Accounts Division deal with external debt and domestic debtrespectively. As in the case of India, the Government of Samoa uses the CommonwealthSecretariat Debt Recording and Management System (CS-DRMS).

The Debt Management Unit in the Ministry of Finance is in charge of keeping records,monitoring debt and making analysis of trends. It is specifically entrusted with thefollowing duties and functions:

To keep accounts of government external debt. To maintain consolidated database under the CS-DRMS.

To make forecasts and produce quarterly updates on government external debt.

To project and execute debt servicing for external loans.

To assist in preparing and finalizing subsidiary loan agreement.

Presently, external debt of Samoa is managed according to the provisions and guidelinesunder the Public Finance Management Act (PFMA) 2001. According to this Act, beforeraising any loan the Finance Minister has to ensure that the access to foreign funds is inpublic interest, consistent with government policies, in accordance with principles ofresponsible fiscal management, and the government has the financial ability to meet the

attendant obligations for repayment of debt and payment of interests.

Table-12: Government External Debt in Samoa (in million US dollars)

1997 1998 1999 2000 2001 2002 2003 2004

Total Debt stock (EDT) 142.2 147.1 147.0 143.7 141.7 147.8 162.2 168.5

Multilateral 130.4 135.4 135.7 129.8 128.2 135.1 149.4 156.0

Bilateral 11.8 11.7 11.3 13.9 13.5 12.7 12.8 12.5

Gross Domestic Product (GDP) 226.3 219 229.1 228 234.9 275.1 341.2 389.9

Exports of goods and services (XGS) 70.2 75.7 79.3 70.3 76.6 85.9 100.6 110.5

International reserves (RES) 57.1 60.7 60.6 55.7 49.2 55.6 73.5 82.3

Key external debt sustainability indicators (in per cent)

EDT/ GDP (per cent) 62.8 67.2 64.2 63.0 60.3 53.7 47.5 43.2

EDT/ XGS (per cent) 202.6 194.3 185.4 204.4 185.0 172.1 161.2 152.5

EDT/ RES (per cent) 249.0 242.3 242.6 258.0 288.0 265.8 220.7 204.7

Multilateral/ EDT (per cent) 91.7 92.0 92.3 90.3 90.5 91.4 92.1 92.6

Bilateral/ EDT (per cent) 8.3 8.0 7.7 9.7 9.5 8.6 7.9 7.4

Source: Ministry of Finance, Government of Samoa

Ministry of Finance has fairly detailed information on government external debt. Trendsof government external debt, as per statistics provided by the Ministry of Finance, are

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given in Table-12. It may be observed from the table that the ratio of governmentexternal debt to GDP has declined continuously 67.2 per cent in 1998 to 43.2 per cent in2004, while that to exports of goods and services declined from 203 per cent to 152 percent, and that to foreign exchange reserves declined from 249 per cent to 205 per centduring the same period.

As regards creditors sources of multilateral debt, Asian Development Bank has a share of52 per cent in the outstanding public debt followed by IDA (39 per cent), EuropeanUnion (5 per cent) and OPEC and IFAD (2 per cent each). As regards creditor sources ofbilateral debt, China has a predominant share of 94% followed by Saudi Arabia at adistant second with a share of 4% and France 2%.

EU

5%

ADB

52%OPEC

2%

IDA

39%

IFAD

2%

EU ADB OPEC IDA IFAD

Figure-1: Creditor Sources of

Multilateral Debt

China

94%

France

2%

Saudi

Fund

4%

China France Saudi Fund

Figure-2: Creditor Sources of

Bilateral Debt

Maturity mix given in Table-13 indicates that 93 per cent of loans are concentrated in theupper end of maturity. As regards sectoral distribution (Table-14), infrastructuredevelopment has the highest share (34 per cent) in total debt followed by agriculture(18%), telecommunications (11%), industry (10%), and power (10%). SDR is the pre-dominant currency followed by US dollar (Table-15).

Table-13 Maturity Mix of Govt Debt Table-14 Sectoral distribution of govt debt

Maturity % of Debt Sectors % of Debt

1-2 years 0.3 1. Infrastructure 34

> 2-4 years 0.6 2. Agriculture 18

> 4-5 years 0.3 3. Telecommunications 11

> 5-10 years 5.2 4. Industry 10> 10-15 years 6.9 5. Power 10

> 15yars 86.7 6. Others 17

Total 100 Total 100Source: Ministry of Finance, Government of Samoa

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Table-15: Currency composition of government debt

Currency % of govt. debt

1. Special drawing rights (SDR) 71

2. United States dollar 17

3. Chinese Yuan/ Renminbis 74. Euro 5

Total 100

6.2 Overall external debt in Samoa

Along with other countries, World Bank publishes external debt statistics for Samoa inthe Global Development Finance (GDF). The World Bank provides data for both publicdebt and private, and for both long term and short-term debt in terms of US dollar. In thelatest issue of GDF (2005), the World Bank has classified Samoa as a severely indebtedmiddle-income country.

As mentioned in the previous section, the central Bank of Samoa and the ministry ofFinance, Government of Samoa also publish external debt statistics. But, they providedata for only the government external debt, which is basically long-term debt, and donotprovide any information on short-term debt and private external debt.

Thus the external debt figures given by the World Bank and the Samoa government arenot strictly comparable. The analysis in this section is based on World Bank data, whichare supplemented by export data for the years 2000-2003 given by the government ofSamoa. Exports data for these years are not available in the World Bank GDF (2005).

As per the World Bank statistics given in Table-16, in recent years, external indebtednessof Samoa has worsened. The external debt to GNI ratio increased substantially from 56per cent in 1990 to 138 per cent in 2003 and the external debt to export ratio increasedfrom 98 per cent to 333 per cent over the same period. The deterioration in external debtsituation is the result of declining share of concessional debt from 91 per cent in 1990 to46 per cent in 2003 and that of multilateral debt from 88 per cent in 1990 to 43 per cent in2003. It is also due to continual increase in the share of short-term debt in total debt fromnegligible amount in 1990 to 54 per cent in 2003.

Although the present debt service ratio at 12 per cent is moderate and the country hassufficient foreign exchange reserves, equivalent to 11 months imports cover, increasing

trend of debt services with nominal increase of exports of goods and services may createliquidity and unsustainability problems in immediate future.

Substantial increase of short-term debt is a matter of concern. It is also not known forwhat purpose this money is being used and whether the sectors, which are using the shortterm external capital, has the capacity to pay back debt and make interest payments.

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Table-16 External Debt of Samoa (in US$ million)

Indicators \ Years 1970 1980 1990 1999 2000 2001 2002 2003

Total Debt stock (EDT) 2.7 60.2 92 192.4 197.4 204.3 234.4 365.2

Long term debt 2.7 53.4 91 156.6 147.3 143.3 156.8 169.5

Public & guaranteed 2.7 53.4 91 156.6 147.3 143.3 156.8 169.5

Private non-guaranteed 0 0 0 0 0 0 0 0

Use of IMF credit 0 5.8 0.8 0 0 0 0 0

Short-term debt 0 1 0.2 35.8 50.1 61 77.6 195.7

Total debt service 0.1 5.5 5.5 6.5 8.5 7.4 7.8 13.1

Interest payments (INT) 0 2.7 1.3 3.2 4.3 3.9 4.3 8.9

Interest on long term debt 0 2.3 1.2 1.4 1.4 1.3 1.3 1.3

Interest on short term debt 0 0.4 0.1 1.8 2.9 2.6 3.0 7.6

Gross national income (GNI) 164.3 235 241.1 235 240.8 264.6

Exp.of goods and services (XGS) 44.4 94.1 126.9 103.9 95.6 105.0 109.5

Workers remittances 0 19 43 45 45 45 45 45

Imp.of goods & services (MGS) 74.3 96.5 142.6 93.6 102.1 100.1 90.4

International reserves (RES) 5.2 2.8 69 68.2 63.7 56.6 62.5 83.9

Current account balance 12.9 8.6 -18.8 10.3 -6.5 4.9 19.1

Sustainability Debt indicators (in per cent)

EDT/ XGS 136 98 152 190 214 223 333

EDT/ GNI 56 82 82 87 97 138

TDS/ XGS 12 6 5 8 8 7 12

INT/ XGS 6 1 3 4 4 4 8

INT/ GNI 0.8 1.3 1.8 1.6 1.8 3.3

RES/ EDT 193 5 75 35 32 28 27 23

RES/ MGS (months) 0.5 9 6 8 7 7 11

Short-term/ Total debt 0 2 0 19 25 30 33 54

Concessional/ EDT 90 56 91 80 73 69 66 46

Multilateral/ Total debt 90 54 88 77 70 63 61 43Source: (1) World Bank, Global Development Finance 2005 (For all data except for current A/C

balance and XGS for the years 2000 to 2003).(2) Economic Intelligence Unit (for current account balance in 2000-2003).

(3) Ministry of Finance, Government of Samoa (for exports of goods and services in 2000-2003)

As short-term debt may create liquidity problems and add to volatility in the foreignexchange markets, the Ministry of Finance in association with the Central Bank of Samoashould make appropriate arrangements to collect information and monitor short-termexternal debt on regular basis..

Samoa should make all possible efforts to enhance exports and encourage tourism to earnforeign exchange for servicing external debt. However, Samoas export base is limited. In2003, fresh fish accounted for 36 per cent of exports, followed by garments 30 per cent,beer 9 per cent, coconut cream 7 per cent and copra 3 per cent. Major destinations forexports were Australia (76 per cent), USA (6 per cent), American Samoa (2.5 per cent),New Zealand (2.3 per cent) and Germany (1.2 per cent). Efforts may be made to enhanceexports to New Zealand, which is the major source (accounting for 22 per cent) of Samoaimports.

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(j) There is a need for setting up an integrated Public Debt Office for the followingfunctions:

o To deal with both domestic & external debt

o To set bench marks on interest rate, maturity mix, currency mix, sources

of debto Identification and measurement of contingent liabilities

Policy formulation for debt management

Monitoring risk exposureso Building Models in ALM framework

(k) It is vital that external forward liabilities and short-term debt are kept within

prudential limits.(l) It is important to strengthen public and corporate governance and enhancetransparency and accountability.(m) It is also necessary to strengthen the legal, regulatory and institutional set up formanagement of both internal and external debt.(n)A sound financial system with well developed debt and capital market is an integral partof a countrys debt management strategy.

(b) External Debt Management Strategy

In all the East Asian crisis economies, weaknesses in financial systems as a result of weakregulation and supervision and a long tradition of a heavy government role in creditallocation led to misallocation of credits and inflated asset prices. Another vital weaknessof all countries was associated with large unhedged private short-term foreign currencydebt in a setting where the private corporate sector was highly leveraged.

Short-term foreign currency denominated debt created two kinds of vulnerabilities inthese economies.First, if some creditors pulled out their money, each individual creditorhad an incentive to join the queue. As a result, even a debtor that had been fully solventbefore the crisis could be plunged into insolvency. Second, such debts also created

vulnerabilities associated with the exchange rate depreciation. Exchange risk was eitherborne directly by the financial institutions or passed on to the corporations as the fundswas on lent (thereby converting exchange risk into credit risk). These factors were furthercomplicated by the interaction of exchange rate and credit risks. Currency depreciationled to wide spread insolvency and created additional counter-party risk, which in turnadded momentum to the exit of foreign capital.

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The management of debt crisis faced by the East Asian countries was not withoutprecedence. Following the inception of the Latin American debt crisis in 1982, and on thepresumption that the debt problem was one of liquidity and not solvency, the initial debtmanagement strategy aimed at normalising the relationship between the debtors andcreditors through a combination of economic adjustment by debtor countries and

negotiations on financial relief. The financing modalities provided debtor countries withsome financial relief through interest rate spreads, reduced fees, and extension ofmaturities and provision of some new finances. The negotiations conducted on a case-by-case approach for debtor countries were co-ordinated by the private bank steeringcommittees in consultation with the IMF, World Bank and governments of the creditorbanks home countries (Islam 1998).

In the case of Asian crisis, countries succeeded in striking a reasonably comprehensivedebt-rescheduling strategy with creditor banks. The implementation of the deal wasvoluntary and all creditors did not join the scheme. So long as free movement ofinternational capital is allowed, there is no guarantee that the debt crisis will not recur in

future. Whenever such a financial crisis occurs in future, it is necessary to formulate aninternational debt management strategy on the basis of negotiations among internationalprivate lenders, investors and borrowers for sharing the responsibility for debt relief, forrescheduling or for delaying claims on repayment.

More effective structures for orderly debt workouts, including better bankruptcy laws atthe national level and better ways at the international level of associating private sectorcreditors and investors with official efforts are needed to help resolve sovereign andprivate debt problems.

In the case of East Asian crisis, considerable thought was given to mechanisms thatinvolve private sector to forestall and resolve crisis in a more timely and systematic way.A range of options are available in this respect, viz. (a) to contract credit and swapfacilities with groups of foreign banks, to be activised in the event of liquidity pressures,such as those contracted by Argentina and Mexico; (b) embedding call options in certainshort-term credit instruments to provide for an automatic extension of maturities in timesof crises; (c) feasible modifications of terms of sovereign bond contracts to includesharing clauses; and (d) a possible role for creditor councils for discussion betweendebtors and creditors. However, these are complex issues and need to be designedcarefully so that there are no perverse incentives, which may encourage private creditorsto bail themselves out at the first sight of difficulty, rather than providing net newfinancing in the event of a crisis.

Developing countries need to strengthen their debt management strategy by developingcomprehensive debt sustainability models, which will integrate external sector,particularly the flows of external debt, with broad macro-economic variables and provideearly warning regarding any possible debt trap. In this respect, separate debt models maybe developed with respect to sovereign external debt and private debt.

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All countries need to monitor very carefully short-term debt, long-term debt by residualmaturity, all guarantees and all contractual contingent liabilities arising out of both debtand non-debt creating financial flows.

A more comprehensive approach is needed when trying to deal with excessive private

borrowing and risk taking in the presence of large capital inflows and weak financialsystems. This often means applying more flexible exchange rates, tighter fiscal policyand improved financial system. Domestic financial sector liberalisation should alsoproceed carefully and in step with tighter financial regulation and supervision, andinternationally recognised prudential norms for capital adequacy and provisioning fornon-performing assets by commercial banks and financial institutions.

We can conclude with the following observations made by the World Bank in theirReport on Global Economic Prospects and the Developing Countries (1999):

The most pressing issue is to develop better mechanisms to facilitate private-to-private

debt workouts, including standstills on external debt under some conditions, and torestore capital flows and increased international liquidity to countries in crisis. Althoughthere are some compelling arguments for a lender of the last resort, difficult issues arisefor appropriate burden sharing, the rules for intervention, and the avoidance of moralhazard. Improved regulation by creditor country authorities and better risk managementof bank lending to emerging markets should also help reduce probability of crisis. Moretimely and reliable information is desirable, but complete transparency and betterinformation alone will not prevent a crisis.

The main lessons of the East Asian crisis are that countries need to build and strengthenregulatory and institutional capacities to ensure the safety and stability of financialsystems, especially at the interfaces with international financial markets; and that theinternational architecture to prevent crises and deal with them needs to be strengthenedmore effectively.

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Selected References

Anderson, Philip (2000) Sovereign debt management in an Asset-Liability Management

Framework, pp.139-153, in Sovereign Debt Management Forum: Compilation ofPresentations, November 2000, World Bank, Washington D.C.

Credit Rating Information Services of India Limited (CRISIL) (1999) CorporateExternal Debt Management, pp.1-316, edited by Jawahar Mulraj, CRISIL, Bombay,December 1999.

_________(2001) External Debt Management- Role of Financial Institutions, pp.1-382,edited by Ashok Kumar, CRISIL, Bombay, January 2001.

Das, Tarun (1999a) East Asian Economic Crisis and Lessons for External Debt

Management, pp.77-95, in External Debt Management, ed. by A. Vasudevan, April 1999,RBI, Mumbai, India.

_______ (1999b) Fiscal Policies for Management of External Capital Flows, pp. 194-207, in Corporate External Debt Management, edited by Jawahar Mulraj, December1999, CRISIL, Bombay.

_______ (2000a) Management of external debt in India, 21-24 March 2000, IMF-Singapore Regional Training Institute, Singapore.

_______ (2000b) Sovereign Debt Management in India, pp.561-579, in Sovereign DebtManagement Forum: Compilation of Presentations, November 2000, World Bank,Washington D.C.

_______ (2002a) Implications of Globalisation on Industrial Diversification in Asia,pp.ix+1-86, UN Publications Sales No.E.02.II.F.52, March 2002, ESCAP, Bangkok.

_______ (2002b) Management of Contingent Liabilities in Philippines- Policies,Processes, Legal Framework and Institutions, pp.1-60, March 2002, World Bank,Washington D.C.

_______ (2003a) Management of Public Debt in India, pp.85-110, in Guidelines forPublic Debt Management: Accompanying Document and Selected Case Studies, 2003,IMF and the World Bank, Washington D.C.

_______ (2003b) Economic Reforms in India- Rationale, Scope, Progress andUnfinished Agenda, pp.1-80, February 2003, Bank of Maharashtra, PlanningDepartment, Pune, India.

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