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UN-ESCAP- Lecture-1 Kathmandu Nepal
External Deb-Tarun Das 1
Sustainable External Debt Management
Presented by
Dr Tarun DasEconomic AdviserMinistry of Finance
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Contents 1. Definition of external debt2. Conceptual issues3. Different Types of Risk4. Measures for Risk Management5. Sustainability Indicators6. World Bank Classification of Ext
debt
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1.1 Definition of external debt “Gross external debt, at any time, is the
amount of disbursed and outstanding contractual liabilities of residents of a country to non-residents to repay the principal with or without interest, or to pay interest with or without principal”.
1. Gross external debt2. Contractual obligation3. Disbursed and outstanding4. Principal with or without interest5. Interest with or without principal6. Concept of residency not nationality 7. Current not contingent
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1.2 Definition of external debt
- Other Issues1. Valuation of external debt2. Present value of debt3. Short-term debt – original and
residual maturity4. Interest costs- actual / accrued5. Foreign and domestic currency6. Traded and unlisted securities7. Govt and non-govt( monetary
authority, banks, others)
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2 Conceptual Issueson Sustainable Debt
a) Debt Sustainability and Fiscal Deficit
b) Debt Sustainability and Current Account Deficit
c) Liquidity versus Solvencyd) Economy wide modelse) Asset Liability frameworkf) Debt sustainability indicators
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3.1 External Debt Management
and Risk Management• A government should manage its debt in order to raise the required amount of resources subject to the lowest possible medium/long term cost and consistent with a prudent degree of risk
• Poor debt management poses risks for both the public and private sectors– Risks include fiscal crisis; change in
creditworthiness and insolvency (‘debt distress’); economic crisis and instability
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3.2 Transparency in Risk Management
• Debt management objectives should be clearly defined and publicly disclosed
• The measures of cost and risk that are adopted should be explained– Objectives/preferences of policy– Rules of the game (institutional and
legal framework)
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3.3 Basic Principles of Risk Management
• The risks in the structure of government debt should be carefully monitored and evaluated– Risks associated with foreign-currency
and short-term or floating rate debt• The risks should be mitigated to
the extent feasible – Modify the debt structure, taking into
account cost of doing so
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3.4 Different types of risk• Market-Based Risks a) Liquidity risk b) Interest rate risks c) Credit risk d) Currency risk e) Convertibility risk f) Budget/ Fiscal Risk g) Contingent liabilities
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3.5 Different types of risk• Country specific and Political risks a) appropriation of capital, b) nationalisation of companies, c) no repatriation of capital etc. d) no sovereign guarantee• Operational Risks a) Control system failure risks b) Financial error riskc) Auditing/ Accounting/ Monitoring
Risk
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4.1 Debt Management Strategy• Market risk management involves
understanding financial characteristics of revenue flows to government and matching with liabilities with similar characteristics as far as possible (“asset and liability management”)– Not so feasible in countries without
well-developed debt markets• Credit risk management depends on
diversification• Rollover risk can be created by excessive
short-term or floating rate debt (high potential impact)
• Effective cash management is necessary for effective risk management (e.g., payment arrears)
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4.2 Risk Management Framework
• A risk management framework should help to identify and manage the trade-offs between expected cost and risk in the debt portfolio
• Cost includes: financial cost and potential cost of real economic loss– Market risk is measured in terms of
potential increases in debt servicing costs associated with changes in interest or exchange rates
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4.3 Assessing Risk• To assess risk conduct stress tests
of the debt portfolio based on economic and financial shocks
• Simple scenario models: Fund/Bank Debt Sustainability Analysis (DSA)– Project future debt service costs over
MT/LT– List key risk indicators– Summarize costs and risks of
alternative strategies
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4.4 Management of liquidity risk (a) Monitor debt by residual maturity (b) Monitor exchequer cash balance and
flows (c) Maintain certain minimum level of cash
balance (d) Maintain access to short-term borrowing (e) But, fix limits for short-term debt (f) Pre-finance maturing debt (g) Do not negotiate for huge bullet loans (h) Smooth the maturity profile to avoid
bunching of debt services (i) Develop liquidity benchmarks
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4.5 Management of interest rate risk
(a) Fix benchmark for ratio of fixed versus floating rate debt
(b) Maintain ratio of short-term versus long-term debt
(c) Use interest rate swaps
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4.6 Management of credit risk
(a) Have credit rating of various scrips by international credit rating organizations such as S&P’s, Moody’s, JBR etc.
(b) Identify key factors that determine credit-rating
(c) Develop a culture of co-operation and consultation among different departments and with credit rating organisations
(d) Set overall and individual counter-party credit limits
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4.7 Management of currency risk
(a) Fix benchmark for the ratio of domestic and external debt
(b) Fix ratios of short-term /long-term debt (c) Fix currency mix for external debt (d) Determine single currency and
currency pool debt (e) Use currency swaps (f) Try to have natural hedge by linking
dominant currency of exports & remittances to the currency denomination of debt
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4.8 Convertibility Risk (a) Have gradual and cautious approach
towards capital account convertibility.(b) An orderly and sequenced manner in
line with strengthening domestic financial systems through adequate prudential and supervisory regulations.
(c) Encourage initially non-debt creating financial flows followed by long term capital flows.
(d) Short term or volatile capital flows may be liberalised only at the end of capital account convertibility.
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4.9 Budget Risk (a) Enact a Fiscal Responsibility
Act. (b) Put limits on debt outstanding
and annual borrowing as a percentage of GNP or GDP
(c ) Use government guarantees and other contingent liabilities (such as insurance and pensions etc,) judiciously and sparingly.
(d) Fix limits on contingent liabilities (e) Fix targets on fiscal deficit,
primary deficit (f) Fix limits on short term borrowing (g) Monitor debt service payments
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4.10 Operational Risk (a) Have stable and sound macro-
economic policies (b) Have co-ordination among monetary
and fiscal authorities (c) Allow independence and
transparency of different offices (such as front, back, middle and head offices) dealing with public debt
(d) Strengthen capability of different offices
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5.1 Solvency Ratio (a) Interest service ratio –interest
payments / XGS ratio (b) External debt / GDP ratio (c) External debt / exports ratio (d) External debt / revenue ratio (e) PV of debt services/ GDP ratio (f) PV of debt services / XGS ratio (g) PV of debt services / revenue
ratio
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5.2 Liquidity monitoring ratio (a) Basic debt service ratio- Ratio of debt
services on long term debt to XGS ratio (b) Cash-flow ratio for total debt or the total
debt service ratio (i.e. total debt services to XGS ratio
(c) Interest payments to reserves ratio. (d) Ratio of short-term debt to exports of
goods and services (e) Import cover ratio- Ratio of total
imports to total foreign exchange reserves. (f) Reserves to short-term debt ratio (g) Short-term debt to total debt ratio
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5.3 Debt Burden Ratio (a) Total external debt to GDP (GNP)
ratio (b) Total external debt to XGS ratio (c) Debt services to GDP (GNP) ratio (d) Total public debt to revenue
ratio (e) Ratio of concessional debt to
total debt
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5.4 Debt structure indicators (a) Rollover ratio- ratio of
amortization (i.e. repayments of principal) to total disbursements
(b) Ratio of interest payments to total debt services
(c) Ratio of short-term debt to total debt
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5.5 Public sector indicators (a) Public sector debt to total external
debt (b) Public sector debt services to
exports ratio (c) Public sector debt to GDP ratio (d) Public sector debt to revenue ratio (e) Average maturity of non-
concessional debt (f) Foreign currency debt over total
debt
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5.6 Financial sector indicators (a) Open foreign exchange position-
Foreign currency assets minus liabilities plus long term position in foreign currency stemming from off-balance sheet transactions
(b) Foreign currency maturity mismatch (c) Ratio of foreign currency loans for real
estate to total debt (d) External sector related contingent
liabilities (e) Trends of share market prices (f) GDRs and Foreign cur conv bonds issued (g) Inflows of FDI and portfolio investment
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5.7 corporate sector indicators (a) Leverage (debt/ equity ratio)-
Normal value of debt over equity (b) Interest to cash flow ratio (c) Short-term debt to total debt (d) Return on assets (e) Exports to total output ratio (f) Net foreign currency cash flow (g) Net foreign currency debt over
equity
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5.8 Dynamic ratios (a) Average interest rate/ growth rate of
exports (b) Average interest rate/ growth rate of GDP (c) Average interest rate/ growth rate of
revenue (d) Change of PV of debt service/ change of
exports (e) Change of PV of debt service/ change of
GDP (f) Change of PV of debt service/ change
of revenue
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5.9 Standard Stress Tests in the DSA• Real GDP growth = baseline – 1 SD• Export value growth = baseline – 1
SD• GDP deflator = baseline – 1 SD• Net non-debt creating flows =
baseline – 1 SD• Primary balance = baseline – 1 SD• One-time major nominal or real
depreciation• Combinations (with ½ SD shocks,
e.g.)
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5.10 Identifying Debt Distress EpisodesDebt distress indicated by recourse to any
of three forms of exceptional finance:• Arrears: Years in which principal and
interest arrears to all creditors is in excess of 5% of total debt outstanding
• Paris Club Relief: Year of initial Paris Club agreement, plus two subsequent years
• Non-Concessional IMF Balance of Payments Support: Years in which Standby Arrangement or Extended Fund Facility are in effect, commitments greater than 50% of quota. Normal times are non-overlapping periods of five years in which no indicators of debt distress are observed
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5.11 Determinants of Debt Distress• Traditional Debt Indicators
– Present value of debt/exports, debt service/exports
– Debt service/current revenues, debt service/reserves
• Policy– CPIA– KKZ indices of institutional quality (single
cross-section)• Shocks
– Real GDP growth– Real depreciations– Income effect of changes in terms of
trade
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5.12 Implications for Lending Strategies of Multilateral
Concessional Lenders1. Substantial value-added in looking at
role of institutions/policies and shocks in addition to traditional debt burden indicators when assessing probability of debt distress
2. Using a common debt-burden threshold to assess sustainability for all countries is unlikely to be appropriate: strong tradeoffs between quality of institutions/policies and sustainable level of debt
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5.13 Indicative Policy-Dependent Debt and Debt-Service
Thresholds (%)Quality of Policies and
InstitutionsPoor Medium Strong
NPV debt/GDP
30 45 60
NPV debt/Xs
100 200 300
NPV debt/rev
200 275 350
Debt svc/Xs
15 25 35
Debt svc/rev
20 30 40
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5.14 Debt Distress Classification• Low risk—all indicators well below
thresholds• Moderate risk—baseline ok, but
scenarios/shocks near thresholds• High risk—baseline in breach over
projection period• In debt distress—current breach
that is sustained/significant
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Thank youHave a Good Day