EXTERNAL DEBT-Financial

MarketingSuryakumar T

VIT BS

What is Debt? Debt refers to borrowings, usually made to run a business or make new investments. The borrower receives the amount required, usually a large capital sum upfront, and agrees to repay the same with applicable interest in installments. Public Debt is the debt borrowed by government through various methods from the public. Methods adopted by the government through the processing of FLOATING, REFUNDING & REPAYMENT of public debt. Government goes for public debt. To avoid Inflation Deflation

Types of Debt Productive debt & Unproductive debt Voluntary debt & Compulsory debt Internal debt & External debt Short term debt, Medium term debt & Long term debt Redeemable debt & Irredeemable debt Funded debts and Unfunded debts

External Debt Debts raised from foreign countries or international institutions Debts repayable in foreign currencies Voluntary in nature It involves transfer of resources from foreign countries to the domestic country Repayment of interest and principal amount through transfer of resources takes place in the reverse direction. Help to take up various developmental programs in developing and underdeveloped countries

Risks Related to Debt Management Market Risk : Risks associated with changes in market prices (such as interest rates, exchange rates, commodity prices) on the cost of the government’s debt servicing

Rollover Risk: Risks that debt has to be rolled over at an unusually high cost or, in extreme cases, cannot be rolled over

Liquidity Risk : Two types of liquidity risk One refers to the cost investors face in trying to exit a position because of the lack of depth of a particular market

Second refers the risk for a borrower when the volume of liquid assets diminish quickly in the face of unanticipated cash flow obligations or a difficulty in raising cash through borrowing

Risks Related to Debt Management - Contd

Credit Risk : Risks of non-performance by borrowers on loans Settlement Risk : Potential loss that the government suffer as a result of failure to settle by another counterparty

Operational Risk : Including transaction errors in the various stages of executing and recording transactions; inadequacies or failures in internal controls, or in systems and services; reputation risk; legal risk; security breaches; or natural disasters that affect business activity

Rise of India’s External Debt

Rise of India’s External Debt - Contd India’s total external debt stock stood at $ 426.0 billion on 31 December 2013, 5.2 per cent higher than that on 31, March, 2013. 

The increase in external debt was due to long-term debt, especially Non Resident Indian (NRI) deposits.

Component-wise, commercial borrowings accounted for 31.5 per cent of the total external debt, followed by NRI deposits (23.2 per cent) and multilateral debt (12.3 per cent). 

Pros of External Debt Control: Debt financing allows the borrower to retain ownership on the control of the business, unlike equity financing.

Retain Profit : Debt financing allows the entrepreneur to retain the profit earned by the business without sharing it with the debtor.

Timely Payments: Timely repayment of debt enhances and improves the credit rating of the business, making it easier to obtain other types of financing in the future.

Tax Deduction: One of the most attractive aspects of debt financing is tax advantages. The interest on borrowed money, paid to the lender is tax-deductible. 

Cons of External Debt Repayment: A debt requires repayment irrespective of whether the debtor makes a profit or loss with the loan. 

High Cost: The fixed interest costs can raise the company’s break-even point, or the point where no profit and no gain occurs.

Risk Outlook: Debt financing increases the company's risk outlook, for higher the business’s debt-equity ratio, the more risky the company becomes for other lenders and investors.