external debt management pradhan

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BangladeshBank

UNITED NATIONS ECONOMIC AND SOCIAL COMMISSION FOR ASIA AND THE PACIFIC

Regional High-Level Workshop onStrengthening the Response to the Global Financial Crisis in Asia-Pacific:

The Role of Monetary, Fiscal and External Debt Policies27-30 July 2009

Dhaka, Bangladesh

Session on External Debt Management

Strengthening the response to the global financial crisis inAsia-Pacific:

The Role of external debt management policies

ByDr HK Pradhan

Professor of Finance & EconomicsXLRI Jamshedpur

India

July 2009

The views expressed in the paper are those of the author(s) and should not necessarily be considered as reflectingthe views or carrying the endorsement of the United Nations. This paper has been issued without formal editing.


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1. Introduction

There has been a renewed concern as regards the level of debt and financial flows to thedeveloping countries, with the apprehension of a further slippage in the debt burden in theaftermath of the present global financial crisis. This apprehension has come about of acombination of factors such as the increase in debt financed fiscal stimulus, erosion of debtservicing capacity due to falling exports and economic growth, and escalation of cost of debtservice following currency depreciations in a number of developing countries. Multilateralinstitutions appear to have scaled up their capacity building programmes aimed at improving thedebt management capacity of the low income countries, and continue to extend new financingand debt restructuring initiatives for countries hit by the present crisis1.

The paper discusses the analytical and contemporary issues in public debt managementunder globalization, focusing on the external debt management issues under the present financialturmoil affecting the developing countries. The implications of the global financial crisis on theexternal debt management are being discussed, with implications on the Asia Pacific region, andparticularly in the context of eleven countries pilot countries (Bangladesh, Bhutan, Cambodia,Fiji, Kazakhstan, Lao PDR, Maldives, Nepal, Pakistan, Sri Lanka, and Viet Nam). The elevencountries selected in the present study bring in significant diversity in their economic andfinancial situation, characterized, in general, by high savings rates, but having underdevelopeddomestic bond markets, highly sensitive to the general conditions in the world economy, havewitnessed fluctuations in migrant remittances and inward tourism flows, exacerbated in somecases by natural disasters, and have significant commodity concentration in their exports, as wellas bilateral trade imbalances with the US and Europe.

The paper first provides an overview of the present financial crisis, and its various channelsof impact on external debt. It then discusses the impact of debt levels and its sustainability

considerations. The management of government debt portfolio assumes critical importance underpresent situation, and the consideration has to be given on all forms of debt, to include theexternal borrowings of the government as well private sector, contingent liabilities and on-lending of external loans. The paper also discusses the issues relevant in the context of prudentdebt management, the aspects of coordination of debt management with macroeconomic policy,and management of risk in debt portfolio and reserve management. The paper concludes with abrief discussion on the regional cooperation in promoting financial stability and liquidityarrangement.

1 See World Bank, Swimming Against the Tide: How Developing Countries are Coping with the Global Crisis,Background Paper prepared by World Bank Staff for the G20 Finance Ministers and Central Bank GovernorsMeeting, Horsham, United Kingdom on March 13-14, 2009. In the same direction, the IMF Executive Boardmeeting held on March 25, 2009 endorsed the Fund assistance for the low income countries to maintain asustainable level of debt and prudent forms of financing. See also the United Nations, Report of the Commission ofExperts of the President of the United Nations General Assembly on Reforms of the International Monetary andFinancial System, as presented UN Conference on the World Financial and Economic Crisis and its Impact onDevelopment, New York on 24-26 June 2009.

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2. Developing countries face significant vulnerability under the present globalisedfinancial system

The changes in the structure of global capital markets since the debt crisis of 80s, thecontinuing process of financial market integration, and the increasing role of private investment

flows, have all made the developing countries highly vulnerable to the forces of the worldeconomy. The developing countries are increasingly becoming susceptible to the vagaries of theprivate capital flows, largely governed by the macroeconomic uncertainties of the majoreconomies, and the fall out of the financial innovations that basically emerged in financialsystems of US and Europe. The macroeconomic imbalances facing the major economies haveexhibited wide gyrations in exchange rates, interest rates and commodity prices, exacerbating theunderlying speculative sentiments of the private investors and resulting in volatility in financialflows. The global financial crisis was yet another bout of shocks that affected almost allcountries of the world, but hitting hard the low income countries in particular.

The financial crisis erupted at a time the developing countries had been grappling with the

rise in food and energy prices. These economies got affected due to the contraction in externalcapital flows, export loss arising out of global recession, and domestic fiscal costs of themacroeconomic impulses, including the provision for social safety nets and human development.The contraction in world output and trade combined with lower inflows of foreign remittancesand investment flows have increased the financing gap for several countries in the region. Thefinancial crisis affected severely the public finances of most developing countries, determined bythe extent of direct fiscal support to the banking sector, the revenue impact of falling commodityprices, discretionary fiscal stimulus to support growth, and such other provisioning towardscontingent liabilities.

The extent of a debt financed fiscal stimulus has been significant in most developingeconomies, however, which has led to increase in public debt as well as government contingentliabilities. Governments face rising servicing costs of foreign currency debt, at a time when theirdebt servicing capacities are eroded due to falling export earnings. The increase in governmentdebt levels and fiscal sustainability has triggered the market reactions, as the sovereign bondspreads have widened sharply, which has particularly raised the cost of borrowing frominternational markets. The appreciating exchange rates of the US Dollar and the Japanese yenagainst the Asian currencies were yet another factor adding to the debt servicingcosts, as most ofthe governments in the region borrow predominantly in these two currencies 2. The decline inexchange rates in the region were primarily due to the reversal in capital flows impacted by thefinancial crisis, and easy monetary policies pursued in response to credit crunch.

The stronger Asian economies could weather to an extent the adverse impact of thefinancial crisis essentially due to the policy environment that followed the 1997 crisis and theirstronger current account position at the time. The recapitalization of banks with the prudentialsupervision under Basel II new accord, growth of domestic bond markets facilitating corporatefinancing, and the abandonment of exchange rate fixation with more flexible exchange rate

2 For instance the share of US Dollar and Japanese yen in the total foreign currency debt, respectively, of East Asiaand Pacific were 58.4 per cent and 24.5 per cent, and South Asia at 56.1 per cent and 18.1 per cent for the year 2007.Source, World Bank, Global Development Finance, Volume II, 2009.

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policies have all reduced the impact of external vulnerability . At the same time the increasedholdings of foreign exchange reserves has provided the necessary wherewithal to minimizeexchange rate volatility and sustaining capital flows, as international financial markets andrating agencies have often rewarded the countries with having larger reserve holdings. Most ofthe Asian countries have abandoned pegged exchange rates and adopted more flexible exchange

rate regimes in the post crisis period, and this environment has given the banks and firmsrealistic expectations of managing exchange rate risk. Banks and corporations that resorted toexcessive foreign currency borrowing under the pegged exchange rate regimes carrying hugecurrency mismatch in their balance sheets have been rather more prudent in the post crisis years.Though the rising foreign exchange reserves created conflicts in macroeconomic management,this provided the much needed support in a few countries that witnessed drying up of newresource inflows.

3. The complexities of public debt management have been compounded each time theworld economy witnessed financial and foreign exchange crisis

The complexities of public debt management have been compounded as countries havetraversed through several episodes of financial and foreign exchange crisis (such as in Mexico(1994), East Asia (1997), Brazil (1998), Russia (1998), Turkey (1994 & 2001), and Argentina(2001). These episodes of crises, irrespective of their underlying factors, have demonstrated howvulnerable the debt indicators can be, breaching their indicative thresholds of sustainability for alarge group developing countries for extended periods, leading to defaults and rescheduling, withsubstantial costs to the debtors economy in terms of output losses, high unemployment, andaccentuating the incidence of poverty.

The present financial crisis (2008-09), however, differs significantly with that of the earlierones, permeating to almost all countries globally. The crisis is more pervasive, affecting abruptlyalmost all countries in some way or the other, with significantly affecting the private corporatesector. The medium term repercussions depend to a large extent on the resilience and defensivemechanisms of the country concerned, and on the resource availability to mitigate thedeceleration in investment climate. Financial market impact has been somewhat lower on theemerging economies of East Asia, China and India; given the strength of their bankingsupervision and capital market integration, although the impact of lower global growth and lowercapital inflows are expected to result in higher debt level of government almost everywhere.

The Third World debt crisis of 1980s was essentially one of external debt problemsbetween sovereign borrowers and international lenders, which occurred in consequence of a hostof factors exogenous to the developing countries, viz. oil price hikes during 1970s, globalrecession during 1981-82, rising interest rates and the US dollar exchange rates during early1980s and above all, the over lending syndrome by a number of developing countries facilitatedby positive perceptions of sovereign ratings. The developing countries suffered heavy erosion oftheir debt service capability, which eventually resulted in a series of defaults starting Mexico in1982.

The East Asian crises 1997 erupted due to the speculative attack on their currencies, withsharp depreciation of local currencies, the authorities being forced to defend the plummeting

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currencies by depleting large volumes of international reserves, corporate bankruptcy leading tobanking crisis, thereby compelling the governments to extend massive financial assistance tobanks through budgetary support to prevent a collapse. A distinguishing feature of the 1997 EastAsian crisis was the effect of contagion; crisis in one country spreading into several others in theregion. The contagion impact depended on the degree of markets integration in the region as well

as the existing state of the economy. The speculative attacks were on those countries currenciesthat were competing in the same world markets for goods and capital. Nevertheless the EastAsian crisis had significant impact on growth and exports in the region, which lasted for almost adecade.

The Asian crisis, however, brought several new dimensions to the debt problems of thedeveloping countries. The issue was not so much to do with the aggregate level of debt but moreto do with their composition between private and public sector, its maturity structure, the level ofcontingent liabilities, and the pursuance of macroeconomic policies that were inconsistent withthe external sector objectives. The contributory factors underlying the financial crisis were thepremature liberalization of capital accounts in many countries that were under pegged exchange

rates. Capital flows from the developed countries have tended to become less counter cyclical,with shortening of maturities as well as intensified volatility. These trends have also underscoredthe importance of a sound and coherent policy framework for managing and monitoring capitalflows in general and debt management in particular. The relative immunity to the crisis incountries such as India or China had to do with their status of currency convertibility undercapital accounts, with significant controls on foreign exchange transactions and short-termcapital flows.

The present financial crisis which originated in the developed nations financial system, inmortgage and derivatives markets had a spillover effect on rest of the world. The implications ondeveloping countries (post 2008), and particularly on the low income countries, have beensomewhat severe, despite the fact that their financial systems lack mortgage related securities orare less integrated in capital accounts, or characterized by absence of trading in derivativeinstruments. The first reaction was capital outflows due to an exodus of foreign investors fromthe emerging capital markets, and these put severe pressure on their balance of payments andreserves. The global financial crisis came at a time the when most of the economies in the AsiaPacific region were adjusting to the adverse terms of trade shocks, arising out of a surge in foodand fuel prices. Between January 2003 and May 2008, the terms of trade losses were estimated tobe ranging from as much as 34 per cent of GDP in Maldives, 21.2 percent for Nepal, 11.2 percent for Pakistan, 10.2 per cent Sri Lanka, and 8 percent for Bangladesh.3

4. Trends debt and capital flows exhibited significant drop in the Asia Pacific region

Asia Pacific region had witnessed significant changes in their structure of capital flows anddebt in recent years. The buoyant growth in Asia and significantly improved current accountpositions in a large number of countries in the region indicated their strong debt servicingcapacity, and this attracted bank lending and bond financing. There was a marked decline in the

3 Pakistan and India actually benefitted from the rise in food prices, as these are the rice exporters. See World Bank,Global Financial Crisis: Implications for South Asia, October 21, 2008.

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proportion of short term debt to total debt and higher build up of foreign exchange reserves inrelations to external debt. Several countries pushed the domestic bond market developmentinitiatives, leading to a shift towards domestic borrowings by governments, and increasedissuance of domestic debt instruments by the corporate sector. In their desire to self-insureagainst capital account instability and due to the surge in non-debt creating flows such as foreign

direct and portfolio investment flows, many countries in the region have built large volumes ofinternational reserves. The financial crisis of 2008 witnessed a reversal of this trend with abruptfall of capital flows to almost all countries in the region.

For the developing country as a whole, the net private capital inflows estimated to havedropped to USD 727 billion in 2008, from USD 1.2 trillion in 20074. The decline was significantfor the net debt flows, which fell from USD 499 billion in 2007 to USD 128 billion in 2008;which was primarily due to the private creditors (by way of bonds and bank loans), falling fromUSD 498.9 billion to USD 107.9 billion. There was slight increase in foreign direct investmentflows, up from USD 523 billion in 2007 to USD 583 billion in 2008, but a large part ofinvestments went to few countries in East Asia and South Asia. Along with the decline in capital

flows, the concern regarding credit risk and increased risk aversion of international investors,led to a significant widening of the lending spread, estimated with the median rise of 336 basispoints since mid-2007 and even more than 1,000 basis points for few countries ( in case ofKazakhstan and Pakistan)5. The decline in capital flows was more marked in the net short-termdebt flows, down from USD 202.5 billion in 2007 to USD (-)16.3 billion in 2008 for alldeveloping countries.

Table 1: Net Resource Flows to the Developing Countries ($ billion)

2002 2003 2004 2005 2006 2007 2008eAll developing countries

Net private and officialinflows 162.4 258.6 370.7 498.7 668.3 1157.7 727.3

Net FDI inflows 152.5 155.5 216.0 279.1 358.4 520.0 583.0Net Portfolio equityinflows

9.0 25.5 38.7 68.1 104.3 138.6 15.7

Net debt flows 0.9 77.6 116.0 151.5 205.6 499.1 128.3Net short-term debt flows -5.4 61.5 68.5 86.6 110.1 202.5 -16.3Workers remittances 115.9 143.6 161.3 191.2 229.0 265.0 305

East Asia and PacificNet private and officialinflows

53.0 74.7 125.0 184.7 196.5 278.3 201.2


3.8 12.5 19.3 25.7 56.2 35.2 7.4

Net debt flows -10.2 5.4 35.4 54.6 35.1 67.8 8.7Net short-term debt flows 9.9 22.3 32.7 45.4 29.2 42.6 -5.7

4 The data and inferences on global financial flows presented in this section are based on the World Banks GlobalDevelopment Finance, Volume I & II, 2009.5 Global Development Finance, Volume I, 2009, Page 45.

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2002 2003 2004 2005 2006 2007 2008eWorkers remittances 29.5 35.4 39.2 46.7 53.0 65.3 69.6

Europe and Central AsiaNet private and official

inflows

46.5 83.4 124.1 156.3 279.0 465.8 255.8


3.5 0.7 3.6 8.0 10.5 26.4 -8.4

Net debt flows 24.5 52.2 65.0 85.5 153.6 285.0 93.4Net short-term debt flows 4.7 33.9 20.4 20.3 54.7 101.3 -5.7Workers remittances 13.7 15.5 22.2 31.2 38.3 50.4 53.1

Latin America and the CaribbeanNet private and officialinflows

38.0 61.8 59.9 81.7 64.8 215.1 130.9

Net FDI inflows 53.0 42.3 64.9 70.8 71.6 107.5 124.8

Net Portfolio equityinflows

1.4 3.3 -0.6 12.2 11.2 29.6 -6.5

Net debt flows -16.4 16.2 -4.4 -1.3 -18.0 78.0 12.6Net short-term debt flows -20.3 2.3 5.5 15.8 -1.0 33.1 -2.7Workers remittances 27.9 36.6 43.3 50.1 59.2 63.1 63.3

South AsiaNet private and officialinflows

7.4 13.8 25.4 28.6 76.6 116.5 77.0


1.0 8.0 9.0 12.4 10.4 36.1 18.0

Net debt flows -0.3 0.4 8.6 5.9 43.0 50.5 11.5Net short-term debt flows 1.8 0.7 2.6 1.6 18.0 19.3 -0.8Workers remittances 24.1 30.4 28.7 33.1 39.6 52.1 66.0

Sub-Saharan AfricaNet private and officialinflows

9.6 15.0 23.2 31.8 38.0 60.4 38.7


-0.4 0.7 6.7 7.4 15.0 13.5 3.2

Net debt flows -0.2 1.4 6.6 7.6 4.5 18.3 3.1Net short-term debt flows 0.2 3.3 5.6 -0.2 0.3 0.7 -0.4

Workers remittances 5.0 6.0 8.0 9.4 12.9 18.6 19.8Middle East and North Africa

Net private and officialinflows

7.7 9.8 12.1 15.8 13.4 21.6 23.3


-0.5 0.2 0.7 2.4 1.0 -2.1 2.0

Net debt flows 3.5 2.0 4.5 -0.7 -12.6 -0.5 -1.2

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2002 2003 2004 2005 2006 2007 2008eNet short-term debt flows -2.5 -10.4 -36.1 -55.3 -70.2 -58.7 -78.3Workers remittances 15.2 20.4 23.0 24.3 25.7 31.3 33.7

Source: Global Development Finance, 2009. Notes: Figures for 2008 are estimated by GDF2009.

The inaccessibility to trade credit was felt in many developing countries creating apprehensionthat it would affect global trade flows, and there were a number of bilateral agreements seen toease the strains on access to short term credits, including trade finance. The foreign exchangereserves accumulation slowed down significantly in most of the developing countries, ascountries began drawing down their reserves to mitigate the drop in capital flows.

The volume of gross capital inflows also sharply plunged for the Asia Pacific region. Net capitalflows to South Asia dropped from USD 117 billion in 2007 to USD 77 billion in 2008. The fallwas marked in all categories of flows except net foreign direct investments which increased fromUSD 30 billion to USD 48 billion in 2008 (although most of the FDI went to countries such asRussian Federation, China, Malaysia, and India). Net portfolio investment flows dropped from

USD 36 billion in 2007 to USD 18 billion in 2008 and this was accompanied by collapsing stockprices everywhere. Net capital flows from private creditors (banks and bond issuances, includingshort term debt issuances) fell from USD 47 billion in 2007 to a meager USD 1.0 billion in 2008.There was an increase in capital flows on account of remittances in the region(from USD 52billion to USD 66 billion), which could be attributed to the migrants who have returned homewith their accumulated savings. Global Development Finance (2009) reported that the inflows ofcapital to Bangladesh, Pakistan, and Sri Lanka almost fell to zero in the aftermath of the crisis.Faced with a balance of payments crisis Pakistan reached an agreement with the IMF on a stand-by facility in May 2009, and Sri Lanka is currently in discussion with the Fund for such a facilityto tide over the foreign exchange gap. The balance of payments situation remains critical inMaldives, with having the current account deficit at 53 percent of GDP.

The prospects of external capital flows to the low income countries of the region are likely to bemarkedly lower until the resolution of the present crisis. Governments, in their attempts todampen the adverse repercussions of the current financial crisis, have all resorted to higherdomestic borrowings. Several countries are experiencing significant shortages of funds, which iscurtailing essential imports and impacting poverty. The low income countries generally lackaccess to private capital markets overseas, and therefore depend to a large extent on theassistance from bilateral and multilateral donors, primarily in the form of concessionalfinancing(Chart 1). Resolving debt issues for this group of countries requires stepping up ofdonor supported assistance.

Chart 1: Share of Concessional Debt as % of Total Debt

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5. Given the recurrence of financial crisis, countries should undertake debtsustainability analysis.

The debt level of a country must be sustainable, and the present uncertain external financialenvironment demands that countries must assess the sustainability of their debt levels. Debtsustainability, as defined and widely applicable under the IMF/World Bank framework, relates tothe debtors ability to generate future external debt service obligation in full, without recourse todebt relief, rescheduling of debts, or the accumulation of arrears, and without compromisinggrowth6. Although debt sustainability has been interpreted in several ways, two simple conceptscan be considered relevant: one which is concerned with economic debt sustainability, whichmeans that the debt service does not inhibit growth and the overall economic policy, and, therelating to financial debt sustainability, which means that a country is able to service itsoutstanding level of debt. The Monterrey Consensus contemplates to broaden the debtsustainability framework after considering the social and development imperatives of agovernments expenditure and revenue-raising capacity, thereby the making the conditions forservicing of debt without affecting the development goals as contained in the MillenniumDeclaration7.

6 The operational framework for debt sustainability analysis (DSA) in low-income countries are adopted by the IMFand the World Bank. See IMF, A Guide to LIC Debt Sustainability Analysis, May 2005. The Guide provides step-by-step interpretation of DSA. DSA analysis are conducted jointly with the IMF, using the agreed framework andExcel-based country templates.

7 United Nations, Doha Declarations on Financing for Development, Follow-up International Conference onFinancing for Development to Review the Implementation of the Monterrey Consensus Doha, Qatar, 29 November2 December 2008, Page 25.

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There are several issues as regards the assessment of debt sustainability. Traditionally debtsustainability has been carried out in the context of external debt, and the domestic debt issuesare seen primarily as the roll over or refinancing problem. It is expected that a well functioningdomestic bond market would enable governments to borrow and roll over the requirements forrefinancing. However, high domestic debt can also significantly affects sustainability of budget

balance, and domestic debt markets are not deep enough in many low income countries to meetgovernment financing requirements. Interest rates on domestic debt markets are generally highin low-income countries and with maturities being short, which typically exposes to significantroll-over risks. Private sector external debt needs to be included, as large scale defaults in theaftermath of a currency crisis or devaluation, as seen following the Asian financial crisis, willimpose severe burden on government balance sheet. It is also necessary to take into account thequantum of government guarantee, which are in the form of contingent liabilities that carry fiscalrisks. There are of course constraints in establishing frameworks for assessing debt sustainabilityin developing countries, especially in low income countries, due to limitations of data,transparency and governance issues. The extent of such liabilities can also be enhanced in thepresence of poor governance and regulatory regimes.

It should also be noted that sustainability analysis has to be country specific, consideringthe debt history, the level of sovereign ratings, the development of the financial sector and thedebt markets. A well functioning capital market would enable governments to borrowdomestically thus avoiding external debt. Country-specific external debt-burden thresholds alsodepend on the quality of the countrys economic policies and institutions. Countries withdifferent levels of policy performance can handle different levels of debt burden. Table 2presents the results of DSA carried out by the IMF for the countries, with the country specificthresholds.

Table 2 : Examples of Debt Sustainability Analysis in Bangladesh, Lao PDR and Vietnam

Bangladesh Lao PDR Vietnam

Th. 2007 2008 Th. 2007 2008 Th. 2007 2008

PV of debt in percent ofGDPExportsRevenues

40150250

1784

166

114492

30100200

46129318

38106253

50

200300

172263

161964

Debt Service in percent ofExportsRevenues

2030

510

36

1525

513

615

2535

48

47

IMF, Joint Fund-World Bank Debt Sustainability Analysis (DSA): Bangladesh (September

2008), Lao PDR(July 2008), and Vietnam(February 2009). Th. denotes threshold ratios. Figuresfor 2008 are baseline simulations.

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A recent IMF study8 on debt simulation for 2009 revealed the debt situations to havedeteriorated to medium and high risks in a large number of low income countries following thefinancial crisis. Of the 13 countries considered from the Asia Pacific region, four countries(Bhutan, Cambodia, Lao Peoples Democratic Republic, Sri Lanka) appear to have unsustainabledebt thresholds, as measured relative to GDP. The debt level is considered at high risk of debt

distress if its ratios relative to GDP exceed their corresponding sustainable thresholds. The studyalso reveals that the risks to debt sustainability posed by the current financial crisis varydepending on the initial economic conditions.

Table 3: Selected Indicators of External Debt of Eleven Countries

Country Name 2000 2001 2002 2003 2004 2005 2006 2007 External debt stocks (% of GNI)

Bangladesh 32.2 31.4 34.3 34.3 33.8 29.9 31.1 30.0Bhutan 45.6 54.7 70.5 78.8 85.2 79.5 76.5 68.6Cambodia 72.5 69.8 72.0 70.3 65.0 56.7 50.4 47.1Fiji 7.8 7.0 7.6 8.8 7.4 7.6 7.7 11.4Kazakhstan 72.5 70.8 76.5 78.3 81.4 83.8 103.4 103.7Lao PDR 150.7 146.7 167.0 107.8 104.2 98.4 92.4 84.4Maldives 34.7 40.1 45.0 43.5 51.7 53.2 54.4 56.4Nepal 52.0 45.3 49.5 50.0 46.3 39.0 37.4 35.0Pakistan 44.9 44.4 46.2 41.6 35.5 29.7 27.6 28.0Sri Lanka 57.2 56.5 57.8 55.8 54.2 46.7 41.7 43.8Vietnam 41.7 39.0 38.7 41.8 40.5 37.1 34.5 36.3

Concessional debt (% of total external debt) Bangladesh 94.8 93.4 92.8 93.2 92.1 91.0 88.2 87.7Bhutan 65.5 51.7 49.4 43.7 40.5 37.8 38.8 40.0Cambodia 88.2 88.4 88.9 89.5 89.2 89.5 93.8 93.7Fiji 14.0 15.0 18.7 16.5 17.9 11.4 12.2 7.4Kazakhstan 3.3 2.6 2.7 3.3 3.0 2.1 1.3 1.0Lao PDR 98.0 98.4 88.8 86.2 80.7 73.0 73.3 72.8Maldives 69.1 59.5 60.5 64.4 57.7 54.2 47.6 43.7Nepal 98.4 97.6 98.4 99.0 98.1 97.7 96.2 95.5Pakistan 55.0 62.1 64.7 66.7 70.9 71.4 70.6 68.2Sri Lanka 74.2 74.1 74.8 79.3 80.1 74.3 76.7 69.3Vietnam 61.5 66.5 72.5 74.3 71.7 68.2 70.6 66.9

Short-term debt (% of total external debt)Bangladesh 2.1 2.4 3.4 3.3 3.5 3.6 5.7 6.3Bhutan 0.8 0.0 0.3 0.9 0.0 1.9 2.2 0.0

8 IMF, The Implications of the Global Financial Crisis for Low-Income Countries, March 2009. The studyconsidered the following countries from Asia Pacific: Afghanistan, Bangladesh, Bhutan, Cambodia, India, LaoPeoples Democratic Republic, Mongolia, Myanmar, Nepal, Pakistan, Papua New Guinea, Sri Lanka, Vietnam.

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Country Name 2000 2001 2002 2003 2004 2005 2006 2007Cambodia 8.6 8.3 7.5 6.9 7.6 7.9 5.9 6.0Fiji 11.8 13.9 26.3 42.5 37.4 48.7 47.4 28.4Kazakhstan 7.7 9.0 10.2 12.4 12.0 18.6 17.0 12.2Lao PDR 0.3 0.0 0.0 0.0 0.2 0.2 0.2 0.2

Maldives 10.4 23.1 17.9 9.1 10.9 14.3 19.5 23.1Nepal 1.0 2.0 1.3 0.4 1.1 1.5 2.4 2.2Pakistan 4.6 4.2 4.6 3.5 3.5 3.7 3.4 5.5Sri Lanka 7.5 7.2 7.2 5.9 5.8 8.8 7.3 11.6Vietnam 7.2 6.2 5.9 8.1 11.9 13.4 12.4 19.3

Debt service (% of exports of goods, services and income)Bangladesh 8.6 7.5 7.4 5.9 5.2 5.4 3.8 3.9Bhutan .. .. .. .. .. .. .. ..Cambodia 1.6 1.0 0.8 0.9 0.8 0.7 0.6 0.5Fiji 2.8 2.2 2.0 1.3 0.9 1.0 1.0 ..Kazakhstan 32.0 32.0 34.5 34.8 38.0 42.2 33.7 49.6

Lao PDR 7.9 9.0 17.6 21.5 22.2 23.1 19.5 18.9Maldives 4.3 4.7 4.5 3.7 4.7 7.0 4.4 5.1Nepal 6.9 7.0 6.3 6.1 5.6 4.7 5.1 4.5Pakistan 25.2 24.6 18.1 16.2 21.1 10.1 8.6 8.9Sri Lanka 10.3 10.1 9.8 7.5 8.6 4.5 8.7 6.7Vietnam 7.5 6.7 6.0 3.4 2.6 2.6 2.0 2.3

Source: Global development Finance, 2009.

All the eleven economies considered in the present study appear are experiencingsignificant shortages of new funds, constraining government expenditures and essential imports

(Bhutan with negative net resource transfers, with very small transfers in the case of Maldivesand Nepal). Based on the figures for the year 2007, the debt situation can be considered criticalin Kazakhstan with the present value of debt to GNI at 131 percent of GDP(Table 4). High shortterm debt was observed for Fiji had high short term debt (28.4 per cent) and Maldives (23.1 percent) for the year 2007(Table 3).

Table 4: Key External Debt Ratios for Selected Countries (averages for 2005-07)

TotalExternal

Debt2007

(USDMillions)

Presentvalue (PV)ofExternalDebt 2007

(USDMillions)

Totalexternal

debt(EDT)to exports of

goods &services(%)

Present value ofdebt to exportsof goods and

services

Externaldebt as %of grossnational

income(GNI)

PV as %of debt to

GNI

Bangladesh 22,033 15,142 121 84 33 22Bhutan 775 742 186 178 81 71Cambodia 3,761 3,222 73 63 53 46Fiji 387 387 22 22 12 12Kazakhstan 96,133 94,263 222 218 133 131Lao PDR 3,337 2,784 320 267 100 84

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Maldives 562 468 78 65 65 54Nepal 3,645 2,001 127 70 39 22Pakistan 40,680 32,807 153 123 32 25Sri Lanka 14,020 11,638 126 105 50 42Vietnam 24,222 20,558 53 45 41 35

Source: World Bank, Global Development Finance, 2009.

The impact of the global slowdown is highly dependent on policy responses and domesticfactors, as well as on the interaction of different economic shocks 9. There is possibility for anumber of countries to cross the debt sustainability thresholds under the present circumstances, ifcountries donot undertake macroeconomic adjustments and pursue policies mitigating downsiderisks to their economies. Country commitments to macro management are expected to facilitatedebt sustainability by boosting investor and donor confidence.

It is to be recognized here that the concept of debt sustainability is an evolving situation, anoutcome of debt dynamics as well as macro-economic policies. It relates to the governments

ability to generate future debt servicing and assessing the evolving economy in an era of rapidchanges. Historical episodes of debt crisis provide various indications and circumstances underwhich the countries had debt distress. Debt dynamics depends on the way the current accountdeficits are being financed: by recourse to external borrowings or by non-debt creating flowssuch as foreign direct investments or other forms of private flows. Countries should maintain itslevel of external debt consistent with the trends in balance of payments and its sustainability, andat the same time, maintaining an orderly access to global capital markets, preserving its creditratings, and ensuring that the new external borrowings are well within the accepted risk and costpreferences. Country authorities should prepare a medium term debt management framework,which could then be refined and modified during the course of time as the fiscal and balance ofpayments situation improve. Maintaining macroeconomic stability on a sustainable basis forms

the main focus of a sound debt management policy, and the later should focus on monitoringtargets and indicators of debt sustainability.

Debt sustainability also requires maintaining an optimum composition of external anddomestic debt in the public debt portfolio. There is of course no single optimal solution to thegovernment financing mix, as regards domestic versus external sources. It also depends on theavailability of financing alternatives at any given time, the depth of the Government securitiesmarket, and the stance of fiscal policy. The choice of financing is determined to a large extent bythe debt management objective, which aims at minimizing the costs and risks to the economy.Sound debt management can prevent a debt crisis; at least minimize the costs to the economy.

9The thresholds are as applied in World Bank/IMF debt sustainability analysis for low income countries. The

baseline scenario indicates a breach of debt and/or debt-service thresholds over the projection period. For example,under the HIPC Initiative, thresholds for external debt sustainability are defined as the Net Present Value (NPV) ofdebt-export ratio, which should be below 150%; or the NPV of debt-to-fiscal revenue ratio which should be below250%. See Mark Allen and Gobind Nankani, Debt Sustainability in Low-Income CountriesProposal for anOperational Framework and Policy Implications, IMF/IBRD, February 2004.

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Debt managers can contribute by promoting prudent debt composition and provide early warningsignals of debt distress. If debt levels and its composition cannot be made less crisis prone in themedium term, costly options would be inevitable (such as currency float with initial devaluation,control on capital inflows, costly fiscal adjustments involving primary balance).

6. Government debt should cover comprehensively all forms of potential exposures tothe government balance sheet

Government debt management functions evolved over the years have covered acomprehensive measure debt such as external, domestic, and contingent liabilities, within privateas well as public sectors. The broadening of the scope for debt reporting has also been inresponse to the growing complexities witnessed in the debt management. This is expected to thepotential exposures to the government balance sheet which may emerge from the liability ofother sector in the economy.

Private Sector Debt: Experience of Asian crisis demonstrated that external exposures ofprivate sector (to include corporate sector and financial institutions) can have adverse fiscalimplications, due to the bail-out costs of the financial sector or the cost of corporate restructuringafter a currency crisis. The increasing role of private sector in all economies has led to raising ofbonds and loans from commercial sources internationally, which has been complimented by thechanging composition capital flows (such as increased importance of direct and portfolioinvestment flows). These would create new dimensions of the debt complexities as regardsliabilities of the corporate sector, exchange rate-debt linkages, domestic-external debt linkages,and the exposure to contingent liabilities. It is necessary to monitor the level of private sectordebt, which will include corporate debt as well as debt by financial intermediaries. Transparentand strong legal framework enabling contract enforcement between lenders and borrowers areconsidered important as the country allows more private sector borrowings, most importantly

when from external sources.

Contingent Liabilities: The debt management strategy should integrate the managementof contingent liability with the framework of aggregate public sector exposure, due to theirpossible repercussions on the future increases in government obligations. Common form ofexplicit contingent liabilities would include loans guarantees, guarantees of domestic publicsector debt, cross-border provision of guarantees, and such other contractual arrangements of theGovernment such as the line of credit, exchange rate and interest rate guarantees, etc. Implicitcontingent liabilities, on the other hand, may arise due to contractual or legal obligations of thegovernment conditional upon certain events occurring such as ensuring systemic solvency of thebanking system, bail outs under a financial crisis, and fulfilling obligations of subnational

governments in the event of defaults. Debt mangers need to budget for the contingent liabilities,making appropriate stress tests of abnormal market conditions, and quantifying and estimatingthe potential costs of such liabilities in the eventuality. The government should develop andmaintain a comprehensive database of all guaranteed loans, and these should be tracked and theexposure monitored on a regular basis.

Onlending: Recently governments in developing countries have shown increasing interestsin reporting and managing their onlending portfolio, considering its importance in financing

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development projects as well as its fiscal implications due to accumulated arrears on suchloans10. This is an emerging feature as countries are embarking on decentralization and the needfor expanding infrastructure investment requirements, there would be significant demand forfinancing at the subnational level requiring onlending arrangements. Debt reporting frameworkneeds to capture the loans that have an on-lending arrangements with other government agencies.

Experience from countries such as China, India, Indonesia, and Mongolia show that thegovernments can come under significant unanticipated fiscal burden in public finances when thestate-controlled entities default or delay on their obligations. Foreign currency risk is typically animportant issue in case of external loans when onlent in local currency, as the central governmentassumes currency mismatches in its balance sheet.

Government onlent portfolio involves a range of operations with important implications onbudget. Either they have direct fiscal impacts whereby Government engages in debt servicing, orthey involve quasi-fiscal operations when onlent loans carry significant exchange risks.Information on these aspects is important because they can threaten the maintenance of fiscalcontrol. It is thus crucial that onlending portfolio is assessed and recognized within a ri sk

management framework, so that the fiscal risks are factored into in the budgetary context

11

.Though some advanced countries have established better processes in managing their onlentportfolios, the need to establish such processes is yet to be appreciated in developing countries.The international attention apparently focuses mainly on government guarantees and thequantification of fiscal risk arising out of contingent liabilities, although the economicimplications of guarantees and onlending may overall be equated.

7. Prudent public debt management is considered critical to reducing the countriesvulnerability to financial crises.

The swift changes in global financial environment and the periodic recurrence of financialcrisis impose renewed emphasis on debt management and make it necessary for countries toreview their institutional arrangements. The volatility in global financial markets and the widegyration in asset prices have underscored the importance of a sound and coherent policyframework for managing and monitoring debt flows. Developing countries that are liberalizingtheir capital accounts and their governments having significant exposure to external creditorsneed to review as a matter of priority their debt management framework. Government debtmanagers need to develop capacity to manage their debt portfolio covering both domestic andforeign loans and assess tradeoffs between cost and risk.

10

On-lending is used to mean the same where by an institutional unit within an economy borrows funds and thenon-lends to a second institutional unit. Typically in a developing economy, the higher level of government(particularly the central government raises an external loan from the multilateral and bilateral lenders, export creditagencies, international commercial banks as well as from private capital markets and simultaneously enters anagreement with the subnational or the local governments or public sector units in the form of subloans with varyingterms and conditions. See the World Bank, World Bank Lending for Lines of Credit: An IEG Evaluation, 2006, page7.

11 It is to be noted here that IMFs fiscal transparency requires uniform and complete disclosure of guarantees givenby the Government in the financial statements of the Governments.

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The objectives of debt management are best described by the IMF and the World Bank, asthe process of establishing and executing a strategy for managing the governments debt inorder to raise the required amount of funding, achieve its risk and cost objectives, and to meetany other sovereign debt management goals that the government may have set, such asdeveloping and maintaining an efficient market for government securities12. An efficient debt

management would encompass in normal times several areas as efficient cash management,financing government budget, risk management, effective coordination with fiscal and monetarypolicies, supported by an adequate institutional and staff capacity13. The diagram below presentsan interface that is part of a modern debt management office:

There is need to promote stronger institutional arrangements and strengthen coordinationbetween debt management and other organs of government responsible for macroeconomicpolicies. It needs to be noted here that the diffusion of debt management responsibilities acrossmultifarious agencies could make it difficult for the authorities to clearly define the functions ofdebt management. There are good reasons for consolidating in one debt office the responsibilityfor managing all aspects of government debt, including monitoring the liabilities of other sectorsin an economy. This facilitates an integrated management of the nations debt portfolio,strengthens accountability, reduces information gap and establishes coordination. Strengtheninginstitutional arrangement with effective debt management guidelines and manuals can assist inprudent debt management. The agencies with which coordination would be necessary include the

relevant line ministries, government bodies/corporation that has autonomous functions forborrowing, financial management as well as audit divisions. All the above agencies need toappreciate the important role of public debt management, and their proper representations in thedebt coordination committees are essential.

12 See the Guidelines for Public Debt Management, Prepared by the Staffs of the International Monetary Fund andthe World Bank, March 21, 2001.13 See the World Bank, Managing Public Debt: From Diagnostics to Reform Implementation, 2007.

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The institutional arrangement should be supported by a strong legal framework defining

regulatory structure at all levels of debt management. This framework must guide the policiesand practices that are to be followed by the debt management units, with necessary interfacesamong its different constituents and stakeholders. This in turn should also be followed by

manuals consistent with the guidelines at the operational levels, to clearly outline the majorfunctions and responsibilities of the staff. While passive approach to debt management isdesirable under normal circumstances, active management requires analytical study of interlinkages and the risk factors underlying debt portfolio. It is necessary to maintain a comprehensivedata base of all government liabilities, to include domestic and external, contingent and on-lending, etc. Such comprehensive picture of the liabilities can be of greater relevance formacroeconomic purposes.

The World Bank is developing a program to help strengthen capacity and institutions indeveloping countries to manage government debt which is called the Debt ManagementPerformance Assessment Tool (DeMPA)14. Along with the DeMPA, the Guide to the Debt

Management Performance Assessment document serves as the guiding tool for assessing debtmanagement capacity of a country. Countries are encouraged to use this framework to assesstheir debt management performance consistent with long term debt sustainability and identifypriority areas for policy action. As of December 2008 DeMPA has been applied in 20 lowincome and 3 middle income countries.

8. Coordination between debt management and macroeconomic policies is critical

The Guidelines for Public Debt Management spelt out that the Debt managers, fiscalpolicy advisors, and central bankers should share an understanding of the objectives of debt

management, fiscal, and monetary policies given the interdependencies between their differentpolicy instruments15. What was being emphasized is the coordination between debtmanagement and macroeconomic policies, and the later giving due attention to policies such asmonetary, fiscal, exchange rate and reserve management. Also pursuance of an efficient publicdebt management remains critical to promoting sound macroeconomic management and ensuringfinancial market stability and credibility.

The basic objectives of policy coordination between macroeconomic policies and debtmanagement can be explained as follows:

Macroeconomic Objectives Goals of Debt Management

Objectives of monetary policy is toconcentrate on its primary task ofmaintaining price stability & liquidity

Debt managers role is to provide accurateforecast of cash-flow supporting central banksliquidity management

14 See the World Bank, Debt Management Performance Assessment Tool(DeMPA), October 31, 2007.

15 Amendments to the Guidelines for Public Debt Management, International Monetary Fund and the World BankNovember 25, 2003.

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management

Fiscal policy objectives are to financebudget deficit using government securitiesmarket, and avoiding direct monetization(inflationary) of deficits with securities incentral bank portfolio

The role of the debt manager is to provide debtservicing projections to budget preparations, andmore proactive role in advising government onthe long run implications of rising domestic debton fiscal sustainability

Objectives of exchange rate policy are toavoid falling price competitiveness ofexports, stability in exchange markets,foreign exchange market interventions, andprevent a rise in the cost of external debtservicing

Debt managers role in providing feedback ofexchange rate changes on government debtservicing, liquidity management in the bankingsector and its impact on foreign exchange markets

Reserve management objectives aims atmaintaining reserve adequacy, keeping in

view the costs of holding reserves as well asexchange market stability

Debt managers role in providing external debtservice projections and the future

flows/disbursements of external creditors

While pursuing the debt management strategy, therefore, it is essential for the Governmentto maintain consistency between macroeconomic policies and debt management objectives.Consistency and coherence between these two policy objectives are needed, in order to attainappropriate macroeconomic goals such as stable interest rate and inflation rate in the mediumrun. Government borrowing strategies cannot ignore the sustainability of the fiscal deficit in themedium run. At the same time, debt management policy should not become subordinate tomonetary and fiscal policy objectives, rather be based on the principles of sound portfoliomanagement. At times conflicts of objectives might occur, e.g. the Central Bank might proposeto raise foreign currency debt to build reserves when debt management office might see thismove as an increase in overall risk of the governments debt portfolio. These conflicts could beavoided in the presence of effective institutional arrangements which provides clarity in the areasof policy coordination and separate accountability.

The simplified channels of policy linkages between debt management and macroeconomicpolices were somewhat twisted during the recent financial crisis. Countries which responded toglobal slowdown by easy monetary policies faced trade-offs between the benefits of lowerinterest rates and a weaker exchange rate for economic activity and exports, and the negativeimpact of depreciation on government debt16. Countries with large debt overhang have verylimited fiscal space to support a stimulus without unduly crowding out private investments, or asharp increase in funding costs, or undermining medium term debt sustainability. However thegeneral responses were both easy monetary policies and extended fiscal stimulus in response tocollapsing external demand and weakening domestic growth, and this definitely led to a

16 See Atish R. Ghosh, Marcos Chamon, Christopher Crowe, Jun I. Kim, and Jonathan D. Ostry, Coping with theCrisis: Policy Options for Emerging Market Countries, IMF Staff Papers, April 2009.

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compromise of debt sustainability in several countries. Some countries could use foreignexchange reserves to prevent a local currency depreciation or substitute for foreign creditsthereby supporting domestic credit expansion, but this luxury was available to only few amongthe best performing emerging markets.

It is to be recognised that the debt management complexity depends to a large extent on theeconomic characteristics of the country, the size and structure of domestic debt marketfacilitating government financing, the resilience of the economy to absorb external shocks, aswell as track record of international borrowings. The situations in many countries in the AsiaPacific are precarious, however, as a large number of countries have both structural budgetdeficits and high levels of debt. Persistence of the present recession and fiscal expansion areexpected only to precipitate their debt situation. Thus the interaction of monetary and fiscalpolicies with that of debt management was vigorously evident during recent period; though thelater appears remain subordinate in many economies. Effective coordination between the CentralBank and the Ministry of Finance, in sharing of information (e.g. cash flow forecasts), having anunderstanding to avoid competing and conflicting market interventions are crucial. It might be

even necessary to review the coordination process between the Ministry of Finance and theCentral Bank, in order to asses if the present debt management framework adequately recognizestheir necessary interfaces.

9. Government debt portfolio is subject to various forms of risk, the effectivemanagement of which renders stability in debt service costs over time.

The size of the governments debt portfolio is the largest in any economy, therefore, has thepotential to generate significant fiscal and financial market implications. Structuring the debtportfolio with focus on minimizing its exposure to the various forms of risk is important, such asfluctuations in exchange rates and interest rates, in a world where risk factors affecting debtportfolio fluctuate continuously. Commodity price fluctuations add further risk by affecting theability to service the debt. Financing decision without due cognizance to its underlying riskfactors can make the debt portfolio vulnerable to adverse economic and financial shocks, whichwill have implications on future fiscal situation and costs of debt servicing. Currency andmaturity mismatches were the major elements in almost every financial crisis in emergingmarket economies, which also involved very costly process of resolution involving bailouts andrestructuring.

Typically debt managers grapple with various forms of risk (such as currency and interestrate risk, credit risk, liquidity risk, and roll over risk) while managing the government debtportfolio. The implications of certain risk that the debt portfolio is subjected to can be explainedas follows:

External debt denominated in foreign currencies is exposed to risks of changes in exchange rates, due to thechanges in loan currency against local currency as well as cross-currency movements in the global currency markets.

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The later aspect is also important; for instance, the appreciation of the Japanese yen against US dollar in recent

months have caused a rise in the dollar value of the external debt obligations contracted in Japanese yen17

.

Debt contracted at variable interest rates is subject to interest rate risk as market rates rise, or debt contracted atfixed interest rates can have risk in the presence of substantial decline in interest rates. Debt prepayments to takeadvantage of favourable interest rate environment entail costs. The portion of debt contracted at variable interestrates should be controlled, and its exposure to rising interest rates is monitored and managed.

Associated with interest rate risk is the rollover risk if the debt portfolio has significantportion of short term debt, which can create rollover problems and implications onmoney markets. Typically measured as interest rate re-fixing whereby the amount fordebt on which a new interest rate is to be fixed within one year. The debt portfolioaffected by the interest rate re-fixing within a year will include short term foreigncurrency debt, floating rate debt instruments and treasury bills that are part of domesticdebt portfolio.

Liquidity risk can arise out of the governments cash management function, due todifficulty in raising enough borrowing in a short period of time. If financial markets

characterized by currency convertibility are subjected to reversibility in short-termexternal capital flows, and this can impose additional liquidity risk. The financial crisishas created liquidity problems in most of the developing countries, triggered by a sharpdrop in export earnings, drop in capital inflows and new borrowings.

Credit risk arises due to the impact of rating downgrades or default of the assets held by the government. Alsorelevant here would be the full acceptance of bids in auctions of government securities, as well as in the on-lendingportfolio of the government.

Concentration risk can arise due to the concentration of debt portfolio in a specific classof debt instruments, market segment, sector or lender, domestic or external. Forexample, overtly concentrating on one major external lender would expose the

economy to either future changes in the lender behavior or changes in the conditionsaffecting the project performance domestically

18. It would be desirable to optimize the

borrowing sources for the economy, with due importance given to their compositions asregards different lenders and project mix, such that proper synergy is being achievedbetween the lenders preferences and the countrys resource requirements forinvestments.

Government should structure the debt portfolio to provide reasonable cost stability overtime. The focus of debt management is to attain an optimum choice of currency, interest rate andmaturity structure, which is expected to minimize the exposure to changes in risk factors that areinherent in the profile of the debt stock. Efforts should be made in lengthening the maturity of

new issuances and allocating more issuances in the longer maturity buckets, thereby reducingpressure on short to medium term bunching and liquidity risk. The maturity profile of debtshould be structured, avoiding bunching of repayment obligations in any particular year. The

17 For instance, the share of US Dollar and Japanese yen in the total public and publicly guaranteed external debt ofEast Asia and Pacific , respectively, was 58.4 per cent and 24.5 per cent, and for South Asia was 56.1per cent and18.1 per cent for the year 2007.18 Lending portfolio of some of the Pacific Islands countries have predominant share of one or two lenders (with theAsian Development Bank having a very major financing role).

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risk inherent in the government debt portfolio has to be interpreted in a forward lookingframework, in terms of its potential impact on the increase in future debt servicing. This is not tosay that the debt structure be based on a particular exchange rate or interest rate outlook, but thedebt manager needs to analyse the sensitiveness of market prices on debt service projections andexplore options to keep the debt-servicing costs within targets and stable over time.

Some governments use financial derivatives such as interest rate and currency swaps tohedge medium to long term risks of foreign currency debt. Derivatives allow locking in today(or on the day of the contract) an exchange rate or interest rate for future debt servicetransactions, involving interest payments as well as principal repayments, thereby eliminatesuncertainty. However these instruments require careful assessment, and debt managers need toevaluate the costs of hedging vs magnitude of market risks, with recognizing clearly theunderlying risk factors. Multilateral lenders such as the World Bank and the ADB offer riskmanagement products if a borrower decide to avail such facilities. For example, under the IBRDrisk management arrangements the borrower can amend the currency and interest rate mix toreflect their desired portfolio. The risk management instruments offered in the IBRD portfolio

are interest rate conversions or swaps, interest rate caps and collars, currency conversions orswaps, commodity swaps, etc19.

It is necessary to make risk and vulnerability assessments of debt portfolio, considering theimpact of alternative government debt borrowing policies and changes in key risk parameters(such as floating vs. fixed interest rate, long term vs. short term maturity and duration, and localcurrency vs. foreign currency linked public debt). Debt managers should ensure that debtservicing trends are consistent with the governments tolerance for risk ( e.g. maintaining annualdebt service to fiscal revenue targets). This depends crucially on the environment within whichthe debt management function is undertaken, considering the country specific factors such as theborrowing history, sovereign ratings, and development of the financial sector, monetaryconditions and the climate of external resources, including the shocks to the economy.Considerations should be on the long-term strategic view of the debt structure, balancing thebenefits of greater stability in debt-servicing costs against the cost of achieving stability. Suchconsiderations would make debt managers aware of the impact of changes in financial andeconomic circumstances on their external as well as domestic obligations and will put them in abetter position to develop the right policy responses to address debt management issues.

10. Need to maintain adequate level of foreign exchange reserves, to preventexternal sector vulnerabilities and to manage exchange market volatility

In the post crisis Asia as more countries began adopting flexible exchange rate regimes, theincreased holdings of reserves were undertaken to manage exchange rate volatility. In severalother countries the greater holdings of reserves were justified on grounds of factors such as thehigher ratio of foreign currency debt in the government debt portfolio, a higher share short-termexternal debt, the size of capital flows that were more in the form of portfolio investments.Reserve holdings were being increasingly built to serve as cushion against temporary liquidityproblems affecting debt servicing difficulties and foreign exchange market intervention affectingexchange market volatility. The present crisis once again brought to the forefront the liquidity

19. See the World Bank, Guidelines for Using IBRD Hedging Products, February 2001.

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problems as the governments of several developing economies were forced to refinance maturingshort term foreign currency denominated debt under severely deteriorating economic conditions(depreciated domestic currencies, fiscal vulnerability, sudden drop in capital inflows, and fallingforeign exchange earnings).

Governments need to maintain adequate level of foreign exchange reserves, in order tocushion against external sector vulnerabilities and to use as a tool for exchange rate policy 20.There is need to assess the vulnerability in the event of capital flight or repayments on account ofshort term debt or due to such other forms of speculative capital outflows. Maintenance of a setof liquidity specific indicators, such as the ratio of foreign exchange reserves to imports andreserves to short term debt, at their desired level would prevent liquidity crisis.

It is common practice in most developing countries to manage external public debtindependently of the holdings in foreign exchange reserves. However, some governments havedeveloped a fully integrated approach for the management of external assets and liabilities(suchas Canada, Turkey, the U.K., New Zealand, Latvia, and Hungary), who typically manage foreign

currency liabilities in conjunction with the reserve assets, to minimize the impact of exchangerate changes. Such an approach considers aligning the currency composition of reserves on theasset side with that of the currency composition of debt on the liability side, thereby minimizingthe foreign exchange risk to the economy. Active management of reserves is undertaken in anasset-liability framework whereby the portfolios are benchmarked as regards currency, duration,and interest rate.

11.Improve cooperation in debt management and establish regional arrangements

The present financial crisis that has global dimension requires global responses. The issueof regional cooperation in promoting financial stability has been the centre stage of discussionsince the Asian crisis of 1997, particularly in the provision of international liquidity, progressingtowards the regional financial architecture, developing domestic and regional bond markets, andstrengthening of mutual surveillance mechanisms.

The post crisis Asia witnessed some of the significant initiatives as regards regionalmonetary cooperation such as the setting up of regional liquidity support arrangements throughthe Chiang Mai Initiative (CMI), the establishment of the Asian Bond Fund (ABF), the AsianBond Market Initiative (ABMI), and the road map for monetary and financial integrationundertaken by ASEAN. The Chiang Mai Initiative (CMI) agreed in May 2000 by the financeministers of ASEAN+321 countries created emergency liquidity provision by creating a networkof bilateral swap agreements (BSAs) and repurchase agreement facilities among the member

20 See for a review of best practices in reserve management and guidelines for the developing countries: IMF,Guidelines for Foreign Exchange Reserve Management: Accompanying Document, Prepared by the Monetary andExchange Affairs Department, March 26, 2003.

21 The 10 ASEAN members (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore,

Thailand and Vietnam) together her with Japan, China and South Korea.

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countries. The ASEAN+3 have successfully concluded 16 bilateral swap arrangements of $90billion involving eight countries as of May 2009. The membership of the CMI could beexpanded to cover more countries from the region, and the purpose of fund support could bebroadened to include liquidity and solvency issues. The establishment of Asian Bond Fund(ABF) and the ongoing Asian Bond Market Initiative are important steps towards developing the

regional bond market and facilitating investments in infrastructure in the region.

Going further, the proposal for broadening the bilateral liquidity support under the CMI toa multilateral institution such as the establishment of an Asian Monetary Fund(AMF) in theregion is gaining ground. The AMF was proposed as a regional currency fund to provideemergency support during a currency or liquidity crisis in Asia, by pooling Asian reserves andmaking funds available to the members enabling them to stabilize currency markets. The ideahas received a fresh impetus recently with South Korea, Japan, China and the 10 members ofASEAN proposing to establish an $80 billion fund to aid the nations in dealing with the globalcredit crisis, though the details of this proposal are yet to be materialized.

It is also necessary to improve regional cooperation through more organized arrangementsin the Asia-Pacific region to enhance debt management capacities, and share experiences in debtmanagement as well as risk management. There is need for significant technical support inbuilding debt management capacity, in strengthening the institutional arrangements for managinggovernment debt as well as imparting analytical capabilities through training.

12. Conclusions

The global financial crisis erupted at a time when the developing countries had beengrappling with the rise in food and energy prices. The financial crisis affected severely the publicfinances of most countries from the region, due to the direct fiscal support to the banking sector,the revenue impact of falling commodity prices, discretionary fiscal stimulus to support growth,and such other provisioning towards contingent liabilities.

The complexities of public debt management have been compounded each time the worldeconomy witnessed financial and foreign exchange crisis. The implications on developingcountries, and particularly on the low income countries in Asia, have been somewhat severe,despite the fact that their financial systems are less integrated globally.

The prospects of external capital flows to the low income countries of the region are likelyto be markedly lower until the resolution of the present crisis. Several countries are experiencingsignificant shortages of funds, which is curtailing essential imports and impacting poverty. Thelow income countries generally lack access to private capital markets overseas, and therefore willdepend to a large extent on the assistance from bilateral and multilateral donors, primarily in theform of concessional financing

The debt level of a country must be sustainable, and the present uncertain external financialenvironment demands that countries must assess the sustainability of their debt levels. There ispossibility for a number of countries to cross the debt sustainability thresholds under the present

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circumstances, if countries donot swiftly pursue policies mitigating downside risks to theireconomies. Country commitments to macro management are expected to facilitate debtsustainability by boosting investor and donor confidence. Countries with large debt overhanghave very limited fiscal space to support a stimulus without unduly crowding out privateinvestments, or a sharp increase in funding costs, or undermining medium term debt

sustainability.

Government debt management should cover a comprehensive measure debt such asexternal, domestic, and contingent liabilities. The broadening of the scope for debt reporting hasalso been in response to the growing complexities witnessed in the debt management. This isexpected to the potential exposures to the government balance sheet which may emerge from theliability of other sector in the economy. The swift changes in global financial environment andthe periodic recurrence of financial crisis impose renewed emphasis on debt management andmake it necessary for countries to review their institutional arrangements. Government debtmanagers need to develop capacity to manage their debt portfolio covering both domestic andforeign loans and assess tradeoffs between cost and risk.

While pursuing the debt management strategy, therefore, it is essential for the Governmentto maintain consistency between macroeconomic policies and debt management objectives.Consistency and coherence between these two policy objectives are needed, in order to attainappropriate macroeconomic goals such as stable interest rate and inflation rate in the mediumrun. If debt levels and its composition cannot be made less crisis prone in the medium term,costly options would be inevitable (such as currency float with initial devaluation, control oncapital inflows, costly fiscal adjustments involving primary balance).

The size of the governments debt portfolio is the largest in any economy, therefore, has thepotential to generate significant fiscal and financial market implications. Structuring the debtportfolio with focus on minimizing its exposure to the various forms of risk is important in aworld where risk factors affecting debt portfolio (such as exchange rates, interest rates andcommodity prices) fluctuate continuously. Financing decision without due cognizance to itsunderlying risk factors can make the debt portfolio vulnerable to adverse economic and financialshocks, which will have implications on future fiscal situation and costs of debt servicing.

Debt managers can contribute by promoting prudent debt composition and provide earlywarning signals of debt distress. Emphasis on debt management should not be the outcome of acrisis, but a continuous focus of macroeconomic policy. Successful debt management woulddepend to a large extent on the judgment of policy makers and planners. Debt manager cannotignore how the financial markets react to the governments debt level and borrowings.

It is to be recognised that the debt management complexity depends to a large extent on theeconomic characteristics of the country, the size and structure of domestic debt marketfacilitating government financing, the resilience of the economy to absorb external shocks, aswell as track record of international borrowings.

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References

Atish R. Ghosh, Marcos Chamon, Christopher Crowe, Jun I. Kim, and Jonathan D. Ostry,Coping with the Crisis: Policy Options for Emerging Market Countries, IMF Staff Papers, April2009.

IMF, Guidelines for Foreign Exchange Reserve Management: Accompanying Document,Prepared by the Monetary and Exchange Affairs Department, March 26, 2003.

IMF, A Guide to LIC Debt Sustainability Analysis, May 2005

IMF Global Financial Stability Report, April 2009.

IMF, The Implications of the Global Financial Crisis for Low-Income Countries, March 2009.

Mark Allen and Gobind Nankani, Debt Sustainability in Low-Income CountriesProposal foran Operational Framework and Policy Implications, IMF/IBRD, February 2004.

Michael D. Bordo, and David Stuckler and Christopher M. Meissner, Foreign Currency Debt,Financial Crises and Economic Growth: A Long Run View, March 2009.

World Bank, Guidelines for Using IBRD Hedging Products, February 2001.

World Bank, Amendments to the Guidelines for Public Debt Management, InternationalMonetary Fund and the World Bank November 25, 2003.

World Bank, Managing Public Debt: From Diagnostics to Reform Implementation, 2007.

World Bank, Global Financial Crisis: Implications for South Asia, October 21, 2008.

World Bank, Swimming Against the Tide: How Developing Countries are Coping with theGlobal Crisis, Background Paper prepared by World Bank Staff for the G20 Finance Ministersand Central Bank Governors Meeting, Horsham, United Kingdom on March 13-14, 2009.

external debt management pradhan

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