For the past nine years, the Union Ministry of Finance has been releasing
an annual “status paper” on the country’s external debt situation. The
latest in this series was made public a few days back. According to
it, India’s external debt-that is, the debt it has to pay back to foreign
lenders and to NRIs-is around $ 105 billion (1 billion= 100 crore) as
of end-December 2002. This means that every Indian has an external debt
burden of about $ 100 or roughly Rs 4600.

In absolute terms, India now ranks ninth amongst the world’s top debtor
countries after Brazil, Russia, Mexico, China, Argentina, Indonesia,
South Korea and Turkey. But international agencies like the World Bank
put India into the category of the less indebted. How is this possible?

First, the structure of India’s external debt is fundamentally different
than that of other countries. 45% of the total debt is debt owed to
foreign governments and to international organisations like the World
Bank. The bulk of debt in other countries is owed to commercial banks.
Further, within this 45%, almost four-fifths is concessional debt-that
is debt that has a grace period, a long schedule repayment and lower
interest rates.

Second, what matters more than the absolute level of debt is its size
in relation to GDP which is a measure of national income. Here too,
India comes out very well and external debt is just about 20% of GDP.
Only China has a lower proportion at about 14% of GDP. Further, what
is crucial is the ability to service the debt. Progressively, this ability
measured by the ratio of debt payments to foreign exchange earnings
through exports and remittances has been improving and presently this
ratio stands at about 14%. The World Bank calculates the present value
of the debt as a proportion to both foreign exchange earnings and to
GDP.

There is yet another aspect of external debt that is important and this
relates to the relative importance of short-term debt-that is, debt
that has to be repayed within one year. It was the inability to repay
or roll-over such short-term debt that caused India’s financial collapse
in 1991 before the Narasimha Rao government assumed office reflected
in the level of foreign exchange reserves of just $ 900 million. It
was a high volume of short-term debt that led to the financial collapse
of East Asia also in 1997-98. In 1990/91 which was the year of acute
external crisis for India the ratio of short-term debt to foreign exchange
reserves was almost 147%. Now it is now down to just 5%.

Thus, perhaps the most outstanding success story in India since 1991
has been the prudent manner in which external debt has been managed
by successive governments. The fact that India’s foreign exchange reserves
are now touching $ 83 billion (of which the “hot” component that can
vanish overnight is no more than 10-15%) without any significant increase
in indebtedness (external debt has increased by around $ 21 billion
since 1991) reflects this prudence. The framework was established and
first implemented by Dr. Manmohan Singh and his policies were carried
forward by P. Chidambaram, Yashwant Sinha and Jaswant Singh. Thankfully,
this is one area which has been completely insulated from domestic politics.

What was done to transform the external debt situation in the past twelve
years?

First, short-term debt was either liquidated or converted into medium-term
debt. One reason why India collapsed in 1991 was the flight of NRI deposits
from Indian banks beginning October 1990. Over a period of time various
schemes for NRI deposits were rationalized and converted into debt that
would mature in three to five years or more. Of the $ 105 billion of
external debt, about $ 28 billion is outstanding NRI deposits. Higher
interest rates in India compared to other countries like the USA has
led to an influx of money into NRI deposit accounts in Indian banks,
although a part of such deposits could well be unaccounted money of
residents coming back under the NRI route.

Second, there was a phased movement away from fixed exchange rates to
a system where the exchange rate of the rupee in relation to the dollar
and other major currencies is determined not by the Reserve Bank of
India but by market forces-by the forces of supply and demand. The RBI
intervenes only where there are very sharp movements or when there appears
to be excess volatility not justified by the supply-demand balance.
There were fears that the movement towards a flexible exchange rate
that took place in 1993 would cause capital flight out of India. Instead,
what has happened is that there has been substantial inflows of dollars
into India. In fact, in the past year, the rupee’s value in relation
to the dollar has gone up (“appreciated”) . The reason why the rupee
has strengthened in the past twelve months and is continuing to do is
that dollars are continuing to pour in reflecting international confidence
in India but the demand for dollars is not picking up because of sluggish
economic growth rates. If the supply of dollars increases while the
demand remains pretty much the same, then the value of the dollar goes
down or correspondingly the value of the rupee goes up. This makes imports
cheap and hurts exports. That is why, if the appreciation of the rupee
in relation to the dollar continues (and about two-third of our international
trade is transacted in dollars), the RBI may well have to intervene
to protect the interests of Indian exporters in agriculture, industry
and services.

Third, the growth of what are called “invisibles” has been dramatic-and
this has been policy-induced. Visible trade is of manufactured goods,
products and commodities. Invisible trade is of items you cannot physically
see. In India, the bulk of “invisibles” earnings of dollars has taken
place through software exports and remittances from Indians working
overseas both in West Asia and in USA. The liberalisation of gold imports
in 1996 knocked the hawala route out and brought most of the remittances
through official banking channels. The success of Indian software exports
in recent years is well-known. Together, these two items contributed
close to $ 13 billion in foreign exchange earnings last year .

India’s central economic problem is not external debt. That is well
under control. What is killing India is the simply unsustainable level
of internal debt reflected in the bankruptcy of all governments. Indian
households save about 10-11% of GDP in financial savings. This is also
the fiscal deficit of the centre and state and public enterprises combined.
This means that whatever Indians save is simply taken away by the government.
Worse, almost 70% of this is taken away not for investment but for meeting
government’s expenditure on interest payments, defence, subsidies and
public sector losses and salaries and pensions. There is no significant
public investment taking place in essential physical or social infrastructure.
Private investment too is stalled. Both are a direct consequence of
the quantity and quality of the fiscal deficit at the centre and in
states. Alas, there appears to be no respite on the horizon as the season
of politics takes over.