The question of India's external debt

1""IFORLD BAN!4Z1 REPRINT ,iERSt: Number Four Ravi . Gulhati The4 QAuestion of rn'aa s External Debt ,eprinted from Inidla Quartte.rly VOCIlume XXVIII, No. 1, January-March 1972  THE QUESTION OF INDIA'S EXTERNAL DEBT by Ravi I. Gulhati Reprinted from INDIA QUARTERLY January-March 1972 INDIAN COUNCIL OF WORLD AFFAIRS SAPRU HOUSE, BARAKHAMBA ROAD NEW DELHI-1  INDIA'S EXTERNAL DEBT' by RAVI I. GULHATI TOWARDS the end of the Third Plan, it became clear that India was having difficulties in servicing its external debt. This situation was not unique. The foreign indebtedness of developing countries had been a matter of internatiorial concern for many years. Mlultilateral renegotiations of debt contracts had taken place on many occasions during the Fifties and early Sixties to provide relief to Argentina, Brazil, Chile and Turkey. The debt problem had figured prominently on the agenda of UNCTAD meetings in Geneva in 1964 and in New Delhi in 1968. Little is known outside government circles about the history or the nature of the Indian debt problem. There is no dearth of statistics in government publications or in reports by the Estimates Committee of the Lok Sabha. However, the significance of this information is seldom clear. The relation- ship between debt and other aspects of the Indian economy are not generally understood. And yet, it is important to build a body of informed opinion on these subjects. What should be done about the country's external debt is a question which requires consideration not only by government officials and experts but also by students of international relations, parliamentarians, journalists and other readers of this Quarterly. An attempt is made in this article to present the main facts in bold relief, eschewing the teclhnicialities and the mumbo-jumbo of high finance. I will also try to sumniarize the present policy of the Government of India and its major creditors. From this juxtaposition of faca and policy it should be possible to get a glimpse of the future prospect not only for India's debt but also for the rate and pattern of the country's development. When India gained independence she had little external debt and large external reserves, mainly in the form of sterling securities. At the outset of the First Plan, these reserves amounted to the equivalent of U.S. dollars 2.1 billion. Nearly two decades later, on the eve of the Fourth Plan, these reserves had dropped to a level of $767 million while e x t e r n a 1 d e b t had climbed up to $6.3 billion.2 This transformation in India's international position-from being one of the important creditors of Great Britain to being the biggest debtor country in the developing world-was the result of deliberate policy. The rise in the foreign debt was not the result of either absent-mindedness or financial irresponsibility. It was a calculated by- product of the strategy for economic development conceived and implemented by Indian planners with the full knowledge and blessing of the Lok Sbaha. Briefly, the strategy was to raise the rate of investment in the economy as quickly as possible, supplementing national savings with external resources. A consistent feature of successive five-year Plans was the setting of investment targets above the level permitted by savings expected to materialize within the economy. Looked at from the viewvpoint of the balance of paymenits, the planners counted on imports which were much bigger than the projccted level of exports. The planned resource-gap between investment and savings (or that between imports and exports) was to be financed by drawing down the reserves, foreign borrowing and by external transfers in the form of grants. The idea was to build a momentum in the economy. As the Second Plan put it "It is the crossing of this 'threshold' at a time when living standards and the saving potential are low that calls for a measure of external assistance to supplement domestic resources" (page 11),  4 GULHATI The conception of the strategy was one thing; its implementations was someting else. Policy-makers had to contend with unforeseen circumstances as well as simple errors in Plan estimates. During the First Plan, there took place a sharp increase in the rate of investment (from 5.5 %of national income to 8.0%; see Table I) and some increase in the savings rate. The resource- gap tumed out to be much lower than forecast and it was not necessary to draw down reserves or to increase foreign debt very much. Another big jump in the rate of investment took place during the Second Plan, with the savings rate trailing behind. It seemed that planners had grossly under- estimated the resource gap. The balance of payments got into serious trouble. To finance the deficit, reserves were drawn down by nearly $1.3 billion. The Aid India Consortium was established in 1958 to rescue the Indian economy. The foreign debt rose by $1.1 billion. The resource gap during the Third Plan averaged more than $ 1 billioin per annum as the investment rate continued to move far ahead of domestic savings. The country's external debt increased by $ 3 billioni. In the period after April 1966-the so called Plan Holiday-both investment and saving rates suffered a set back. The economy, it seems, lost a part of the dynamism generated during the Fifties and early Sixties. Most observers agree that while India has made substantial progress during the last two decades, no 'threshold' has yet been crossed. Many of the deep-seated problems of poverty and technological backwardness remain unsolved. TABLE I Resources-Gap, Savings and Investment Resource Gap Net Investment as Dorn .wsic Planned Actual Per cent of Savings (million dollars) National Income First Plan 1,680 317 5.5 8.0 5.5 7.0 Second Plan 2,310 4,000 8.0 11.0 7.0 8.5 Third Plan 5,567 5,150 11.0 13.5 8.5 9.9 1966-67 1,312 12.7 9.2 1967-68 1,192 11.4 8.0 1968-69 597 11.3 8.0 Fourth Plan 3,019 11.3 14.5 8.0 13.2 Meanwhile, we have incurred external debt to the extent of $6.3 billion. To some people the absolute size of the debt figure will be frightening. How- ever, a, few relationships between external debt and other economic para- m=ters will put things ia the proper perspective. The external debt in 1969 was about 13 % of GNP, 83 % of gross domestic savings and nearly three times the export earnings of the country. Of course, the external debt does tnt have to be repaid all at once. Debt service payments during 1967-70 were just over 1% of GNP, 7% of gross savings,, nearly 30% of export enarings and 48% of gross foreign aid disbursements. From these compari- sons, it should be clear that debt service payments were not a major claim on total GNP or gross savings. However, they did pre-empt more than a quarter of foreign exchange earnings. This relationship between annual debt service payments and foreign exchange earninos constitutes an important aspect of the debt problem and we will return to it later. It is also clear that the reverse flow of debt service from India to her creditors is almost  INDIA'S EXTERNAL DEBT 5 half the total amount of foreign aid. In other words, on the basis of the 1969-70 relationship, a net transfer of resources to the Indian economy of one dollar requires almost two dollars in the ,. ,, of new loans or grants. This, too, is an important aspect of the debt problem. Who are the major creditors of India? The most important amongst them is the United States government (see Table II) represented in Newv Delhi both by Treasury officials and employees of the Agency for Inter- national Development. Over a long period, India has figured prominently in discussions on foreign aid in the U.S. Congress and many American econo- mists have made a career out of analyzing the behavior of the Indian economy. We absorbed nearly one-fifth of the total bilateral assistance extended by the U.S. in recent years. The second rank in the league of creditors is held by the World Bank Group of institutions. Their presence in New Delhi is in the form of a resident mission which prepares detailed reports on the financial and ec-onomic healtlh of the country. Up till 1960, lending to India was through the International Bank for Reconstruction and Develop- mient, more commonly known by its acronym, IBRD. These loanis carried interest rates of 5-6% and were for periods varying between 15-20 years. With the establishment in 1960 of the International Development Association (IDA)-the soft loan agency affiliated with the World Bank Group-the IBRD began to recede into the background. At one time India was the biggest borrower from the IBRD but now that position is held by Mexico. Instead, India became a prominent user of IDA funds which carry a negligible interest rate and a repayment period of 50 years. During the initial years of IDA operations, India absorbed more than one half of total leIninig by IDA.3 In time IDA was compelled to ration the amount which could be lent to India to about 40 " of the overall total for all developing countries. TABLE II Structure of Debt and Debt Se.vice 1969 Per cent Debt Services as Distributioni Per cetnt of Debt of Outstandinig Debt Outstanding Bilateral: Official 72 6.4 U.S.A. 35 2.8 U.K. 9 7.8 Germany 8 9.9 USSR 8 14.0 Others4 12 8.5 Multilateral: Official 20 5.2 IDA 13 0.8 IBRD 7 12.9 Suppliers' Credits 8 28.4 Next in importance as India's creditors are the United Kingdomn, Germany and the Soviet Union. The USSR, of course, is not a member of the Aid India Consortium. The Soviet Union's relationship with the Government of India is strictly bilateral in character. Typically, loans from the USSR (as well as other East European countries) carry a low interest rate of of 2.5 % but they have to be repaid within 12 years. In many cases payments on Soviet credits begin even before projects financed by these  ( GULHATI credits have come into full production.5 Total debt service payments to the USSR constitute a relatively high share of debt outstanding (see Table II). However, this comparison is not altogether accurate as it fails to take account of a distinctive feature of the relationship between the Soviet Union and India. Debt service payments to the Soviet Union are transferred in the form of Indian exports under the framework of trade and rupee payment agreements between the two governnments. The precise economic conse- quences of these arrangements have never been established and remain a matter of some controversy between the Governmenit of India and her western creditors. However, the fact remains that Indian exports to the USSR have increased rapidly and debt service payments to that country have not impinged much on the limited supply of free foreign exchange. The relation- ship with the Soviet Union has elements of mutuality and reciprocity which are lacking in India's economic contacts with westerni countries. Soviet loans to India are tied to that country's exports and our debt service pavnyents on these loans are tied to Indian exports. We cannot use Soviet loanls to buy articles in third countries. Reciprocally, the Soviet Union cannot use debt service paid by India for purchases in third countries. The bulk of loans from western countries are also tied to procurement in these countries but debt service payments on these loans have to be made in freely convertible currencies, It is not easy to measure precisely the terms on which India has borrowed from different external sources. The question of terms is not simply a matter of interest rates, grace periods (the interval during which loan repayment is not necessary) and maturity schedules (the sequence in which repayment is to be made). The effective cost of borrowing also depends on the severity of restrictions on the use of the loan, the extent to which prices of articles purchased with the loan are uncompetitive, the mode of transfer of debt service and the like. Nevertheless, it is possible to conclude that (a) The share of grants and grant-like transfers in the total resource flow to India has declined sharply. Correspondingly, the share of loans rose from 43 % in the Second Plan to 61 % in the Third Plan.6 This upward movement has continued in recent years. (b) The financial terms on loans have softened considerably. Actual interest payments as a proportion of debt outstanding, declined from 4.4% to 3.4% during the Third Plan. Similarly, the average life of the debt had lengthened from about 13 years to 23 years.6 These trends have continued in the second half of the Sixties. Everything considered, the Indian debt structure is not an unfavourable one. The Government has followed a prudent policy in limiting the share in total of sup,liers' credits and otherloans from private sources. At present the proportion of debt in this category is only 8 % (see Table II). This policy of rcstraint has been in effect since the first foreign exchange crisis in 1957-58, to avoid the building up of onerous service payments. It is this relatively low share of supplier's credits that distinguishes the Indian debt situation from that prevailing in Latin America.7 Official loans from multi- lateral institutions constitute one-fifth of the total Indian debt. The terms of multilateral loans have softened appreciably as IDA has displaced the IBRD. Offcial loans from bilateral sources constitute the remaining 72% of the debt. The financial terms of US loans have been soft for many years.8 Conditicns attached to loans from the UK and Germany have improved recently.  INDIA'S EXTERNAL DEBT 7 The diagnosis of India's debt difficulty depcnds on the frame of reference adopted by the analyst. If the subject is approached from the standpoint of a conventional banker, the conclusion' will be that India has "over- borrowed", and that the c' ;ntry should either scale down national expendi- ture or raise national savings. In any event, we should reduce reliance on ex- ternalresouirees and stabilize thelevel of the foreign debt for some considerable time. If following this prescription means a setback in the growth rate of the economy, accentuation of unemployment or a persistonce of idle industrial capacity, that is just too bad. To the banker, the concept of credit-worthiness is sacrosanct and everything must adjust to the imperatives embodied in loap contracts. Alternatively, the subject may be approached from the standpoint of international development and welfare. In this context, the common goal of creditor and debtor governments will be to speed up the tempo of develop- ment, to improve the efficiency of the growth process and to raise the standard of living of the poor. Foreign loans and grants are instruments for achieving these objectives. Financial conditions on which loans are extended should be respected so long as they are consistent with development considerations. If debt servicing obligations impede development, they should be revised in an appropriate framework of consultation. Viewed in a developmental framework, India has hardly "over-borrowed". Most observers agree that the total resource flow from abroad-grants and loans-has been quite modest, considering the size of the economy. On a per capita basis, India's receipts of net official aid have been strikingly low compared to the general average for developing countries.9 Net aid financcd 19 % of total Indian investment during the Second Plan and 22% during the Third. Besides, the resource transfer to India has had a relatively short history-not much more than a decade. India started its development from an extremely low base-an abysmal per capita income far short of $100, a meagre saving rate of about 5 % of national income and many sociological as well as institutional handicaps which cannot be described in statistics. The export structure was dominated by commodites-jute, tea, cotton textiles-out of favour with demand condi- tions in the world economy. A country such as this cannot be expected to achieve a decisive transformation in a decade. Economic development in such a context requires a sustained transfer of foreign resources on a rising scale for many decades.10 What then is the genesis of the Indian debt problem? A part of the difficulty arises from having borrowed too little and for too short a time. This may sound like a puzzle but it is true. The transfer of foreign resources is shrinking prematurely. In 1968-69, the net transfer was one-half that in the preceding year (see Table I) and it declined sharply once again in 1969-70. India's debt problem is not only the result of a shrinking flow of aid, it is also caused by the inappropriate form in which aid is extended. The tying of resource transfers to currencies of creditor countries as well as to the foreign exchange component of specific investment projects creates a serious dilemma for managers of the Indian balance of paymnents. Whlile the need is for foreign excliange to import raw inatcrials, spare parts, semi-nmanufac- tures, services and a wide aLssortment of machinery of small value, the bulk of foreign aid cannot be used for these purposes. Meanwhile, debt service payments pre-empt a very large portion of the country's export earnings in free foreign exchange which could otherwise be used for the above-mentioned items. This divorce between needs and availability has come to be known in Finance Ministry circles as the "cashew-nut problem". The reference  8 GULIHATI is to the anomalous siuation in which resources are available to buy costly, sophisticated machinery and capital equipment for which there is little need, but an acute shortage of cash to buy East African cashew nuts for pr-ocessilng in India for export to western countries." It is not my intention to assert that the Indian debt problem is entirely the result of the short-sighted policies of creditor countrie-. Such a view would be untenable, Our present predicamnciit is partly t'~ result of cx.tra- economic events-the rise in defence expenditures after the war with China in 1962 and with Pakistan in 1965-and partly the conseluence of errors in economic policy as well as administrative inefficienlcics. We have been far too optimistic about the speed with which the import bill can be reduced and far too pessimistt about the feasibility of expanding exports. These biases have coloured the evolution of economic policy. Although the frame- work of policy was revised during and after the Thiird Plan, the new emphasis on export promotion was not sufficiently far-reaching. Incentives to produce for the home market remaini much more powerful than those for exportation. To this imbalance should be added the fact that the new export measures have not been implemented as vigorously as one would wish. The value of Indian exports showed no decisive upward movement throughout the, Fifties when the debt service payments, starting from zero, climbed up to about $590 niillion. During the Third Plan exports rose at an average rate of about 4