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UNITED NATIONS ECONOMIC AND SOCIAL COMMISSION FOR ASIA AND THE PACIFIC Regional High-Level Workshop on Strengthening the Response to the Global Financial Crisis in Asia-Pacific: The Role of Monetary, Fiscal and External Debt Policies 27-30 July 2009 Dhaka, Bangladesh


Session on External Debt Management

Strengthening the response to the global financial crisis in Asia-Pacific: The Role of external debt management policies

By Dr HK Pradhan Professor of Finance & Economics XLRI Jamshedpur India July 2009

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

1. Introduction There has been a renewed concern as regards the level of debt and financial flows to the developing countries, with the apprehension of a further slippage in the debt burden in the aftermath of the present global financial crisis. This apprehension has come about of a combination of factors such as the increase in debt financed fiscal stimulus, erosion of debt servicing capacity due to falling exports and economic growth, and escalation of cost of debt service following currency depreciations in a number of developing countries. Multilateral institutions appear to have scaled up their capacity building programmes aimed at improving the debt management capacity of the low income countries, and continue to extend new financing and debt restructuring initiatives for countries hit by the present crisis 1 . The paper discusses the analytical and contemporary issues in public debt management under globalization, focusing on the external debt management issues under the present financial turmoil affecting the developing countries. The implications of the global financial crisis on the external debt management are being discussed, with implications on the Asia Pacific region, and particularly in the context of eleven countries pilot countries (Bangladesh, Bhutan, Cambodia, Fiji, Kazakhstan, Lao PDR, Maldives, Nepal, Pakistan, Sri Lanka, and Viet Nam). The eleven countries selected in the present study bring in significant diversity in their economic and financial situation, characterized, in general, by high savings rates, but having underdeveloped domestic bond markets, highly sensitive to the general conditions in the world economy, have witnessed fluctuations in migrant remittances and inward tourism flows, exacerbated in some cases by natural disasters, and have significant commodity concentration in their exports, as well as bilateral trade imbalances with the US and Europe. The paper first provides an overview of the present financial crisis, and its various channels of 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 under present situation, and the consideration has to be given on all forms of debt, to include the external borrowings of the government as well private sector, contingent liabilities and onlending of external loans. The paper also discusses the issues relevant in the context of prudent debt 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 a brief discussion on the regional cooperation in promoting financial stability and liquidity arrangement.

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 Governors Meeting, Horsham, United Kingdom on March 13-14, 2009. In the same direction, the IMF Executive Board meeting held on March 25, 2009 endorsed the Fund assistance for the low income countries to maintain a sustainable level of debt and prudent forms of financing. See also the United Nations, Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, as presented UN Conference on the World Financial and Economic Crisis and its Impact on Development, New York on 24-26 June 2009.

2. Developing countries face significant vulnerability under the present globalised financial system The changes in the structure of global capital markets since the debt crisis of 80s, the continuing 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 world economy. The developing countries are increasingly becoming susceptible to the vagaries of the private capital flows, largely governed by the macroeconomic uncertainties of the major economies, and the fall out of the financial innovations that basically emerged in financial systems of US and Europe. The macroeconomic imbalances facing the major economies have exhibited wide gyrations in exchange rates, interest rates and commodity prices, exacerbating the underlying speculative sentiments of the private investors and resulting in volatility in financial flows. The global financial crisis was yet another bout of shocks that affected almost all countries 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 external capital flows, export loss arising out of global recession, and domestic fiscal costs of the macroeconomic impulses, including the provision for social safety nets and human development. The contraction in world output and trade combined with lower inflows of foreign remittances and investment flows have increased the financing gap for several countries in the region. The financial crisis affected severely the public finances of most developing countries, determined by the extent of 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 extent of a debt financed fiscal stimulus has been significant in most developing economies, however, which has led to increase in public debt as well as government contingent liabilities. Governments face rising servicing costs of foreign currency debt, at a time when their debt servicing capacities are eroded due to falling export earnings. The increase in government debt levels and fiscal sustainability has triggered the market reactions, as the sovereign bond spreads have widened sharply, which has particularly raised the cost of borrowing from international markets. The appreciating exchange rates of the US Dollar and the Japanese yen against the Asian currencies were yet another factor adding to the debt servicing costs, as most of the governments in the region borrow predominantly in these two currencies 2 . The decline in exchange rates in the region were primarily due to the reversal in capital flows impacted by the financial crisis, and easy monetary policies pursued in response to credit crunch. The stronger Asian economies could weather to an extent the adverse impact of the financial crisis essentially due to the policy environment that followed the 1997 crisis and their stronger current account position at the time. The recapitalization of banks with the prudential supervision under Basel II new accord, growth of domestic bond markets facilitating corporate financing, and the abandonment of exchange rate fixation with more flexible exchange rate

For instance the share of US Dollar and Japanese yen in the total foreign currency debt, respectively, of East Asia and 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.

policies have all reduced the impact of external vulnerability . At the same time the increased holdings of foreign exchange reserves has provided the necessary wherewithal to minimize exchange rate volatility and sustaining capital flows, as international financial markets and rating agencies have often rewarded the countries with having larger reserve holdings. Most of the 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 firms realistic expectations of managing exchange rate risk. Banks and corporations that resorted to excessive foreign currency borrowing under the pegged exchange rate regimes carrying huge currency 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 new resource inflows.

3. The complexities of public debt management have been compounded each time the world economy witnessed financial and foreign exchange crisis The complexities of public debt management have been compounded as countries have traversed 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 how vulnerable the debt indicators can be, breaching their indicative thresholds of sustainability for a large group developing countries for extended periods, leading to defaults and rescheduling, with substantial costs to the debtors economy in terms of output losses, high unemployment, and accentuating the incidence of poverty. The present financial crisis (2008-09), however, differs significantly with that of the earlier ones, permeating to almost all countries globally. The crisis is more pervasive, affecting abruptly almost all countries in some way or the other, with significantly affecting the private corporate sector. The medium term repercussions depend to a large extent on the resilience and defensive mechanisms of the country concerned, and on the resource availability to mitigate the deceleration in investment climate. Financial market impact has been somewhat lower on the emerging economies of East Asia, China and India; given the strength of their banking supervision and capital market integration, although the impact of lower global growth and lower capital 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 problems between sovereign borrowers and international lenders, which occurred in consequence of a host of factors exogenous to the developing countries, viz. oil price hikes during 1970s, global recession during 1981-82, rising interest rates and the US dollar exchange rates during early 1980s and above all, the over lending syndrome by a number of developing countries facilitated by positive perceptions of sovereign ratings. The developing countries suffered heavy erosion of their debt service capability, which eventually resulted in a series of defaults starting Mexico in 1982. The East Asian crises 1997 erupted due to the speculative attack on their currencies, with sharp depreciation of local currencies, the authorities being forced to defend the plummeting

currencies by depleting large volumes of international reserves, corporate bankruptcy leading to banking crisis, thereby compelling the governments to extend massive financial assistance to banks through budgetary support to prevent a collapse. A distinguishing feature of the 1997 East Asian crisis was the effect of contagion; crisis in one country spreading into several others in the region. 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 currencies that were competing in the same world markets for goods and capital. Nevertheless the East Asian crisis had significant impact on growth and exports in the region, which lasted for almost a decade. The Asian crisis, however, brought several new dimensions to the debt problems of the developing countries. The issue was not so much to do with the aggregate level of debt but more to do with their composition between private and public sector, its maturity structure, the level of contingent liabilities, and the pursuance of macroeconomic policies that were inconsistent with the external sector objectives. The contributory factors underlying the financial crisis were the premature 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 underscored the importance of a sound and coherent policy framework for managing and monitoring capital flows in general and debt management in particular. The relative immunity to the crisis in countries such as India or China had to do with their status of currency convertibility under capital accounts, with significant controls on foreign exchange transactions and short-term capital flows. The present financial crisis which originated in the developed nations financial system, in mortgage and derivatives markets had a spillover effect on rest of the world. The implications on developing countries (post 2008), and particularly on the low income countries, have been somewhat severe, despite the fact that their financial systems lack mortgage related securities or are less integrated in capital accounts, or characterized by absence of trading in derivative instruments. The first reaction was capital outflows due to an exodus of foreign investors from the emerging capital markets, and these put severe pressure on their balance of payments and reserves. The global financial crisis came at a time the when most of the economies in the Asia Pacific region were adjusting to the adverse terms of trade shocks, arising out of a surge in food and fuel prices. Between January 2003 and May 2008, the terms of trade losses were estimated to be ranging from as much as 34 per cent of GDP in Maldives, 21.2 per cent for Nepal, 11.2 per cent 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 and debt in recent years. The buoyant growth in Asia and significantly improved current account positions in a large number of countries in the region indicated their strong debt servicing capacity, and this attracted bank lending and bond financing. There was a marked decline in the

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.

proportion of short term debt to total debt and higher build up of foreign exchange reserves in relations to external debt. Several countries pushed the domestic bond market development initiatives, leading to a shift towards domestic borrowings by governments, and increased issuance of domestic debt instruments by the corporate sector. In their desire to self-insure against 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 of international reserves. The financial crisis of 2008 witnessed a reversal of this trend with abrupt fall of capital flows to almost all countries in the region. For the developing country as a whole, the net private capital inflows estimated to have dropped to USD 727 billion in 2008, from USD 1.2 trillion in 2007 4 . The decline was significant for 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 from USD 498.9 billion to USD 107.9 billion. There was slight increase in foreign direct investment flows, up from USD 523 billion in 2007 to USD 583 billion in 2008, but a large part of investments 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 basis points since mid-2007 and even more than 1,000 basis points for few countries ( in case of Kazakhstan and Pakistan) 5 . The decline in capital flows was more marked in the net short-term debt flows, down from USD 202.5 billion in 2007 to USD (-)16.3 billion in 2008 for all developing countries. Table 1: Net Resource Flows to the Developing Countries ($ billion) 2002 2003 2004 2005 All developing countries 162.4 258.6 370.7 498.7 152.5 9.0 0.9 -5.4 115.9 155.5 25.5 216.0 38.7 279.1 68.1 2006 668.3 358.4 104.3 205.6 110.1 229.0 196.5 105.2 56.2 35.1 29.2 2007 1157.7 520.0 138.6 499.1 202.5 265.0 278.3 175.3 35.2 67.8 42.6 2008e 727.3 583.0 15.7 128.3 -16.3 305 201.2 185.1 7.4 8.7 -5.7

Net private and official inflows Net FDI inflows Net Portfolio equity inflows Net debt flows Net short-term debt flows Workers remittances Net private and official inflows Net FDI inflows Net Portfolio equity inflows Net debt flows Net short-term debt flows

77.6 116.0 151.5 61.5 68.5 86.6 143.6 161.3 191.2 East Asia and Pacific 53.0 74.7 125.0 184.7 59.4 3.8 56.8 12.5 5.4 22.3 70.3 19.3 35.4 32.7 104.4 25.7 54.6 45.4

-10.2 9.9

The data and inferences on global financial flows presented in this section are based on the World Banks Global Development Finance, Volume I & II, 2009. 5 Global Development Finance, Volume I, 2009, Page 45.

Workers remittances

2002 29.5

2003 35.4

2004 39.2

2005 46.7

2006 53.0

2007 65.3

2008e 69.6

Net private and official inflows Net FDI inflows Net Portfolio equity inflows Net debt flows Net short-term debt flows Workers remittances Net private and official inflows Net FDI inflows Net Portfolio equity inflows Net debt flows Net short-term debt flows Workers remittances Net private and official inflows Net FDI inflows Net Portfolio equity inflows Net debt flows Net short-term debt flows Workers remittances Net private and official inflows Net FDI inflows Net Portfolio equity inflows Net debt flows Net short-term debt flows Workers remittances Net private and official inflows Net FDI inflows Net Portfolio equity inflows Net debt flows

Europe and Central Asia 46.5 83.4 124.1 156.3 18.5 3.5 30.5 0.7 55.5 3.6 62.8 8.0

279.0 114.9 10.5 153.6 54.7 38.3 64.8 71.6 11.2 -18.0 -1.0 59.2 76.6 23.2 10.4 43.0 18.0 39.6 38.0 18.5 15.0 4.5 0.3 12.9 13.4 25.0 1.0 -12.6

465.8 154.4 26.4 285.0 101.3 50.4 215.1 107.5 29.6 78.0 33.1 63.1 116.5 29.9 36.1 50.5 19.3 52.1 60.4 28.6 13.5 18.3 0.7 18.6 21.6 24.2 -2.1 -0.5

255.8 170.8 -8.4 93.4 -5.7 53.1 130.9 124.8 -6.5 12.6 -2.7 63.3 77.0 47.5 18.0 11.5 -0.8 66.0 38.7 32.4 3.2 3.1 -0.4 19.8 23.3 22.5 2.0 -1.2

24.5 52.2 65.0 85.5 4.7 33.9 20.4 20.3 13.7 15.5 22.2 31.2 Latin America and the Caribbean 38.0 61.8 59.9 81.7 53.0 1.4 -16.4 -20.3 27.9 7.4 6.7 1.0 -0.3 1.8 24.1 42.3 3.3 64.9 -0.6 70.8 12.2 -1.3 15.8 50.1 28.6 10.3 12.4 5.9 1.6 33.1 31.8 16.8 7.4

16.2 -4.4 2.3 5.5 36.6 43.3 South Asia 13.8 25.4 5.4 8.0 7.8 9.0

0.4 8.6 0.7 2.6 30.4 28.7 Sub-Saharan Africa 9.6 15.0 23.2 12.9 0.7 9.9 6.7

10.2 -0.4

-0.2 1.4 6.6 7.6 0.2 3.3 5.6 -0.2 5.0 6.0 8.0 9.4 Middle East and North Africa 7.7 9.8 12.1 15.8 4.7 -0.5 3.5 7.6 0.2 2.0 6.9 0.7 4.5 14.1 2.4 -0.7

2002 2003 2004 2005 2006 2007 2008e Net short-term debt flows -2.5 -10.4 -36.1 -55.3 -70.2 -58.7 -78.3 Workers 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 GDF 2009. The inaccessibility to trade credit was felt in many developing countries creating apprehension that it would affect global trade flows, and there were a number of bilateral agreements seen to ease the strains on access to short term credits, including trade finance. The foreign exchange reserves accumulation slowed down significantly in most of the developing countries, as countries 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 capital flows to South Asia dropped from USD 117 billion in 2007 to USD 77 billion in 2008. The fall was marked in all categories of flows except net foreign direct investments which increased from USD 30 billion to USD 48 billion in 2008 (although most of the FDI went to countries such as Russian 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 stock prices everywhere. Net capital flows from private creditors (banks and bond issuances, including short 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 52 billion to USD 66 billion), which could be attributed to the migrants who have returned home with their accumulated savings. Global Development Finance (2009) reported that the inflows of capital 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 standby facility in May 2009, and Sri Lanka is currently in discussion with the Fund for such a facility to tide over the foreign exchange gap. The balance of payments situation remains critical in Maldives, 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 be markedly lower until the resolution of the present crisis. Governments, in their attempts to dampen the adverse repercussions of the current financial crisis, have all resorted to higher domestic borrowings. Several countries are experiencing significant shortages of funds, which is curtailing essential imports and impacting poverty. The low income countries generally lack access to private capital markets overseas, and therefore depend to a large extent on the assistance from bilateral and multilateral donors, primarily in the form of concessional financing(Chart 1). Resolving debt issues for this group of countries requires stepping up of donor supported assistance. Chart 1: Share of Concessional Debt as % of Total Debt

5. Given the recurrence of financial crisis, countries should undertake debt sustainability analysis. The debt level of a country must be sustainable, and the present uncertain external financial environment demands that countries must assess the sustainability of their debt levels. Debt sustainability, as defined and widely applicable under the IMF/World Bank framework, relates to the debtors ability to generate future external debt service obligation in full, without recourse to debt relief, rescheduling of debts, or the accumulation of arrears, and without compromising growth 6 . Although debt sustainability has been interpreted in several ways, two simple concepts can be considered relevant: one which is concerned with economic debt sustainability, which means that the debt service does not inhibit growth and the overall economic policy, and, the relating to financial debt sustainability, which means that a country is able to service its outstanding level of debt. The Monterrey Consensus contemplates to broaden the debt sustainability framework after considering the social and development imperatives of a governments expenditure and revenue-raising capacity, thereby the making the conditions for servicing of debt without affecting the development goals as contained in the Millennium Declaration 7 .

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

United Nations, Doha Declarations on Financing for Development, Follow-up International Conference on Financing for Development to Review the Implementation of the Monterrey Consensus Doha, Qatar, 29 November 2 December 2008, Page 25.
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There are several issues as regards the assessment of debt sustainability. Traditionally debt sustainability has been carried out in the context of external debt, and the domestic debt issues are seen primarily as the roll over or refinancing problem. It is expected that a well functioning domestic bond market would enable governments to borrow and roll over the requirements for refinancing. 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 meet government financing requirements. Interest rates on domestic debt markets are generally high in low-income countries and with maturities being short, which typically exposes to significant roll-over risks. Private sector external debt needs to be included, as large scale defaults in the aftermath of a currency crisis or devaluation, as seen following the Asian financial crisis, will impose severe burden on government balance sheet. It is also necessary to take into account the quantum of government guarantee, which are in the form of contingent liabilities that carry fiscal risks. There are of course constraints in establishing frameworks for assessing debt sustainability in 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 the presence of poor governance and regulatory regimes. It should also be noted that sustainability analysis has to be country specific, considering the debt history, the level of sovereign ratings, the development of the financial sector and the debt markets. A well functioning capital market would enable governments to borrow domestically thus avoiding external debt. Country-specific external debt-burden thresholds also depend on the quality of the countrys economic policies and institutions. Countries with different levels of policy performance can handle different levels of debt burden. Table 2 presents the results of DSA carried out by the IMF for the countries, with the country specific thresholds. Table 2 : Examples of Debt Sustainability Analysis in Bangladesh, Lao PDR and Vietnam Bangladesh Th. 2007 2008 Lao PDR Th. 2007 2008 Vietnam Th. 2007 2008

PV of debt in percent of GDP 40 17 11 30 46 38 50 17 16 Exports 150 84 44 100 129 106 200 22 19 Revenues 250 166 92 200 318 253 300 63 64 Debt Service in percent of Exports 20 5 3 15 5 6 25 4 4 Revenues 30 10 6 25 13 15 35 8 7 IMF, Joint Fund-World Bank Debt Sustainability Analysis (DSA): Bangladesh (September 2008), Lao PDR(July 2008), and Vietnam(February 2009). Th. denotes threshold ratios. Figures for 2008 are baseline simulations.

A recent IMF study 8 on debt simulation for 2009 revealed the debt situations to have deteriorated to medium and high risks in a large number of low income countries following the financial crisis. Of the 13 countries considered from the Asia Pacific region, four countries (Bhutan, Cambodia, Lao Peoples Democratic Republic, Sri Lanka) appear to have unsustainable debt 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 study also reveals that the risks to debt sustainability posed by the current financial crisis vary depending on the initial economic conditions.

Table 3: Selected Indicators of External Debt of Eleven Countries Country Name Bangladesh Bhutan Cambodia Fiji Kazakhstan Lao PDR Maldives Nepal Pakistan Sri Lanka Vietnam Bangladesh Bhutan Cambodia Fiji Kazakhstan Lao PDR Maldives Nepal Pakistan Sri Lanka Vietnam Bangladesh Bhutan
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2000 32.2 45.6 72.5 7.8 72.5 150.7 34.7 52.0 44.9 57.2 41.7 94.8 65.5 88.2 14.0 3.3 98.0 69.1 98.4 55.0 74.2 61.5 2.1 0.8

2001 2002 2003 2004 2005 External debt stocks (% of GNI) 31.4 34.3 34.3 33.8 29.9 54.7 70.5 78.8 85.2 79.5 69.8 72.0 70.3 65.0 56.7 7.0 7.6 8.8 7.4 7.6 70.8 76.5 78.3 81.4 83.8 146.7 167.0 107.8 104.2 98.4 40.1 45.0 43.5 51.7 53.2 45.3 49.5 50.0 46.3 39.0 44.4 46.2 41.6 35.5 29.7 56.5 57.8 55.8 54.2 46.7 39.0 38.7 41.8 40.5 37.1 Concessional debt (% of total external debt) 93.4 92.8 93.2 92.1 91.0 51.7 49.4 43.7 40.5 37.8 88.4 88.9 89.5 89.2 89.5 15.0 18.7 16.5 17.9 11.4 2.6 2.7 3.3 3.0 2.1 98.4 88.8 86.2 80.7 73.0 59.5 60.5 64.4 57.7 54.2 97.6 98.4 99.0 98.1 97.7 62.1 64.7 66.7 70.9 71.4 74.1 74.8 79.3 80.1 74.3 66.5 72.5 74.3 71.7 68.2 Short-term debt (% of total external debt) 2.4 3.4 3.3 3.5 3.6 0.0 0.3 0.9 0.0 1.9

2006 31.1 76.5 50.4 7.7 103.4 92.4 54.4 37.4 27.6 41.7 34.5 88.2 38.8 93.8 12.2 1.3 73.3 47.6 96.2 70.6 76.7 70.6 5.7 2.2

2007 30.0 68.6 47.1 11.4 103.7 84.4 56.4 35.0 28.0 43.8 36.3 87.7 40.0 93.7 7.4 1.0 72.8 43.7 95.5 68.2 69.3 66.9 6.3 0.0

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

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Country Name Cambodia Fiji Kazakhstan Lao PDR Maldives Nepal Pakistan Sri Lanka Vietnam

2001 2002 2003 2004 2005 2006 2007 8.3 7.5 6.9 7.6 7.9 5.9 6.0 13.9 26.3 42.5 37.4 48.7 47.4 28.4 9.0 10.2 12.4 12.0 18.6 17.0 12.2 0.0 0.0 0.0 0.2 0.2 0.2 0.2 23.1 17.9 9.1 10.9 14.3 19.5 23.1 2.0 1.3 0.4 1.1 1.5 2.4 2.2 4.2 4.6 3.5 3.5 3.7 3.4 5.5 7.2 7.2 5.9 5.8 8.8 7.3 11.6 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 3.9 Bhutan .. .. .. .. .. .. .. .. Cambodia 1.6 1.0 0.8 0.9 0.8 0.7 0.6 0.5 Fiji 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 18.9 Maldives 4.3 4.7 4.5 3.7 4.7 7.0 4.4 5.1 Nepal 6.9 7.0 6.3 6.1 5.6 4.7 5.1 4.5 Pakistan 25.2 24.6 18.1 16.2 21.1 10.1 8.6 8.9 Sri Lanka 10.3 10.1 9.8 7.5 8.6 4.5 8.7 6.7 Vietnam 7.5 6.7 6.0 3.4 2.6 2.6 2.0 2.3 Source: Global development Finance, 2009.

2000 8.6 11.8 7.7 0.3 10.4 1.0 4.6 7.5 7.2

All the eleven economies considered in the present study appear are experiencing significant shortages of new funds, constraining government expenditures and essential imports (Bhutan with negative net resource transfers, with very small transfers in the case of Maldives and Nepal). Based on the figures for the year 2007, the debt situation can be considered critical in Kazakhstan with the present value of debt to GNI at 131 percent of GDP(Table 4). High short term debt was observed for Fiji had high short term debt (28.4 per cent) and Maldives (23.1 per cent) for the year 2007(Table 3). Table 4: Key External Debt Ratios for Selected Countries (averages for 2005-07) Total External Debt 2007 (USD Millions) 22,033 775 3,761 387 96,133 3,337 Present value (PV) of External Debt 2007 (USD Millions) 15,142 742 3,222 387 94,263 2,784 Total external debt(EDT) to exports of goods & services(%) 121 186 73 22 222 320
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Present value of debt to exports of goods and services

Bangladesh Bhutan Cambodia Fiji Kazakhstan Lao PDR

84 178 63 22 218 267

External debt as % of gross national income (GNI) 33 81 53 12 133 100

PV as % of debt to GNI

22 71 46 12 131 84

Maldives 562 468 78 65 Nepal 3,645 2,001 127 70 Pakistan 40,680 32,807 153 123 Sri Lanka 14,020 11,638 126 105 Vietnam 24,222 20,558 53 45 Source: World Bank, Global Development Finance, 2009.

65 39 32 50 41

54 22 25 42 35

The impact of the global slowdown is highly dependent on policy responses and domestic factors, as well as on the interaction of different economic shocks 9 . There is possibility for a number of countries to cross the debt sustainability thresholds under the present circumstances, if countries donot undertake macroeconomic adjustments and pursue policies mitigating downside risks to their economies. Country commitments to macro management are expected to facilitate debt sustainability by boosting investor and donor confidence. It is to be recognized here that the concept of debt sustainability is an evolving situation, an outcome 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 rapid changes. Historical episodes of debt crisis provide various indications and circumstances under which the countries had debt distress. Debt dynamics depends on the way the current account deficits are being financed: by recourse to external borrowings or by non-debt creating flows such as foreign direct investments or other forms of private flows. Countries should maintain its level of external debt consistent with the trends in balance of payments and its sustainability, and at the same time, maintaining an orderly access to global capital markets, preserving its credit ratings, and ensuring that the new external borrowings are well within the accepted risk and cost preferences. 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 of payments 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 monitoring targets and indicators of debt sustainability. Debt sustainability also requires maintaining an optimum composition of external and domestic debt in the public debt portfolio. There is of course no single optimal solution to the government financing mix, as regards domestic versus external sources. It also depends on the availability of financing alternatives at any given time, the depth of the Government securities market, and the stance of fiscal policy. The choice of financing is determined to a large extent by the 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.

The 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) of debt-export ratio, which should be below 150%; or the NPV of debt-to-fiscal revenue ratio which should be below 250%. See Mark Allen and Gobind Nankani, Debt Sustainability in Low-Income CountriesProposal for an Operational Framework and Policy Implications, IMF/IBRD, February 2004.
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Debt managers can contribute by promoting prudent debt composition and provide early warning signals of debt distress. 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 on capital inflows, costly fiscal adjustments involving primary balance). 6. Government debt should cover comprehensively all forms of potential exposures to the government balance sheet Government debt management functions evolved over the years have covered a comprehensive measure debt such as external, domestic, and contingent liabilities, within private as well as public sectors. The broadening of the scope for debt reporting has also been in response to the growing complexities witnessed in the debt management. This is expected to the potential exposures to the government balance sheet which may emerge from the liability of other sector in the economy. Private Sector Debt: Experience of Asian crisis demonstrated that external exposures of private sector (to include corporate sector and financial institutions) can have adverse fiscal implications, due to the bail-out costs of the financial sector or the cost of corporate restructuring after a currency crisis. The increasing role of private sector in all economies has led to raising of bonds and loans from commercial sources internationally, which has been complimented by the changing composition capital flows (such as increased importance of direct and portfolio investment flows). These would create new dimensions of the debt complexities as regards liabilities 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 sector debt, which will include corporate debt as well as debt by financial intermediaries. Transparent and strong legal framework enabling contract enforcement between lenders and borrowers are considered important as the country allows more private sector borrowings, most importantly when from external sources. Contingent Liabilities: The debt management strategy should integrate the management of contingent liability with the framework of aggregate public sector exposure, due to their possible repercussions on the future increases in government obligations. Common form of explicit contingent liabilities would include loans guarantees, guarantees of domestic public sector debt, cross-border provision of guarantees, and such other contractual arrangements of the Government such as the line of credit, exchange rate and interest rate guarantees, etc. Implicit contingent liabilities, on the other hand, may arise due to contractual or legal obligations of the government conditional upon certain events occurring such as ensuring systemic solvency of the banking 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 estimating the potential costs of such liabilities in the eventuality. The government should develop and maintain a comprehensive database of all guaranteed loans, and these should be tracked and the exposure monitored on a regular basis. Onlending: Recently governments in developing countries have shown increasing interests in 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 such loans 10 . This is an emerging feature as countries are embarking on decentralization and the need for expanding infrastructure investment requirements, there would be significant demand for financing at the subnational level requiring onlending arrangements. Debt reporting framework needs 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 the governments can come under significant unanticipated fiscal burden in public finances when the state-controlled entities default or delay on their obligations. Foreign currency risk is typically an important issue in case of external loans when onlent in local currency, as the central government assumes currency mismatches in its balance sheet. Government onlent portfolio involves a range of operations with important implications on budget. Either they have direct fiscal impacts whereby Government engages in debt servicing, or they involve quasi-fiscal operations when onlent loans carry significant exchange risks. Information on these aspects is important because they can threaten the maintenance of fiscal control. It is thus crucial that onlending portfolio is assessed and recognized within a risk 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 onlent portfolios, the need to establish such processes is yet to be appreciated in developing countries. The international attention apparently focuses mainly on government guarantees and the quantification of fiscal risk arising out of contingent liabilities, although the economic implications of guarantees and onlending may overall be equated. 7. Prudent public debt management is considered critical to reducing the countries vulnerability to financial crises. The swift changes in global financial environment and the periodic recurrence of financial crisis impose renewed emphasis on debt management and make it necessary for countries to review their institutional arrangements. The volatility in global financial markets and the wide gyration in asset prices have underscored the importance of a sound and coherent policy framework for managing and monitoring debt flows. Developing countries that are liberalizing their capital accounts and their governments having significant exposure to external creditors need to review as a matter of priority their debt management framework. Government debt managers need to develop capacity to manage their debt portfolio covering both domestic and foreign loans and assess tradeoffs between cost and risk.

On-lending is used to mean the same where by an institutional unit within an economy borrows funds and then on-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 credit agencies, international commercial banks as well as from private capital markets and simultaneously enters an agreement with the subnational or the local governments or public sector units in the form of subloans with varying terms and conditions. See the World Bank, World Bank Lending for Lines of Credit: An IEG Evaluation, 2006, page 7. 11 It is to be noted here that IMFs fiscal transparency requires uniform and complete disclosure of guarantees given by 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, as the process of establishing and executing a strategy for managing the governments debt in order to raise the required amount of funding, achieve its risk and cost objectives, and to meet any other sovereign debt management goals that the government may have set, such as developing and maintaining an efficient market for government securities 12 . 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 monetary policies, supported by an adequate institutional and staff capacity13 . The diagram below presents an interface that is part of a modern debt management office:

There is need to promote stronger institutional arrangements and strengthen coordination between debt management and other organs of government responsible for macroeconomic policies. It needs to be noted here that the diffusion of debt management responsibilities across multifarious agencies could make it difficult for the authorities to clearly define the functions of debt management. There are good reasons for consolidating in one debt office the responsibility for managing all aspects of government debt, including monitoring the liabilities of other sectors in an economy. This facilitates an integrated management of the nations debt portfolio, strengthens accountability, reduces information gap and establishes coordination. Strengthening institutional arrangement with effective debt management guidelines and manuals can assist in prudent debt management. The agencies with which coordination would be necessary include the relevant line ministries, government bodies/corporation that has autonomous functions for borrowing, financial management as well as audit divisions. All the above agencies need to appreciate the important role of public debt management, and their proper representations in the debt coordination committees are essential.

12

See the Guidelines for Public Debt Management, Prepared by the Staffs of the International Monetary Fund and the 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 policies and practices that are to be followed by the debt management units, with necessary interfaces among 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 major functions and responsibilities of the staff. While passive approach to debt management is desirable under normal circumstances, active management requires analytical study of interlink ages and the risk factors underlying debt portfolio. It is necessary to maintain a comprehensive data base of all government liabilities, to include domestic and external, contingent and onlending, etc. Such comprehensive picture of the liabilities can be of greater relevance for macroeconomic purposes. The World Bank is developing a program to help strengthen capacity and institutions in developing countries to manage government debt which is called the Debt Management Performance Assessment Tool (DeMPA) 14 . Along with the DeMPA, the Guide to the Debt Management Performance Assessment document serves as the guiding tool for assessing debt management capacity of a country. Countries are encouraged to use this framework to assess their debt management performance consistent with long term debt sustainability and identify priority areas for policy action. As of December 2008 DeMPA has been applied in 20 low income 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, fiscal policy advisors, and central bankers should share an understanding of the objectives of debt management, fiscal, and monetary policies given the interdependencies between their different policy instruments 15 . What was being emphasized is the coordination between debt management and macroeconomic policies, and the later giving due attention to policies such as monetary, fiscal, exchange rate and reserve management. Also pursuance of an efficient public debt management remains critical to promoting sound macroeconomic management and ensuring financial market stability and credibility. The basic objectives of policy coordination between macroeconomic policies and debt management can be explained as follows: Macroeconomic Objectives Objectives of monetary policy is to concentrate on its primary task of maintaining price stability & liquidity

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Goals of Debt Management Debt managers role is to provide accurate forecast of cash-flow supporting central banks liquidity management

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

Amendments to the Guidelines for Public Debt Management, International Monetary Fund and the World Bank November 25, 2003.
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management Fiscal policy objectives are to finance budget deficit using government securities market, and avoiding direct monetization (inflationary) of deficits with securities in central bank portfolio Objectives of exchange rate policy are to avoid falling price competitiveness of exports, stability in exchange markets, foreign exchange market interventions, and prevent a rise in the cost of external debt servicing Reserve management objectives aims at maintaining reserve adequacy, keeping in view the costs of holding reserves as well as exchange market stability The role of the debt manager is to provide debt servicing projections to budget preparations, and more proactive role in advising government on the long run implications of rising domestic debt on fiscal sustainability Debt managers role in providing feedback of exchange rate changes on government debt servicing, liquidity management in the banking sector and its impact on foreign exchange markets

Debt managers role in providing external debt service projections and the future flows/disbursements of external creditors

While pursuing the debt management strategy, therefore, it is essential for the Government to maintain consistency between macroeconomic policies and debt management objectives. Consistency and coherence between these two policy objectives are needed, in order to attain appropriate macroeconomic goals such as stable interest rate and inflation rate in the medium run. Government borrowing strategies cannot ignore the sustainability of the fiscal deficit in the medium run. At the same time, debt management policy should not become subordinate to monetary and fiscal policy objectives, rather be based on the principles of sound portfolio management. At times conflicts of objectives might occur, e.g. the Central Bank might propose to raise foreign currency debt to build reserves when debt management office might see this move as an increase in overall risk of the governments debt portfolio. These conflicts could be avoided in the presence of effective institutional arrangements which provides clarity in the areas of policy coordination and separate accountability. The simplified channels of policy linkages between debt management and macroeconomic polices were somewhat twisted during the recent financial crisis. Countries which responded to global slowdown by easy monetary policies faced trade-offs between the benefits of lower interest rates and a weaker exchange rate for economic activity and exports, and the negative impact of depreciation on government debt 16 . Countries with large debt overhang have very limited fiscal space to support a stimulus without unduly crowding out private investments, or a sharp increase in funding costs, or undermining medium term debt sustainability. However the general responses were both easy monetary policies and extended fiscal stimulus in response to collapsing external demand and weakening domestic growth, and this definitely led to a

See 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, April 2009.
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compromise of debt sustainability in several countries. Some countries could use foreign exchange reserves to prevent a local currency depreciation or substitute for foreign credits thereby supporting domestic credit expansion, but this luxury was available to only few among the best performing emerging markets. It is to be recognised that the debt management complexity depends to a large extent on the economic characteristics of the country, the size and structure of domestic debt market facilitating government financing, the resilience of the economy to absorb external shocks, as well as track record of international borrowings. The situations in many countries in the Asia Pacific are precarious, however, as a large number of countries have both structural budget deficits and high levels of debt. Persistence of the present recession and fiscal expansion are expected only to precipitate their debt situation. Thus the interaction of monetary and fiscal policies with that of debt management was vigorously evident during recent period; though the later appears remain subordinate in many economies. Effective coordination between the Central Bank and the Ministry of Finance, in sharing of information (e.g. cash flow forecasts), having an understanding 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 the Central Bank, in order to asses if the present debt management framework adequately recognizes their necessary interfaces.

9.

Government debt portfolio is subject to various forms of risk, the effective management 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 the potential to generate significant fiscal and financial market implications. Structuring the debt portfolio with focus on minimizing its exposure to the various forms of risk is important, such as fluctuations in exchange rates and interest rates, in a world where risk factors affecting debt portfolio fluctuate continuously. Commodity price fluctuations add further risk by affecting the ability to service the debt. Financing decision without due cognizance to its underlying risk factors can make the debt portfolio vulnerable to adverse economic and financial shocks, which will have implications on future fiscal situation and costs of debt servicing. Currency and maturity mismatches were the major elements in almost every financial crisis in emerging market economies, which also involved very costly process of resolution involving bailouts and restructuring. Typically debt managers grapple with various forms of risk (such as currency and interest rate risk, credit risk, liquidity risk, and roll over risk) while managing the government debt portfolio. The implications of certain risk that the debt portfolio is subjected to can be explained as follows:
External debt denominated in foreign currencies is exposed to risks of changes in exchange rates, due to the changes 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 17 months have caused a rise in the dollar value of the external debt obligations contracted in Japanese yen . Debt contracted at variable interest rates is subject to interest rate risk as market rates rise, or debt contracted at fixed interest rates can have risk in the presence of substantial decline in interest rates. Debt prepayments to take advantage of favourable interest rate environment entail costs. The portion of debt contracted at variable interest rates 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 significant portion of short term debt, which can create rollover problems and implications on money markets. Typically measured as interest rate re-fixing whereby the amount for debt on which a new interest rate is to be fixed within one year. The debt portfolio affected by the interest rate re-fixing within a year will include short term foreign currency debt, floating rate debt instruments and treasury bills that are part of domestic debt portfolio. Liquidity risk can arise out of the governments cash management function, due to difficulty in raising enough borrowing in a short period of time. If financial markets characterized by currency convertibility are subjected to reversibility in short-term external capital flows, and this can impose additional liquidity risk. The financial crisis has created liquidity problems in most of the developing countries, triggered by a sharp drop 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. Also relevant here would be the full acceptance of bids in auctions of government securities, as well as in the on-lending portfolio of the government.

Concentration risk can arise due to the concentration of debt portfolio in a specific class of debt instruments, market segment, sector or lender, domestic or external. For example, overtly concentrating on one major external lender would expose the economy to either future changes in the lender behavior or changes in the conditions affecting the project performance domestically 18 . It would be desirable to optimize the borrowing sources for the economy, with due importance given to their compositions as regards different lenders and project mix, such that proper synergy is being achieved between the lenders preferences and the countrys resource requirements for investments.

Government should structure the debt portfolio to provide reasonable cost stability over time. The focus of debt management is to attain an optimum choice of currency, interest rate and maturity structure, which is expected to minimize the exposure to changes in risk factors that are inherent 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 reducing pressure on short to medium term bunching and liquidity risk. The maturity profile of debt should be structured, avoiding bunching of repayment obligations in any particular year. The

For instance, the share of US Dollar and Japanese yen in the total public and publicly guaranteed external debt of East Asia and Pacific , respectively, was 58.4 per cent and 24.5 per cent, and for South Asia was 56.1per cent and 18.1 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 the Asian 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 looking framework, in terms of its potential impact on the increase in future debt servicing. This is not to say that the debt structure be based on a particular exchange rate or interest rate outlook, but the debt manager needs to analyse the sensitiveness of market prices on debt service projections and explore 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 to hedge 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 service transactions, involving interest payments as well as principal repayments, thereby eliminates uncertainty. However these instruments require careful assessment, and debt managers need to evaluate the costs of hedging vs magnitude of market risks, with recognizing clearly the underlying risk factors. Multilateral lenders such as the World Bank and the ADB offer risk management products if a borrower decide to avail such facilities. For example, under the IBRD risk management arrangements the borrower can amend the currency and interest rate mix to reflect 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 or swaps, commodity swaps, etc 19 . It is necessary to make risk and vulnerability assessments of debt portfolio, considering the impact 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 local currency vs. foreign currency linked public debt). Debt managers should ensure that debt servicing trends are consistent with the governments tolerance for risk ( e.g. maintaining annual debt service to fiscal revenue targets). This depends crucially on the environment within which the debt management function is undertaken, considering the country specific factors such as the borrowing history, sovereign ratings, and development of the financial sector, monetary conditions 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 the benefits of greater stability in debt-servicing costs against the cost of achieving stability. Such considerations would make debt managers aware of the impact of changes in financial and economic circumstances on their external as well as domestic obligations and will put them in a better position to develop the right policy responses to address debt management issues. 10. Need to maintain adequate level of foreign exchange reserves, to prevent external sector vulnerabilities and to manage exchange market volatility

In the post crisis Asia as more countries began adopting flexible exchange rate regimes, the increased holdings of reserves were undertaken to manage exchange rate volatility. In several other countries the greater holdings of reserves were justified on grounds of factors such as the higher ratio of foreign currency debt in the government debt portfolio, a higher share short-term external 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 liquidity problems affecting debt servicing difficulties and foreign exchange market intervention affecting exchange market volatility. The present crisis once again brought to the forefront the liquidity

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. 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 maturing short term foreign currency denominated debt under severely deteriorating economic conditions (depreciated domestic currencies, fiscal vulnerability, sudden drop in capital inflows, and falling foreign exchange earnings). Governments need to maintain adequate level of foreign exchange reserves, in order to cushion 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 of short term debt or due to such other forms of speculative capital outflows. Maintenance of a set of liquidity specific indicators, such as the ratio of foreign exchange reserves to imports and reserves to short term debt, at their desired level would prevent liquidity crisis. It is common practice in most developing countries to manage external public debt independently of the holdings in foreign exchange reserves. However, some governments have developed a fully integrated approach for the management of external assets and liabilities(such as 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 exchange rate changes. Such an approach considers aligning the currency composition of reserves on the asset side with that of the currency composition of debt on the liability side, thereby minimizing the foreign exchange risk to the economy. Active management of reserves is undertaken in an asset-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 issue of regional cooperation in promoting financial stability has been the centre stage of discussion since the Asian crisis of 1997, particularly in the provision of international liquidity, progressing towards the regional financial architecture, developing domestic and regional bond markets, and strengthening of mutual surveillance mechanisms. The post crisis Asia witnessed some of the significant initiatives as regards regional monetary cooperation such as the setting up of regional liquidity support arrangements through the Chiang Mai Initiative (CMI), the establishment of the Asian Bond Fund (ABF), the Asian Bond Market Initiative (ABMI), and the road map for monetary and financial integration undertaken by ASEAN. The Chiang Mai Initiative (CMI) agreed in May 2000 by the finance ministers of ASEAN+3 21 countries created emergency liquidity provision by creating a network of bilateral swap agreements (BSAs) and repurchase agreement facilities among the member

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 and Exchange Affairs Department, March 26, 2003.
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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 $90 billion involving eight countries as of May 2009. The membership of the CMI could be expanded to cover more countries from the region, and the purpose of fund support could be broadened 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 to a multilateral institution such as the establishment of an Asian Monetary Fund(AMF) in the region is gaining ground. The AMF was proposed as a regional currency fund to provide emergency support during a currency or liquidity crisis in Asia, by pooling Asian reserves and making funds available to the members enabling them to stabilize currency markets. The idea has received a fresh impetus recently with South Korea, Japan, China and the 10 members of ASEAN proposing to establish an $80 billion fund to aid the nations in dealing with the global credit crisis, though the details of this proposal are yet to be materialized. It is also necessary to improve regional cooperation through more organized arrangements in the Asia-Pacific region to enhance debt management capacities, and share experiences in debt management as well as risk management. There is need for significant technical support in building debt management capacity, in strengthening the institutional arrangements for managing government debt as well as imparting analytical capabilities through training.

12.

Conclusions

The global financial crisis erupted at a time when the developing countries had been grappling with the rise in food and energy prices. The financial crisis affected severely the public finances 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 world economy witnessed financial and foreign exchange crisis. The implications on developing countries, 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 likely to be markedly lower until the resolution of the present crisis. Several countries are experiencing significant shortages of funds, which is curtailing essential imports and impacting poverty. The low income countries generally lack access to private capital markets overseas, and therefore will depend to a large extent on the assistance from bilateral and multilateral donors, primarily in the form of concessional financing The debt level of a country must be sustainable, and the present uncertain external financial environment demands that countries must assess the sustainability of their debt levels. There is possibility 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 their economies. Country commitments to macro management are expected to facilitate debt sustainability by boosting investor and donor confidence. Countries with large debt overhang have very limited fiscal space to support a stimulus without unduly crowding out private investments, or a sharp increase in funding costs, or undermining medium term debt sustainability. Government debt management should cover a comprehensive measure debt such as external, domestic, and contingent liabilities. The broadening of the scope for debt reporting has also been in response to the growing complexities witnessed in the debt management. This is expected to the potential exposures to the government balance sheet which may emerge from the liability of other sector in the economy. The swift changes in global financial environment and the periodic recurrence of financial crisis impose renewed emphasis on debt management and make it necessary for countries to review their institutional arrangements. Government debt managers need to develop capacity to manage their debt portfolio covering both domestic and foreign loans and assess tradeoffs between cost and risk. While pursuing the debt management strategy, therefore, it is essential for the Government to maintain consistency between macroeconomic policies and debt management objectives. Consistency and coherence between these two policy objectives are needed, in order to attain appropriate macroeconomic goals such as stable interest rate and inflation rate in the medium run. 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 on capital inflows, costly fiscal adjustments involving primary balance). The size of the governments debt portfolio is the largest in any economy, therefore, has the potential to generate significant fiscal and financial market implications. Structuring the debt portfolio with focus on minimizing its exposure to the various forms of risk is important in a world where risk factors affecting debt portfolio (such as exchange rates, interest rates and commodity prices) fluctuate continuously. Financing decision without due cognizance to its underlying risk factors can make the debt portfolio vulnerable to adverse economic and financial shocks, which will have implications on future fiscal situation and costs of debt servicing. Debt managers can contribute by promoting prudent debt composition and provide early warning signals of debt distress. Emphasis on debt management should not be the outcome of a crisis, but a continuous focus of macroeconomic policy. Successful debt management would depend to a large extent on the judgment of policy makers and planners. Debt manager cannot ignore 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 the economic characteristics of the country, the size and structure of domestic debt market facilitating government financing, the resilience of the economy to absorb external shocks, as well 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, April 2009. 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 for an 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, International Monetary 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 the Global Crisis, Background Paper prepared by World Bank Staff for the G20 Finance Ministers and Central Bank Governors Meeting, Horsham, United Kingdom on March 13-14, 2009.

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