V: External Debt Management
- International Monetary Fund
- Published Date:
- January 1992
Over the past year, many developing countries, including market re-entrants, have experienced strong net capital inflows. These inflows have reflected a decline in interest rates in industrial countries, as well as increased confidence in investment prospects in these developing countries. The magnitude of the capital inflows has often been large enough to complicate the implementation of macro-economic stabilization policies and to raise questions about the possibility of renewed debt-servicing difficulties. This chapter considers the parallels between recent capital inflows to market re-entrants and those occurring in 1978–82. It compares indicators of external debt and debt service, external financing, and macroeconomic performance for six market reentrants during 1990–92 with indicators for the 1978–82 period. It identifies a number of significant differences between the two periods, which, in the context of prudent economic policies, reduce the risks of renewed debt-servicing difficulties.
The chapter also looks at the experience of countries seeking to manage external debt in the face of strong capital inflows. The key to managing external debt effectively rests with sound macroeconomic policies that keep the accumulation of external debt within sustainable limits, and with structural policies that ensure an efficient use of savings and investment. Over the past year, a number of countries have also adopted several administrative measures to limit inflows more directly.
Comparison of 1990–92 with 1978–82
This section looks at the experience of six heavily indebted countries—Argentina, Brazil, Chile, Mexico, the Philippines, and Venezuela—which encountered debt-servicing problems in the 1980s but are now attracting significant increases in foreign capital inflows. The evidence presented suggests a number of reasons why these economies may now be better placed to avoid debt-servicing problems than prior to the 1982 debt crisis.59 Most of these countries have significantly reduced their dependence on external financing since the late 1970s and early 1980s. The composition of recent flows has changed, with more external financing directed toward the private sector and a higher share provided in the form of equity flows. The economic policies of these countries are generally more sound now than they were in the late 1970s and early 1980s, resulting in a greater capacity to service external obligations. Nevertheless, important risks remain, since these economies still have relatively high levels of debt and continue to be vulnerable to external events.
Recent Capital Flows
For four of the six countries in the sample, recourse to external financing in 1990–92 was substantially less than in 1978–82. Brazil and Chile experienced the largest reduction in net capital flows relative to 1978–82, with declines of 7.8 and 13.7 percent of GDP, respectively (Table 12); external financing declined by 5.2 percent of GDP in Venezuela, and by 3.3 percent in the Philippines. In contrast, in both Argentina and Mexico, net capital flows were 1.3 percent of GDP higher in 1990–92 than in 1978–82. In all the countries except Brazil, net capital flows in 1990–92 exceeded substantially flows during 1983–89.
(In percent of GDPP)1
The composition of capital inflows also changed between the two periods. For the six countries, gross public-sector borrowing from abroad declined from an average of 7.8 percent of GDP in 1978–82 to 2.6 percent in 1990–92 (Table 13). Multilateral and bilateral flows now account for an average of 63 percent of public-sector external borrowing, compared with 13 percent in 1978–82. In all six countries, borrowing by the government from private sources in 1990–92 was a small fraction of 1978–82 levels. With the decline in public-sector borrowing, inflows to the private sector account for a larger share of net external financing. In particular, foreign direct investment rose by an average of 1.3 percent of GDP in Argentina, Mexico, the Philippines, and Venezuela; it now contributes the largest share of external financing to the private sector in these countries (Table A17). In some of these countries, portfolio investment is also becoming a larger share of net external financing, reflecting in part the repatriation of flight capital. Such flows increased by 1 to 5 percent of GDP in Argentina, Mexico, and the Philippines. The growing importance of such equity inflows should help reduce the overall vulnerability of these economies since they lead to more flexible external obligations than debt-service payments.
(In percent of GDP)1
|Other net flows5||−6.6||−1.2||−1.4|
|Other net flows5||0.6||−0.9||−0.8|
|Other net flows5||3.5||1.5||2.1|
|Other net flows5||−1.9||−1.9||1.3|
|Other net flows5||−2.3||−1.9||−2.4|
|Other net flows5||1.3||−1.4||1.7|
In all six countries, the fiscal position, as measured by the balance of the nonfinancial public sector, was stronger in 1990–92 than in 1978–82 (Table A18). The improvement was greatest in Argentina and Mexico, which reduced their nonfinancial public-sector deficits by 6 percent and 10 percent of GDP, respectively. In Brazil and Venezuela, the public-sector deficit declined by 4 percent and 5 percent of GDP, respectively, while in Chile and the Philippines, the fiscal position improved by less than 1 percent of GDP.
These gains were achieved despite a substantial increase in domestic debt-service burdens. The real domestic debts of these countries rose by an average of 125 percent between 1978–82 and 1990–91, while real GDP increased by just 19 percent. Increased domestic debt-servicing costs were offset to some extent by lower external debt service; nevertheless, in all of the countries except Argentina, the total interest burden was greater in 1990–92 than in 1978–82. Thus, the primary budget balance—the overall balance of the nonfinancial public sector minus interest payments on domestic and foreign debt—showed a stronger improvement than the overall balance. The primary fiscal deficits of these countries fell by an average of 6 percent of GDP. This suggests that the underlying fiscal position of these countries is significantly stronger than in the late 1970s and early 1980s.
Improvements in fiscal policy were accompanied in most of these countries by comprehensive structural reforms that permitted a more efficient use of external financing. The elimination of price controls or subsidies, privatization, and financial system reform helped channel this financing toward productive investment. The liberalization of trade, foreign investment, and exchange systems were also important in improving resource allocation.
To correct substantially overvalued exchange rates in the early 1980s, all six countries achieved significant real effective depreciations by the mid- to late 1980s. Since the late 1980s, several countries have experienced real effective appreciations of their exchange rates, associated in part with higher foreign capital inflows. In general, however, real exchange rates in 1990–92 were substantially lower than in the late 1970s and early 1980s. Also, most of these countries have followed a more flexible approach to exchange rate policy, reducing the risk of a sustained over- or undervaluation of exchange rates.
These policy reforms helped narrow the gap between national savings and gross domestic investment (Table A19). As a result, the six countries reduced their current account deficits by up to 15 percent of GDP, mainly reflected in lower imports relative to GDP, but also in better export performance and lower interest accruals. The one exception to this pattern is Mexico, whose current account deficit is at roughly the same level as in the earlier period. In Chile and Brazil, the reduction in net foreign saving was accompanied by large increases in gross national savings, which rose between the two periods by 7 percent and 9 percent of GDP, respectively, and a rise in domestic investment of 2–3 percent of GDP. In contrast, national savings fell by 4–9 percent of GDP in Mexico, Argentina, the Philippines, and Venezuela. Domestic investment fell by 5–15 percent of GDP in these countries, partly reflecting tighter demand policies.
Servicing Existing Obligations
The implementation of sound economic policies, together with the restructuring of external debt, has contributed to significant improvements in the debt-service ratios of these countries. In part, this improvement also reflects lower international interest rates. In most of the six countries, total external debt and debt service relative to merchandise exports were lower in 1990–92 than in 1978–82, with Chile showing the sharpest reduction (Table 14). In addition, most of these countries had a somewhat larger cushion of reserves with which to weather exogenous external shocks. Gross reserves reached an average of 5 ½ months of imports in 1990–92, compared with 4 ½ months of imports in 1978–82. Furthermore, in all cases, exports have become more diversified, reducing vulnerability to swings in commodity prices. In all six countries, the share in total exports of the three principal commodities declined from 1982 to 1991. Export diversification was most pronounced in Mexico, as three principal products accounted for 28 percent of exports in 1992, down from 80 percent in 1982. Export concentration declined from 28 percent to 16 percent in Argentina, from 28 percent to 19 percent in Brazil, and from 26 percent to 10 percent in the Philippines. In Chile, the share of copper in total exports fell slightly to 40 percent, but nontraditional exports grew rapidly. In Venezuela, oil still accounts for 80 percent of the country’s total exports.
|(In percent of exports of goods and nonfactor services)|
|(In percent of U.S. dollar GDP)1|
|(In months of merchandise imports)|
Techniques of External Debt Management
Countries that have faced heavy capital inflows in recent years have responded with a variety of techniques of external debt management. Beyond the overall stance of macroeconomic policies, institutional and administrative measures have been introduced to control or monitor foreign borrowing. This section reviews this experience, with particular reference to Chile, Indonesia, and Mexico.
Monitoring Public and Private Borrowing
At the heart of a country’s debt management strategy is its capacity to manage the accumulation of public external debt, consistent with its overall public-sector balance, its financing from domestic and external sources, and its capacity to repay external debt. A number of countries rely on a strong central coordination unit, particularly in view of the potential conflict between short-run employment and output considerations and the longer-term need to avoid an excessive increase in external indebtedness. In designing an external borrowing program, countries seek to manage the terms and composition of external public debt to minimize costs of borrowing and avoid a bunching of maturities. To achieve these ends, debt management units typically include accounting systems to monitor new borrowing, the stock of external debt, and the profile of future debt-service payments, and to assess the impact of international trends.
In Chile, these functions have been coordinated by the Ministry of Finance, which controls central government and public enterprise budgets. The external financing requirement of the public sector is developed in the context of an overall macro-economic program, including an assessment of the country’s debt-servicing capacity over the medium term.
In Indonesia, in September 1991 the authorities set up a new Foreign Commercial Debt Management Coordinating Team (PKLN), after a rapid buildup of external debt in 1988–91 led to a tightening of terms on new loans as creditors became more cautious. The mandate of the PKLN is to coordinate all public and quasi-public borrowings and monitor all foreign loans from commercial sources, to avoid crowding out smaller, private investments, and to discourage short-term borrowing for long-term projects. In November 1991, the PKLN canceled four large public and quasi-public projects that would have represented commercial borrowing of about $10 billion. It also set ceilings for new commercial borrowing commitments over the succeeding five years, with subceilings for different categories of borrowers. Since there is no clear delineation between the private and public sectors in Indonesia, the PKLN has influence over all projects involving participation by state banks (which represent about half the banking system), public enterprises, or projects with explicit or implicit guarantees by the state. Strictly private-sector projects with private financing are exempt from seeking approval, although they must still report their loans to the PKLN and may be subject to moral suasion.
In Mexico, the Government caps public-sector borrowing within a limit approved by Congress as part of the budget. A key element of the public-sector borrowing strategy has included expanding access to bilateral credit lines, which are generally cheaper than commercial borrowing. To help in administering the limits, Mexico established an informal queuing system that regulates the issuance of securities by public-sector entities. The public sector has also played an active role in the re-entry process, acting partly as a catalyst for other borrowers by establishing benchmarks and promoting Mexico’s image abroad.
In addition to influencing new flows, governments have sought to limit potential problems related to existing debt. In some cases, governments have used excess international reserves to buy back external debt at a discount. Mexico, for example, recently announced that it had bought back about $7 billion of external debt over a period of two years. Similarly, Chile bought back part of its debt to commercial banks in 1988 and 1989, using part of the gains from unusually high copper prices. Moreover, central banks and other public institutions in some borrowing countries are making increasing use of various financial instruments to hedge against movements in interest rates and exchange rates, which makes the stream of debt-service payments more predictable. Countries have also used these techniques to help insulate export earnings or import payments from sharp movements in world commodity prices. The Mexican Government, for example, has reportedly used futures and options to reduce risks associated with oil price movements in 1990 and 1991.60
In view of the increasing role of private-sector external borrowing in recent years, countries have sought to gather information about private-sector borrowing and debt servicing to help formulate macroeconomic and exchange rate policies. Chile’s experience in the early 1980s shows that external borrowing by the private, rather than the public, sector does not, in and of itself, protect the economy from potential external debt-servicing difficulties. For this reason, private borrowers in Chile have in recent years had to register the amounts and terms of external loans with the central bank. In Indonesia, the private sector also has to report to the PKLN for monitoring purposes. In Mexico, on the other hand, nonbank borrowers in the private sector are free to tap international capital markets without a registration requirement, although simplified tax procedures are available to firms registering on a voluntary basis.
Regulations and Other Controls on Private Capital Inflows
The resurgence of capital inflows to the private sector in a number of developing countries has prompted these countries to adopt a variety of administrative controls. Such actions have included tightening prudential standards on banking activity funded by foreign currency borrowing, limiting swap facilities and other special mechanisms for external borrowing, introducing queuing systems for would-be external borrowers, establishing reserve requirements on foreign borrowing, specifying minimum maturities on loans, and imposing withholding taxes on interest payments.
Regarding prudential restrictions on inflows through the domestic banking system, Indonesia put limits on banks’ net open foreign exchange positions both on and off the balance sheet in March 1989. Two years later, these limits were tightened and others were placed on banks’ short-term obligations to nonresidents (30 percent of capital, excluding trade finance). In addition, rules were put in place to ensure that at least 80 percent of all foreign currency loans were directed to foreign-exchange-earning businesses. For similar reasons, in April 1992 Mexico took measures to dampen inflows associated with Euro-CD issues by Mexican banks; the foreign currency liabilities of these banks were limited to 10 percent of their loan portfolios, 15 percent of which had to be in the form of highly liquid instruments.61
Quality requirements have been put in place to limit private capital inflows in some cases. In May 1992, for example, the Chilean central bank issued new regulations covering Eurobond issues and international equity offerings. These regulations state that only companies rated “A” by the Chilean Risk Rating Commission may place such issues; in addition, the issues must have a minimum size of $50 million and, in the case of bonds, a minimum average maturity of four years. For bond issues, an overseas securities firm must commit to underwrite the issue fully. In April 1992, Brazil placed a ban on all new offshore issues of bonds at maturities of less than three years; previously, the minimum maturity had been two years. In addition, the withholding tax was extended to apply to all issues of less than five years’ maturity.
In parallel, some central banks began to eliminate special incentives to borrow abroad that were introduced in the 1980s. In this regard, the Chilean central bank announced a series of measures in March 1990 to reduce the availability of swap and other facilities. These measures aimed at raising commissions, raising interest rates on foreign currency term deposits by the central bank, increasing minimum maturities, and discouraging swap renewals. Similarly, in March 1991, the Indonesian central bank began to scale down its swap operations by reducing individual bank limits and raising the three-month swap premium by 5 percentage points. At the same time, it limited most future swap operations involving a maturity of less than two years. As a result, the amount of swaps outstanding declined to less than $0.5 billion at the end of February 1992, as against a peak of $5.5 billion at the end of March 1991. These measures complemented the establishment of a queuing system in late 1991 to slow external borrowing by private-sector firms in Indonesia.
Countries have also imposed reserve requirements and explicit taxes. In Chile, a noninterest-bearing reserve requirement of 20 percent was introduced on June 15,1991, on almost all capital inflows, including foreign direct investment.62 This was raised to 30 percent in May 1992, in response to pressures associated with the decline of U.S. interest rates. To encourage borrowing with longer maturities, the requirement was designed to make the effective tax on foreign borrowing fall as the maturity of a loan increased.63
Besides trying to restrict inflows, a number of countries have also relaxed restrictions on capital outflows. In Chile, for example, pension fund administrators have been allowed since March 1992 to invest abroad in foreign government bonds, certificates of deposit, and bankers’ acceptances up to a limit that is being increased over a five-year period to a maximum of 10 percent of their investment portfolios. In addition, procedures enabling Chilean enterprises to invest abroad have been liberalized. Similarly, in mid-1991, Colombia began to allow residents to hold foreign exchange deposits abroad.
Balance Between Debt and Equity Flows
Since external debt creates an obligation to pay interest and amortization regardless of changing economic conditions—while the repatriation of profits and capital generally varies with these conditions—countries can benefit from encouraging more equity financing as long as future potential outflows associated with such investment are taken into account in the design of overall economic programs. For this reason, a number of countries have taken steps to attract more foreign direct and portfolio investment.
In Brazil, foreign investment regulations were significantly eased beginning in 1990 by allowing wider access, a lower income tax rate on distributed earnings and cash dividends, greater scope for future divestment, and no tax on capital gains. Foreign portfolio investment through American Depository Receipts was also authorized in 1991. In Chile, the waiting period for the remittance of capital was reduced from three years to one year, while profits continued to be remittable immediately. The rate of tax on repatriated dividends was also lowered. In Mexico during the same period, the authorities broadened opportunities for foreign investors to purchase shares in major companies. Further reforms undertaken in May 1992 made it easier for foreigners to invest in Mexico’s newly privatized banks by buying shares with limited voting rights. In Argentina, the rate of taxation on repatriated capital was lowered, and investment in the domestic stock market encouraged, by the abolition of capital gains taxes for foreign investors. Similarly, the Philippines reformed its foreign investment regime in 1991 by expanding the number of economic sectors open to unlimited foreign ownership without prior approval. In addition, the process for registering and repatriating profits and capital on foreign investments in officially approved Philippines securities was simplified.
The data are not strictly comparable across sources and countries, owing to differences in data reporting and measurement. Moreover, because the indicators are based on estimated purchasing power GDP, the computed ratios do not provide an absolute measure of external performance or allow precise cross-country comparisons. Nevertheless, the information provides a broad indication of how countries’ external financing flows, macro-economic performance, and debt-service capacity have evolved over the past decade.
Private Market Financing for Developing Countries (Washington: IMF, December 1991), page 26.
Some foreign exchange liabilities were exempted from the limit. These exemptions included, among others, credits received from (or guaranteed by) export-import banks, foreign bank credits channeled to the Government, and liabilities arising from operations authorized explicitly by the Bank of Mexico. The regulations allow banks that held foreign exchange liabilities in excess of the limit to maintain the level of those liabilities until the growth of domestic currency liabilities brought foreign exchange liabilities within the limit. Banks that held foreign exchange liabilities below the limit were allowed to increase them toward the limit only gradually.
Since January 1992, the 20 percent reserve requirement has been gradually extended to apply to foreign-currency-denominated deposits held by commercial banks.
Required reserves must be held for 90 days for credits of less than 90 days, for the average maturity for credits of 90 to 365 days, and for one year for credits with maturity longer than one year. This action initially encouraged additional foreign borrowing to cover the reserve requirement, spurring the authorities to set up a special repurchase facility that made borrowers pay the foregone interest on the reserve requirement.