External Debt Policy, 1952–1990
EXTERNAL DEBT POLICY, 1952–1990
EXTERNAL DEBT POLICY, 1952–1990 India chronically suffered from a shortage of resources necessary to finance a rising rate of investment required to yield a growing rate of income growth. India's planned program of economic development began in 1952, with its First Five-Year Plan. Being a low-income country, its savings were inadequate to finance investment. Its difficulties were compounded because India needed foreign exchange to supplement its domestic savings to pay for the import of goods, essential for sustaining the rising investment rate. The growth of the domestic savings rate since the 1950s was impressive, but it was not sufficient to fully support the investment required to sustain rapid growth. Foreign resources were not easily forthcoming, as India's exports were far below its import requirements, thereby impelling it to seek foreign assistance. The balance of payments difficulties and the resultant increase in foreign indebtedness that India faced were, therefore, not a temporary phenomenon but inevitable throughout the process of development, with its calculated strategy to keep the rate of investment consistently above the rate of saving.
During the First Plan, 1951–1956, external assistance served two functions: it would make available adequate supplies of foreign exchange to finance imports; and it would supplement the investment resources the country could raise on its own. The balance of payments did not present problems during the First Plan period. Foreign saving as a proportion of total investment turned out to be 4.6 percent, while the external debt to gross domestic product (GDP) ratio averaged 2.05 percent during the period.
The Second Plan, 1956–1961, which put greater emphasis on industrialization, entailed a larger amount of foreign exchange. Of the estimated current account deficit of 11 billion rupees during 1956–1961, 8 billion rupees was assumed to be met by external assistance. The plan, however, ran into unexpected balance of payments difficulties from the very start, and had to be reappraised in 1958, signaling a turning point in India's external position. Stringent restrictions were imposed on less essential imports, and its own foreign exchange reserves were drawn down to the largest extent of 6 billion rupees during the Second Plan period. In addition, external assistance of the order of 8.72 billion rupees was provided in the public as well as private sectors, besides commodity imports of 5.34 billion rupees under the commodity assistance program and borrowings from the International Monetary Fund (IMF) of 55 billion rupees. The external debt/GDP ratio increased to 8.06 percent during the Second Plan period.
The Third Plan, 1961–1966, reflected some rethinking in India's external financing strategy, highlighting self-sustaining growth as a major goal. While it envisaged that normal capital flows would continue, it set out the contours of the concept of self-reliance. The main elements of this concept were import substitution, with the expansion of capital goods and infrastructure industries on a scale that would enable the country to produce domestically the bulk of capital goods and machinery as well as consumer goods, and a well-defined export strategy. It therefore called for the maximum rate of investment and a change in its structure so as to secure an increase in national income of over 5 percent per annum. Accordingly, gross external assistance of 32 billion rupees was allowed for the Third Plan period, with the assistance net of repayments and liabilities arising from Public Law 480 (PL 480) imports and loans to the private sector being around 22 billion rupees. The Third Plan projection, however, went awry, partly because of its unrealistic nature and misconceived domestic and macroeconomic and foreign exchange policies, and partly because of the Indo-Pakistani hostilities that broke out in 1965.
The same policy was continued during the Fourth Plan (1969–1974), more or less, with additional emphasis on doing away with concessional imports of food grains under the commodity assistance program by 1971. The goal was to reduce net foreign aid to one-half the Third Plan level. External debt to GDP ratio was 13.6 percent during the Fourth Plan.
The Fifth Plan (1974–1979) strategy was based on massive exports growth and on containing imports. By the time the plan was adopted, however, the scenario had changed. Owing to a hike in oil prices and a sharp increase in the import prices of certain other important commodities, like fertilizers and food grains, the size of external assistance was pushed up to over 58 billion rupees from the original estimate of about 24 billion rupees. External debt to GDP ratio averaged 13.4 percent during this plan period.
The Sixth Plan (1980–1985) also saw a major change in the pattern of foreign borrowings, which until the end of the 1970s had contained a bulk of concessional foreign assistance. First, nonconcessional flows accounted for a growing proportion of official borrowings. Second, direct borrowings by financial institutions and the private sector grew substantially, unlike in the previous period of planned development. These factors, combined with outstanding borrowings from the IMF and nonresident Indian (NRI) deposits (transfer of funds by Indians living outside India) raised substantially the average cost of foreign debt, and consequently the external debt to GDP ratio spurted up to 15.5 percent. The situation did not improve during the Seventh Plan period (1985–1990). An increase in imports from hard currency areas; diversion of a substantial part of India's exports to Eastern European, Soviet-dominated countries with nonconvertible currencies; and a shift to high cost commercial debt sharply increased India's hard currency external debt.
The current account deficit of 29 percent during this period, which was widening rapidly, was financed by way of external assistance from multilateral and bilateral donors, 24 percent by commercial borrowings, 23 percent through nonresident deposits under the Foreign Currency Non Resident Account plan and Non Resident External Rupee Account, about 13 percent from other capital transactions, and the remaining by a draw-down of foreign currency reserves. External debt to GDP ratio as a result doubled to 30 percent, with foreign savings as a proportion of investment reaching 11.2 percent.
India was the fourth-largest debtor (after Brazil, Mexico, and Indonesia) among developing countries at the end of March 1991. India's total outstanding external debt, including the use of IMF credit and short-term credit, stood at U.S.$71.6 billion at the end of March 1991, steadily increasing from about $8.9 billion in 1971. In terms of the share of total outstanding debt in GNP at 29.2 percent, it was lower than that of Mexico (36.9 percent) and Indonesia (66.4 percent) but higher than Brazil's 28.8 percent. The vulnerability of the Indian economy by the end of 1990 was reflected in large debt service payments on its huge stock of external debt. India's debt service ratio in 1991, at 30.6 percent, was nearly equal to Brazil's 30.8 percent and Mexico's 30.9 percent and was higher than the average of 27.6 per cent for the moderately indebted low income countries group.
India's Approach to External Debt Policy
Until the beginning of the Fifth Plan, there was almost total reliance on official, especially multilateral flows, mainly on concessional terms and recourse to IMF facilities to meet extraordinary situations such as the drought of the 1960s and the oil shocks of the early and late 1970s. Thus, until the 1980s, external financing was confined to external assistance, mostly on concessional terms. The plan strategy was interventionist and biased against exports. This was an era of perpetual foreign exchange shortage, and foreign resources to a developing country like India, where reliance continued to be on external borrowings, was not easily forthcoming. The policy was to approach the developed countries and the World Bank group with an accent on soft terms of interest and other conditions governing loan repayment. In terms of multilateral financing, the relationship with the World Bank and its soft loan window, the International Development Association (IDA), evolved since the beginning of planning. Until 1979 IDA loans formed between 70 to 80 percent of loans from the World Bank group. These loans were at highly concessional rates and for very long maturities. Between 1980 and 1990, the World Bank loan component increased to about 50 percent of the total loans from the World Bank group, of which India was the largest debtor. Since 1958 the World Bank organized the Aid-to-India consortium, consisting of the World Bank group and thirteen other countries (Austria, Belgium, Canada, Denmark, the former West Germany, France, Italy, Japan, the Netherlands, Norway, Sweden, the United Kingdom, and the United States). The consortium was formed to coordinate aid and establish priorities among the major sources of foreign assistance. Consortium aid was bilateral governmentto-government, and the loans from the World Bank group were loans given for specific projects.
The trends in external debt reflected the evolution of external debt policy during the plan periods. Until the end of the 1960s, the composition of India's external debt was characterized by the predominance of long-term public and publicly guaranteed debt. Bilateral debt comprised about 75 percent of the total debt, while multilateral debt accounted for about 20 percent. The 1970s saw a shift in the composition of the official debt with the share of bilateral debt progressively reduced to about 50 percent. There was a shift from the official debt toward borrowings from private sources during the 1980s. The composition of official debt itself changed, with the share of bilateral debt decreasing sharply. As a consequence of the above two developments, the terms of borrowing, including maturity, interest rate, and the grace period, turned harder. Short-term debt increased during the latter half of the 1980s. Commercial borrowings accelerated, particularly during the latter half of the 1980s. This increased the cost of debt and reduced the average maturities of the debt portfolio. "Scarce" foreign exchange was also sought through a number of nonresident deposit plans, which offered higher rates of interest relative to prevailing international rates and, in addition, exchange guarantees. This change in strategy proved to be unsustainable toward the end of the 1980s, and in 1990, when the Gulf oil crisis erupted, the government was unable to roll over the short-term debt and commercial borrowings, which coincided with withdrawal of "hot" NRI deposits, which had initially flown in to take advantage of arbitrage in interest rates. India went into a crisis in August 1991 and resorted to use of IMF resources. Since 1991, its debt policy also changed, with de-emphasis on debt-creating flows and greater focus on nondebt creating investment flows, that is, equity. Even among debt flows, limits were imposed on commercial borrowings and within more stringent limits on short-term debt. The high interest and exchange-guaranteed nonresident deposits were dismantled. The current NRI deposits offer interest rates around prevailing international rates, and the exchange rate risk is being borne by the depositor.
Since the mid-1990s, India has surpassed the era of chronic foreign exchange shortages. India now has a strong economy, which attracts foreign capital—shortand long-term, equity and debt funds—under market determined conditions.
Government of India. Five Year Plan Documents. Delhi: GOI, 1951–1990.
Kapur, Munish. "India's External Sector since Independence: From Inwardness to Openness." Reserve Bank of India Occasional Papers, vol. 18, nos. 2–3, June and September 1997.