MC Explains | India does not face an external debt crisis

In terms of currency composition, the US dollar dominates the debt at 53%. (Representative image: Reuters)

In the last few days, we have seen a few media reports expressing concern over India’s external debt position. The government has allayed these fears and asked people not to pay attention to rumours. This explainer analyses the country’s external debt position.

What is the external debt of a country? 

Corporate entities and governments have a choice to manage their borrowing both within and outside of their country. The debt raised locally in its own currency is termed internal debt and the debt raised outside in foreign currency such as the US dollar or euro is termed as external debt. Countries prefer to raise debt in foreign currency for two reasons -- undeveloped financial markets at home and lower interest rates. External debt suffers from exchange rate risks. If the exchange rate depreciates in terms of the foreign currency, there is a rise in the cost of servicing external liabilities.

What is the status of external debt in India? 

India’s external debt in March 2022 stood at $620.7 billion, which is 19.9% of Gross Domestic Product (GDP). In terms of maturity, short-term debt comprised 19.6% of GDP and long-term debt comprised 80.4% of GDP. In terms of currency composition, the US dollar dominates the debt at 53%. The Non-Resident Indian (NRI) Deposits and Foreign investment in Government securities are part of external debt but are based in Rupees. Hence external debt is also held in Rupees and its share is 31%.

If we look at it historically, external debt as a percentage of GDP has declined steadily from around 40% of GDP in the early 1990s to averaging 20% of GDP since the 2000s.

Within debt, the focus remains on short-term debt as it has to be paid over a short time. The share of short-term debt was low even during the 1991 crisis and averaged around 5% from 1991 to 2004. In 2005, the definition of short-term debt changed and more items were included. As a result, the share of short-term debt in total debt increased to 13% in 2005 and touched 20% in 2008 following the global financial crisis. The short-term debt has remained around 20% of total debt for most part of the period since 2008.

Another important indicator is the Debt Service Ratio (DSR), a measure of a country’s ability to service debt given current receipts. India’s DSR has declined from around 40% in the 1990s to around 5% today.

Finally, change in total external debt. We do not see a case where India’s external debt has spiraled. External debt has risen mainly during surges in oil/commodity prices as seen during 2007-08 and 2010-12. In 2013, India faced a crisis on multiple fronts leading to a rise in external debt too. Since 2014, growth in external debt has been muted, averaging 5%. In 2022, debt has risen by 8% with most of the increase coming from short-term sources, which has caused some concerns. The markets have also raised concerns that $267.7 billion of debt has to be paid this year. The amount is not very different from previous years.

What are the sources of external debt? 

Within long-term debt, we see changes in sources of borrowing since 1991. In 1991, external debt mainly came from multilateral and bilateral sources whose share was 40% of total long-term debt, which has declined to 17% in 2022.

The share of IMF also declined from around 4-5% in the early 1990s to 0-1% in the 2000s before rising to 3.7% in 2022. The government is the major borrower of multilateral and bilateral loans and the only borrower in case of IMF loans.

In 1991-2022, the share of External Commercial Borrowings (ECBs) and Non-Resident Indian (NRI) deposits has risen from 12% to 37% and 12% to 22%, respectively. ECB are loans taken by corporate entities for their overseas investments whereas Indian banks receive NRI deposits.

Within short-term debt, the major share is held by trade- related credits used by the trading community for managing exports and imports. Of the 19.7% short-term debt as a share of total external debt, share of trade credit is 18.9%.

Is India’s external debt position at risk? 

Given the overall figures, India’s external debt position is hardly at risk. The external debt position has remained stable since the 1991 economic reforms. The Finance Ministry, in an annual review, conducted a cross-country analysis of external debt in 2020. It noted that “total external debt of the world as at end-December 2020 was US $94.5 trillion, while that of India was estimated at US $563 billon occupying 24th position globally”.

In a 2020 research paper, Reserve Bank of India (RBI) economists noted external vulnerability remained minimal. In a 2022 note, RBI economists said the threshold level of external debt is 23-24% of GDP, implying India could raise growth maximizing external debt!

Having said that, India cannot be complacent. The Indian rupee has depreciated recently, creating concerns over macroeconomic stability including external debt. India is running high inflation, accompanied by large twin deficits of the budget deficit and current account deficit. The RBI has started to increase policy rates, which will slow growth, leading to a higher ratio of external debt to GDP in future.

There has also been a shift in sources of external debt from multilateral/bilateral sources to ECBs and NRI deposits. This implies that external debt risks have shifted from the government to the private sector and banking system.

While the government can avail concessional facilities and roll over the liabilities, the same opportunities are not available to the private sector and banks. Policymakers have been alert to the risks. The RBI took several steps recently to arrest currency depreciation and encourage higher NRI deposits in the country. The RBI has also taken a step to internationalise trade in the rupee, which should also hopefully lower dollar-denominated liabilities in the future.