Foreign Debt to the Fore Again

Academic Opinion Dr TK Jayaraman Once again the topic of foreign debt is hitting headlines. This time, it is in Samoa. Based on Debt Sustainability Framework analysis, International Monetary Fund
31 Jul 2014 09:19

Academic Opinion
Dr TK Jayaraman

Once again the topic of foreign debt is hitting headlines. This time, it is in Samoa.
Based on Debt Sustainability Framework analysis, International Monetary Fund (IMF) and the World Bank (WB) have recently assessed low income countries.
The latter do not include Fiji, as its per capita income of US$4430 places the country in upper middle income group.
The objective is to minimise risks to low income countries arising from further unsustainable debts.
Soon Millennium Development Goals will be replaced by Sustainability Development Goals (SDG). Achieving SDGs require investments in infrastructure for which low income countries have to depend upon external resources: loans and grants.

High debt risk countries
The latest list released by IMF and WB in June, classifies Samoa, Republic of Marshall Islands (RMI) as high risk countries; Papua New Guinea and Vanuatu as low risk countries and Tonga as moderate risk country.
Tonga’s budget for 2014-15 is funded by aid to a larger extent than ever before: 59 per cent.
Weaning away from external debt was the subject of intense discussion last month both in the country’s parliament and media.
As RMI is classified as high risk country and from debt sustainability point of view is considered no longer credit worthy, Asian Development Bank announced that the country will be eligible only for grants, not new loans.

Samoa’s external debt
The debate on debt sustainability is not new.
In early April, a visiting IMF Mission referred to increase in expenditure for recovery and reconstruction in the face of recent external shocks, including the global financial crisis, the tsunami and cyclone.
Based on the high risk classification, the Mission warned against any further rise in Samoa’s debt. It advised a process of gradual fiscal consolidation, once the recovery has taken hold.
That drew Samoa’s Prime Minister (PM) to react in his press conference:
“We don’t have to just swallow (whatever advice) is given. We have to use our brains and make a decision that best suits our situation”.
He was recalling IMF’s advice in 2003 asking Samoa not to proceed with the construction of the SamoaTel headquarters, Virgin Samoa joint venture and the construction of Development Bank Building.
Samoa rejected the advice and went ahead.

Defending the debt
In his latest defence of debt, PM rejected the claims that Samoa’s foreign debt was imposing severe burden on the future generations of the country.
Although the debt (most of which is external, as domestic borrowing is minimal) is 960 million tala (US$423 million) or 66 per cent of gross national income (GNI), as against RMI’s debt to GNI ratio of 70 per cent, Samoa’s PM said that annual debt servicing obligations was only 51 million tala or 7 per cent of government revenues of 700 million tala.

Annual flow
Further, PM stressed the annual flow of benefits from the projects, when completed would more than offset the original cost.
The argument put forward by PM is sound.
Thus, an externally funded project would be justified if the internal rate of return exceeds the market rate of interest.
The conditions for a successful borrowing programme is the choice of projects which are growth enhancing rather than image building, unproductive projects. That underscores the need for careful screening of projects.

Debt service ratio
The true indicator of debt servicing capacity is how much of export earnings generated each year are paid out to foreigners for meeting annual debt obligations, known as total debt service (TDS).
Additionally two ratios are used: reserves to external debt; and reserves equivalent to average monthly imports.
In Samoa, total debt service is low, hovering around at 5.3 per cent during past three years. This is because 60 per cent of outstanding debt stock is concessional loans from WB and ADB.
However, the ratio of foreign exchange reserves to external debt is declining from 66 per cent in 2009 to 40 per cent in 2012; and from 6.2 months import equivalent reserves in 2009 declining to 4.4 in 2012.
Fiji belonging to higher middle income group is not eligible for concessional borrowings.

Fiji situation
However, Fiji’s public debt is relatively low at 50 per cent; and external debt is only 19.1 per cent of gross national income.
The total debt service ratio is well below 2 per cent. Ratio of foreign exchange reserves to exports is 126 per cent and in terms of months of imports, it is well above four months of imports.
The way to avoid debt defaults and crises is increasing foreign exchange reserves through commodity exports and tourism, and by encouraging higher remittance inflows.
Above all, projects funded by debt should be capable of earning additional foreign exchange.
nDr Jayaraman is a Professor at the Fiji National University’s School of Economics, Banking and Finance, Nasinu Campus. His website is:

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