External debt, sovereign ratings and debt restructuring

Detail

1. What external debt is

• External debt is money that people and bodies in India owe to non-residents (people or institutions outside India). The borrower must repay the principal (the amount borrowed), pay interest, or both.
• Two types, based on who owes it:
• Sovereign debt is owed by the government.

• Non-sovereign debt is owed by private and public companies and banks.

• Sovereign/non-sovereign split: US$168.4 bn (22.9%) was government debt and US$567.9 bn (77.1%) was non-government debt (end-March 2025) [2].

• Non-financial corporations (ordinary companies, not banks) were the largest single group of borrowers, with 35.5% of the total (end-March 2025) [2].

• So most of India's external debt risk lies with companies, not the government.

• Main components (NCERT scaffold):

• Commercial borrowings, the largest part. These are loans that companies raise from foreign banks and markets, such as external commercial borrowings (ECBs).
• NRI deposits: money that Non-Resident Indians keep in Indian bank accounts. The bank must return it to them, so it counts as debt.
• Short-term trade credit: foreign suppliers let importers pay later, usually within one year.

• Multilateral and bilateral loans: loans from bodies like the World Bank and ADB (multilateral), or from a single foreign government (bilateral).

• RBI's instrument-wise view (end-March 2025) [2]:

• Loans: 34.0% (the largest part; this includes commercial borrowings)
• Currency and deposits: 22.8% (mostly NRI deposits)
• Trade credit and advances: 17.8%
• Debt securities: 17.7%

2. Currency risk: why a falling rupee hurts

• The debt is mostly dollar-denominated, which means it is fixed in US dollars. When the rupee falls, the borrower needs more rupees to repay the same dollars.
• Currency split (end-March 2025) [2]:
• US dollar 54.2%
• Indian rupee 31.1%
• Japanese yen 6.2%
• SDR 4.6%
• Euro 3.2%

• The rupee-denominated share, such as masala bonds, puts the currency risk on the foreign lender.

• Worked example: exchange-rate effect

• A company owes US$100 million.
• At ₹80/$, it needs ₹8,000 crore to repay.
• If the rupee falls to ₹88/$, it needs ₹8,800 crore.

• The debt in dollars is the same, but the burden in rupees is ₹800 crore (10%) higher.

• Valuation effect: RBI reports debt in US dollars. So when the dollar rises against the yen, euro, SDR or rupee, debt held in those currencies looks smaller in dollar terms. In 2024-25 this effect lowered measured debt by US$5.3 bn [2].

3. Size of India's external debt

• US$736.3 bn at end-March 2025, 19.1% of GDP. It was US$668.8 bn at end-March 2024, so it rose by US$67.5 bn in a year [2]. (NCERT: about US$736 bn, about 19% of GDP.)
• At about 19% of GDP, India's external debt is moderate compared with many emerging economies.

4. Vulnerability indicators

These ratios show whether a country could struggle to repay its debt.

• Debt service ratio (DSR)
• Formula: DSR = (Principal repayments + Interest payments) ÷ Current receipts × 100
• Current receipts are the country's earnings from abroad on the current account: exports of goods and services, income from abroad and remittances.
• Worked example: India earns US$1,000 bn in current receipts in a year and pays US$66 bn in principal and interest. DSR = 66 ÷ 1,000 × 100 = 6.6%. So about ₹6.6 of every ₹100 earned from abroad goes to repaying foreign lenders.

• Actual: 6.6% (2024-25), down from 6.7% (2023-24) [2]. (NCERT: about 35% in 1990-91, now in single digits.)

• Short-term debt to reserves

• Formula: Short-term debt ÷ Foreign exchange reserves × 100
• Short-term debt is debt that must be repaid within one year.
• It shows whether the RBI has enough foreign currency to repay all debt falling due within a year.
• By original maturity (the length of the loan when it was first taken): 20.1% (end-March 2025), up from 19.7% [2].
• By residual maturity (all debt due within the next year, including older long-term loans now close to repayment): 45.4% of reserves [2].

• Short-term share of total debt: 18.3% (end-March 2025), down from 19.1% [2].

• Debt to GDP

• Formula: External debt ÷ GDP × 100

• It measures the size of the debt against the whole economy. It was 19.1% (end-March 2025) [2].

• The 1991 benchmark (Class 11)

• In 1990-91, the DSR was about 35%.
• Foreign exchange reserves had fallen so low that they could not pay for more than about two weeks of imports.
• India came close to defaulting (failing to repay) on its external debt. This led to the 1991 reforms: devaluation of the rupee, IMF–World Bank loans, and LPG (liberalisation, privatisation and globalisation) policies.
• Then vs now: the DSR fell from about 35% to 6.6% (2024-25) because exports of services grew, remittances grew and reserves became much larger.

5. Sovereign credit ratings

• A sovereign credit rating is a rating agency's opinion on whether a government is able and willing to repay its debt.
• Why the rating matters:
• A higher rating means lenders see less risk.
• So they ask for lower interest rates.

• This makes borrowing cheaper for the government and also for Indian companies, because a company's rating is usually not higher than its country's rating.

• The big three agencies: S&P, Moody's and Fitch.

• Investment grade: the lowest investment grade is BBB− (S&P/Fitch) or Baa3 (Moody's).
• Anything below this is speculative or "junk" grade.

• Many pension funds and insurance funds are not allowed to invest in bonds below investment grade.

• India's recent upgrades:

• S&P upgraded India's long-term rating from 'BBB−' to 'BBB' in August 2025, with a Stable outlook. It also raised India's short-term rating from 'A-3' to 'A-2' [3].
• This was S&P's first upgrade for India in 18 years. Its last upgrade was in January 2007, to BBB− [3].
• S&P's reasons: fast economic growth, steady fiscal consolidation (the government cutting its deficit), better quality of public spending (more on capex and infrastructure), and strong corporate, financial and external balance sheets [3].

• Morningstar DBRS upgraded India from BBB (low) to 'BBB' (Stable trend) in May 2025 [4].

• Economic Survey 2020-21 critique:

• The Survey argued that India's ratings did not reflect its fundamentals (its growth, its ability to pay and its record of never defaulting) or its willingness to pay.
• It argued that the agencies were biased against large emerging economies, and that fiscal policy should not be held back by rating fears.

6. Sovereign default and restructuring

• Sovereign default: a government misses a payment of principal or interest that is due on its debt.
• Sovereign debt restructuring: the debtor and its creditors (lenders) agree to change the terms of the debt, so the country can pay again. There are three main tools:
• Haircut: the creditor accepts less than the full principal.
• Lower coupon: the interest rate is cut.

• Longer maturity: repayment is spread over more years, often with a moratorium (a period with no repayment).

• Worked example: haircut vs maturity extension

• A country owes US$100 bn.
• Option A, a 30% haircut: the principal falls to US$70 bn.
• Option B, no haircut: the full US$100 bn is still owed, but repayment is pushed from 5 to 20 years and the interest rate is cut from 6% to 2%.
  • The face value (the amount written on the loan) stays US$100 bn.
  • The net present value (NPV), meaning what those future payments are worth today, falls a lot.

• Both options give the country relief. Creditors that do not want to "write off" money on paper often prefer Option B.

• Paris Club: an informal group of mostly Western creditor governments that agree on debt relief together.

• Comparability of treatment: a country that gets relief from one group of creditors must get similar terms from all other creditors, including private bondholders and non-Paris-Club lenders such as China.
• This stops one creditor from "free-riding", where other creditors give relief and that creditor gets paid in full.
• It shares the burden fairly.

7. New frameworks

• G20 Common Framework (November 2020)
• The G20 created it so that low-income countries can restructure debt with Paris Club and non-Paris-Club creditors (such as China) at one table.
• Used by: Zambia, Ghana and Ethiopia.

• Criticism: it has been slow. Cases took years because creditors could not agree and information was not shared.

• Global Sovereign Debt Roundtable (GSDR, 2023)

• Launched in February 2023 by the IMF, working with the World Bank and India's G20 presidency [5][6].
• Members:
  • traditional creditors (Paris Club countries)
  • new creditors: China, India and Saudi Arabia
  • private lenders
  • borrowing countries [5][6]
• Purpose: to support, not replace, existing processes such as the Common Framework. It does this by building shared understanding of concepts and principles [5][6].
• Focus: faster restructurings, and sharing macroeconomic projections and debt sustainability assessments (checks of whether a country can keep paying its debt) early in the process [6].
• 2025: the G20 discussed a "3-pillar approach", proposed by the IMF and World Bank. It is for countries whose debt is sustainable (they can pay in the long run) but that face short-term debt-service pressure (payments falling due now that are hard to meet) [5].

8. Sri Lanka case study

• Default in 2022: Sri Lanka ran out of foreign exchange and stopped paying its external debt.
• India's bridge support: about US$4 bn, given through:
• lines of credit for fuel, food and medicines
• currency swaps, where India lent dollars or rupees for a time in exchange for Sri Lankan rupees

• deferrals of payments due to India

• IMF Extended Fund Facility (EFF), March 2023

• An EFF is a medium-term IMF loan for countries with deep BoP problems. It comes with conditions for structural reform.

• The IMF needs financing assurances (promises from the main creditors that they will restructure the debt) before it will lend.

• Official Creditor Committee (OCC)

• It was co-chaired by India, Japan and France.
• An OCC is a group of bilateral creditor governments that negotiates a joint restructuring with the debtor.

• India, a non-Paris-Club country, sat as a co-chair. This showed India acting as a creditor nation and as a "first responder" in its neighbourhood.

• China is not in the Paris Club. It negotiated separately.

• This feeds the "debt-trap" debate: the argument that opaque loans (terms kept secret) with collateral (assets pledged, such as ports) can push weak borrowers into giving up strategic assets.

9. Innovative finance

• Debt-for-nature swap
• Creditors forgive or refinance part of a country's debt (replace old costly debt with cheaper debt).
• In return, the country commits to spend on conservation, such as marine reserves and forests.
• Examples:
  • Belize (2021): marine conservation
  • Ecuador–Galápagos (2023)
  • Gabon (2023)

• The country pays less on debt and nature gets protected. Critics say the deals are small and complex.

• Blended finance

• It uses concessional money (cheap or low-interest public or philanthropic funds) to take the first loss or lower the risk of a project.
• This makes the project safe enough to draw in private investment.
• It is part of the G20 agenda for reforming Multilateral Development Banks (MDBs), which was pushed during India's 2023 presidency.

Prelims Hooks

• Debt service ratio = (principal + interest payments) ÷ current receipts. Current receipts, not GDP, is the denominator. India's DSR was 6.6% (2024-25), against about 35% (1990-91) [2].
• India's external debt was US$736.3 bn, 19.1% of GDP (end-March 2025) [2].
• By instrument, the largest part is loans (34.0%), then currency and deposits, then trade credit (end-March 2025) [2].
• Currency split: US dollar 54.2%, then the Indian rupee 31.1% (end-March 2025) [2]. Trap: the rupee, not the yen, is the second-largest currency.
• Non-government debt (77.1%) is far larger than sovereign debt (22.9%) (end-March 2025) [2].
• Lowest investment grade: BBB− (S&P/Fitch) = Baa3 (Moody's).
• S&P raised India to BBB in August 2025, its first upgrade since January 2007 [3].
• The GSDR was launched in 2023 by the IMF with the World Bank and India's G20 presidency. It supports, not replaces, the G20 Common Framework (November 2020) [5][6].
• Comparability of treatment means the debtor must get similar relief from all creditors. Paris Club means creditor governments.
• The Sri Lanka OCC was co-chaired by India, Japan and France. China negotiated separately.

Mains Points

• India's external debt is manageable, but watch it closely.
• The DSR is low (6.6%, 2024-25), debt is only 19.1% of GDP, and short-term debt is just 20.1% of reserves [2].
• But 77.1% of the debt is owed by companies, and 54.2% is in US dollars [2]. A sharp fall in the rupee or a sudden rise in global interest rates could hurt companies that have not hedged (protected themselves against currency moves) their loans.

• Lessons from 1991: keep large reserves, keep short-term debt low and keep the current account deficit in check.

• Ratings and fundamentals.

• The S&P upgrade (August 2025) partly answers the Economic Survey 2020-21 complaint that ratings did not match India's fundamentals.

• Better ratings mean cheaper foreign borrowing. They can also help Indian bonds get included in global bond indices, which brings in foreign investment. India should still build its own credibility through fiscal consolidation, not policy chosen to please rating agencies.

• Global debt architecture.

• The Common Framework is slow, and creditors like China are not transparent. Poor countries end up waiting while their debt problems get worse.

• India's role (GSDR under its G20 presidency, co-chair of the Sri Lanka OCC, US$4 bn support to Sri Lanka) shows India as a bridge between the Global South and creditor nations. It also serves India's Neighbourhood First policy and its strategic interests against China's influence.

• Climate and debt link.

• Debt-for-nature swaps and blended finance can free up money for climate action in countries with heavy debt.
• But they are small next to the need. They are best seen as extra tools alongside MDB reform and more concessional finance (low-cost loans and grants).