On Foreign Debt Sustainability of Developing Countries: Towards a Long Run Approach for Development

Abstract

The role of economic theory is to suggest models and indicators that allow in identifying when foreign debt of a developing country is sustainable and when it is “excessive.” The IMF and the World Bank define the external debt sustainability of a country as its ability to meet the current and future external debt service obligations in full, without recourse to debt rescheduling or accumulation of arrears. This concept of sustainability focuses on the behaviour of the borrower (the borrower’s willingness and ability to repay its debt “in full”) rather than on the behaviour of the lender (based on the lender’s liquidity and investment alternatives) and implies that countries receiving external debt relief are in a situation of “excess debt”. But when creditors have to decide for some debt relief measures, they need to establish, by a sustainability analysis, the sustainable debt level of the borrower. This reasoning is evidently circular and shows how the traditional notion of sustainability is arbitrary. This is due to the characteristics of the sovereign debt relationship (Epstein and Gintis, 1992). The aim of this paper is to redefine the concept of foreign debt sustainability. We propose a long run dynamic approach based on a flow analysis rather than a stock analysis. In this approach we try to solve the problem of arbitrariness existing in the traditional approach on foreign debt sustainability.