Sovereign Debt Overhang, Expenditure Composition and Debt Restructurings

Abstract

Sovereigns' public capital influences sovereign debt crises and resolution. We compile a dataset on public expenditure composition around restructurings with private external creditors. We show that during restructurings, public investment (i) experiences severe decline and slow recovery, (ii) differs from public consumption and transfers, (iii) reduces share in public expenditure, and (iv) relates with restructuring delays. We develop a theoretical model of defaultable debt that embeds endogenous public capital accumulation, expenditure composition, production and multi-round debt renegotiations. The model quantitatively shows severe decline and slow recovery in public investment – “sovereign debt overhang” – delay debt settlement. Data support these theoretical predictions.