The adjustment towards national solvency in developing countries: An application to india

Abstract

AbstractA small macromodel of the Indian economy is used to examine the cost of adjustment required by national solvency. The cost is compared with the corresponding cost if India were to repudiate its debts and experience financial autarky as a consequence. Our empirical results suggest that a small drop in the trend growth rate, resulting from a loss of foreign investment and lending to the domestic sector, is sufficient to deter reneging; but only if the government is sufficiently far‐sighted and chooses a discount rate of 5 per cent (or less) a year. If the Indian government were to discount at a 10 per cent rate per annum, then the drop in trend growth of as much as 4 per cent is insufficient to deter reneging. Debt relief generally improves the relative attractiveness of debt repayment. But with a 10 per cent discount rate, even writing off 75 per cent of India's external debt fails to make debt repayment incentive compatible.