Developing Country Debt Research Articles

Financial institutions and developing countries’ debt cancellations: How to get rid of moral hazard?

The purpose of the paper is to shed light on the looming risk of developing country debt defaults for financial institutions in the wake of the pandemic crisis. There are mounting calls to delink debt relief and conditions on developing countries so that debt cancellations should be delivered immediately without performance criteria or record of accomplishment. To date, however, debt cancellations have not sufficiently distinguished developing country beneficiaries according to their performance in sustainable development policies, neither have cancellations taken into account commitments towards improved governance trajectories, despite the requirements of poverty reduction programmes involving civil society. International financial institutions thus face the risk of large write-offs at a time of portfolio fragility due to an environment of low interest rates, meager profitability and weak economic growth. This paper argues that much of the resistance of private creditors comes from deeply rooted skepticism as to whether debt relief and write-offs lead to sustained improvement in creditworthiness. Accordingly, prudent risk management requires resisting calls for blanket debt relief when there is little scope for improved governance. Financial institutions should insist on strict criteria regarding inclusive development policies. As new legislation to facilitate debt-restructuring agreements, likely at the expense of private financial institutions, is currently being discussed, the insistence on ‘fair burden sharing’ between official and private creditors should be a wake-up call for banks. A range of financial risk management instruments could link debt relief with enhanced governance commitments, including debt swaps, recapture clauses and the monitored recycling of debt-servicing relief into high-priority projects. The pandemic crisis provides financial institutions with an opportunity to transform debt relief into a leverage for improving sustainable development prospects, hence better creditworthiness.

Back to the Future: IMF Article VIII Section 2 (B) - A Sovereign Debt Standstill Mechanism

This article provides a proposal to use IMF Article VIII, Section 2 (b) to establish a binding mechanism on private creditors for a sovereign debt standstill. The proposal builds on the original idea by Whitney Deveboise (1984). Using arguments brought forward by confidential IMF staff papers (1988, 1996) and the IMF General Counsel (1988), this paper shows how an authoritative interpretation of Article VIII, Section 2 (b) can provide protection from litigation to countries at risk of debt distress. The envisaged mechanism presents several advantages over recent proposals for a binding standstill mechanism, such as the International Developing Country Debt Authority (IDCDA) by UNCTAD and a Central Credit Facility (CFF) by the Bolton Committee. First, this approach would not require the creation of new intergovernmental mechanisms or facilities. Second, the activation of the standstill mechanism can be set in motion by any IMF member country and does not require a modification of its Articles of Agreement. Third, debtor countries acting in good faith under an IMF program would be protected from aggressive litigation strategies from holdout creditors in numerous jurisdictions, including the US and the UK. Fourth, courts in key jurisdictions would avoid becoming overburdened by a cascade of sovereign debt litigation covering creditors and debtors across the globe. Fifth, private creditors would receive uniform treatment and ensure intercreditor equality. Sixth and last, the mechanism would provide additional safeguards to protect emergency multilateral financing provided to tackle Covid-19.

The new face of developing country debt

Developing country debt has been a major preoccupation for development policy makers and practitioners since the debt crisis of 1982. It is a major obstacle to economic and social progress in developing countries. After the resolution of the Asian financial crisis of the late 1990s and the debt relief initiatives for low-income countries of 1997–2006 concerns about developing country debt seem to have receded. However, there are a growing number of problems that warrant concern, including the accumulation of domestic debt, short-term debt and private non-guaranteed debt, and increasing recourse by low-income countries to international capital markets. At the same time developing countries have strengthened their capacity to oversee and analyse their debt portfolios. Nonetheless, significant weaknesses remain in debt management capacity at the national level. Moreover, the activities of ‘vulture funds’ and the lack of a sovereign debt restructuring mechanism reveal major shortcomings in the international institutional architecture that need to be addressed urgently.

Determinants of developing country debt: the revolving door of debt rescheduling through the Paris Club and export credits

Programmes designed to alleviate developing country debt have been implemented by bilateral, commercial and multilateral creditors and sovereign debt has been restructured under Paris Club negotiations. These strategies have not been very successful at reducing the debt levels of developing countries, in part because they continue to receive export credit insurance facilities through export credit agencies (ecas). The purpose of this paper is to examine the high percentages of developing country debt owed to governmental ecas. Analysis of the external debt of low-income and lower middle-income economies at five year intervals from 1980 to 2010 finds a substantial part of the indebtedness of these economies is held by ecas. Analysis of specific sub-Saharan African countries undergoing debt rescheduling and forgiveness through Paris Club negotiations was done for Ghana and Kenya. These results show that, following debt restructuring, new export credit guarantees and/or loans were forthcoming to these countries from the ecas of the creditor countries that rescheduled their old debt in Paris Club negotiations during 2000–12.

Financing Developing Country Debt: A Sovereign Borrowing Entity Proposal

This paper proposes the creation of a Sovereign Borrowing Entity (SBE) under the auspices of the International Monetary Fund (IMF) and other International Financial Institutions (IFIs). The SBE guarantees bond issuances by developing nations, packages them in relatively small denominations, and auctions them to the public. Should a developing debtor country fail to pay its debt, the SBE would raise funds through a punitive tariff on all exports administered by the IMF member nations. We develop a theoretical model of the proposed Sovereign Borrowing Entity (SBE) and provide viability evidence using export and debt data from the World Bank. It is our hope that this paper will encourage further dialogue and research on financing developing country debt in a more effective manner.

External Debt Accumulation and Its Impact on Economic Growth in Pakistan

The accumulation of external debt is common phenomenon of the developing countries and it has become a common feature of the fiscal sectors of most of the economies. A country with lower saving rate needs to borrow more to finance the given rate of economic growth. So external debt is obtained to sustain the growth rate of the economy, which is otherwise not feasible with the given domestic resources. Pakistan is one of the developing countries and faces serious debt problems, according to World Bank Report 2000-2001, Pakistan is among the Highly Indebted Countries (HICs); because Pakistan’s present and future debt situation is very grim. According to the World Bank total external debt may be defined as debt owed to non-resident repayable in terms of foreign currency, goods or services. External debt is the composition of long term debt (public and publicly guaranteed debt plus private non guaranteed debt), short term commercial debt and International Monetary Fund (IMF) loans. Prior to early 1970s the external debt of developing countries was primarily small and official phenomenon, the majority of creditors being foreign governments and international financial institutions offer loan for development project [Todaro (1988)]. At the same time current account deficit was common which increased the external indebtedness of the developing countries, until when Mexico, despite an oil exporter, declared in august, 1992 that it could not services its debt ever since, the issue of external debt and its servicing has assumed critical importance and introduced the debt crises debate [Were (2001)].

Testing For Weak-Level Efficiency In The Secondary Market For Developing Country Debt

This paper investigates the presence of weak level efficiency in the secondary market for developing country debt y modeling as ARIMA processes debt price variations of eight large debtor countries that were actively traded during the period January 1986 to December 1992. The analysis suggests that in some cases the secondary market for developing-country debt was weakly inefficient and that there existed at least one trading rule capable of generating above-average returns. Moreover, the narrowing of above-average returns in the period following the announcement of the Brady Plan suggests that the secondary market for developing country debit became more efficient, possibly due to a reduction in default risk and an increase in the availability of timely investment information.

The Players and the Game of Sovereign Debt

Is there “justice” in treating developing country debt crises? As a first step toward analyzing ethical questions in sovereign debt, this paper characterizes the actors, their main interests, and how they operate during the build up of government foreign debt and after a default on payments. These actors are the borrowing governments, domestic and foreign commercial banks, purchasers of government bonds, other governments lending to the debtor, and multilateral institutions (International Monetary Fund and development banks). As there is no international sovereign analog to court-supervised bankruptcy, the workout from crisis is found ad hoc, without rules or an enforcement mechanism.

Bono Made Jesse Helms Cry: Jubilee 2000, Debt Relief, and Moral Action in International Politics

Do states and decision-makers ever act for moral reasons? And if they do, is it only when it is convenient or relatively costless for them to do so? A number of advocacy movementsFon developing country debt relief, climate change, landmines, and other issuesFemerged in the 1990s to ask decision-makers to make foreign policy decisions on that basis. The primary advocates were motivated not by their own material interests but broader notions of right and wrong. What contributes to the domestic acceptance of these moral commitments? Why do some advocacy efforts succeed where others fail? Through a case study of the Jubilee 2000 campaign for developing country debt relief, this article offers an account of persuasion based on strategic framing by advocates to get the attention of decision-makers. Such strategic but not narrowly self-interested activity allows weak actors to leverage existing value and/ or ideational traditions to build broader political coalitions. This article, through case studies of debt relief in the United States and Japan, also links the emerging literature on strategic framing to the domestic institutional context and the ways veto players or ‘‘policy gatekeepers’’ evaluate trade-offs between costs and values.

WHY WE MUST DEFUSE THE DEBT THREAT

Developing country debt is back in the news. Public figures such as Gordon Brown, and celebrities such as the rock star Bono are calling for it's cancellation. But what should a debt cancellation program look like? Upon what bases should countries be eligible for debt cancellation? How should the culpability of donors for the developing world debt crisis be addressed? How can debt savings be ring-fenced so that they reach the constituencies who most need them? And will the cancellation of debt on its own suffice? These are the questions Noreena Hertz addresses in this paper.

How Would a New Bankruptcy Regime Help?

A KEV ISSUE IN THE debate over reform of the international financial system is whether adopt a new international bankruptcy regime for sovereign debt, and an important aspect of that debate is the lack of consensus about the problems that such a regime would be designed solve and whether it would solve them. My remarks are focused on a new bankruptcy regime rather than a new court, because the former does not necessarily entail the latter. The authors of the three papers in this symposium all have quite different conceptions of the problems, as do other important protagonists. Bulow's paper, like his past articles on this subject, is focused on the need reduce bailouts of developing-country debt by international financial institutions (IFIs) and governments in the industrial countries, so as achieve more optimal flows of private capital emerging markets. Sachs' paper sees two different roles for the bankruptcy process: avoiding a creditor grab race for the sovereign debtor's assets, and giving the sovereign debtor a new start by substantially reducing its debt. White's paper mainly addresses two objectives that differ from both Bulow's and Sachs': preventing rogue creditors from upsetting private debt reorderings and making sure defaulting countries have adequate sources of funds, through granting seniority creditors who lend in the wake of a default. The U.S. Treasury, in the form of John Taylor's statement during the same week as this conference, (1) has yet a different objective. He wants reduce the uncertainty of the current process by providing a more orderly structure for resolving crises when they occur. Finally, the purpose of the IMF proposal offered by Anne Krueger is more encompassing. In her proposal last November she said the IMF's aim is to create a catalyst that will encourage debtors and creditors come together restructure unsustainable debts in a timely and efficient manner. (2) Krueger's latest proposal for a sovereign debt restructuring mechanism (SDRM) contains the following elements: a stay for some fixed duration on creditors' seizure of a troubled debtor's assets, reform of the debtor's economic policies as part of the bankruptcy plan, seniority for creditors who lend after the petition for a stay, and a mechanism enabling a supermajority of creditors bind other creditors a plan. How does this proposal relate the objectives identified by Krueger herself, Taylor, and the others? The relationship between Krueger's SDRM and reducing bailouts is not clear. One could argue that this objective could be achieved more directly than through adoption of an SDRM, by placing restraints on crisis lending by the IFIs. This could be done in a variety of ways. Under the proposal by Adam Lerrick and Allan Meltzer, (3) IMF support would be limited a commitment buy the debt of defaulting sovereigns at some discount from the price being offered by the sovereign. Under a proposal offered jointly by the Bank of Canada and the Bank of England, (4) there would be procedures like those adopted in the United States in 1991 under the Federal Deposit Insurance Corporation Improvement Act for official lending failed banks. Lending would be permitted only when there is a threat the stability of the international monetary system and only after approval by a supermajority of the IMF's executive board. Krueger's proposal for an SDRM addresses the bailout problem more indirectly. The idea is that pressure for IMF lending would be lessened if the SDRM offered a mechanism by which a troubled sovereign debtor and its creditors could reach an agreement reduce the sovereign's debt. One reason that IMF lending has been so prevalent is that there is no workable mechanism for reducing debt. Indeed, the argument would be that the IMF could not risk the chaos, economic and political, that might ensue in the absence of its lending unless an alternative debt reduction process were in place. …

Globalization is What States Make of It: Constructivism, US Foreign Economic Policy and the Peso Crisis

While constructivist arguments have been extensively applied to issues of national security policy and military-security issues, there has been little effort to consider constructivist contributions to understanding US foreign economic policy. This article examines US developing country debt policy in an era of globalization. In evaluating the limitations of the dominant perspectives — neoliberal institutionalism and new statism — a constructivist-inspired explanation of US policy is offered.

The Debt Crisis

INTRODUCTIONIn recent years public and media attention to the debt problems of developing countries has been growing. In contrast to the crisis of the 1980s, which largely affected middle-income countries burdened by private commercial debt, the present crisis and ensuing discussions have centered on the poorest countries, most of which are in subsaharan Africa.This article explores the developing country debt issue from the perspective of a bilateral donor, with particular emphasis on issues that affect the Canadian International Development Agency (CIDA). Although bilateral aid donors have participated on the margins of policy debates surrounding the need for debt relief initiatives and their implementation, the implications of the enhanced Heavily Indebted Poor Countries (HIPC) initiative (which defines the global debt strategy for the poorest developing countries) implies a stronger role for bilateral development agencies if it is to succeed. However, for some donors such as CIDA, participation is contingent upon overcoming certain capacity constraints.An examination of the evolving pattern of official debt relief in the 1990s - and the role for donors - should begin with the historic and modern day role of the Paris Club(f.1) before looking at the first effort to implement the HIPC initiative (1996-9). The second part of this article will discuss more recent developments in the global debt strategy, stemming from endorsements made at the September 1999 Interim and Development Committee meetings of the International Monetary Fund (IMF) and World Bank, which have a potential impact on bilateral aid agencies.THE PARIS CLUB AND THE GLOBAL DEBT STRATEGY PRIOR TO HIPCMost developing countries in need who request debt relief from their creditors and who have a demonstrated track record of economic reform through an IMF programme are eligible for non-concessional or concessional rescheduling packages from the Paris Club on their outstanding official debts.(f.2) The maximum amount of concessionality offered to developing countries has increased over time beginning with the introduction of the Toronto Terms in 1988.(f.3) Regardless of the depth and breadth of debt relief, the decision was always based more or less on the objective of debt sustainability. In other words, the debtor should be able to manage the debt repayments. However, for many poor developing countries, particularly in subsaharan Africa, the objective was not always achieved. The burden of servicing the debt was such that many countries - Cote d'Ivoire, Madagascar, Niger, and Senegal for example - had to return repeatedly to the Paris Club.(f.4)In Canada, the Department of Finance heads the Paris Club process, in consultation with the Department of Foreign Affairs and with input from the major Canadian creditor agencies: the Export Development Corporation, the Canadian Wheat Board, and CIDA. In the event of a rescheduling, Canada and other official creditors meet in Paris with representatives of the debtor country to negotiate the terms. The affected national creditor agencies then have to negotiate bilateral agreements with the debtor country within a timeframe established by the Paris Club. Although CIDA continues to manage a portfolio of approximately $1.6 billion of official development assistance (ODA) loans,(f.5) it has forgiven most CIDA loans to Paris Club debtor states. It has, therefore, been involved only infrequently in the workings of the Paris Club. Nonetheless CIDA has, over the past five years, finalized (or is close to finalizing) Paris Club rescheduling agreements with Egypt, Algeria, Morocco, Indonesia, and Pakistan.The formal Paris Club operations have often been complemented by unilateral debt forgiveness, typically of ODA loans. Since 1978, for example, Canada has forgiven over $1.3 billion in outstanding ODA loans, mostly to subsaharan states. Debt conversion programmes have also complemented Paris Club actions. …

How much debt must be cancelled?

Developing country debt now exceeds 2.4 trillion dollars and has become a major international political and economic issue for debtor governments, creditor governments, the IMF and World Bank, and campaigning organizations such as Jubilee 2000. For the poorest countries, debt has become unpayable and debt service an obstacle to development. This paper argues that debt crises and substantial debt cancellation are part of the normal economic cycle, and that an unusual aspect of this cycle has been the unwillingness to cancel debt. Recent historic precedent suggest that at least 1 trillion dollars in debt would need to be cancelled. The paper then uses a rights-based approach to development to estimate that more than 600 billion dollars in debt must be cancelled to release sufficient funds to meet internationally agreed development targets and thus satisfy human rights. Finally, the paper argues that lenders must take responsibility for illegitimate, corrupt and odious loans. Debt cancellation is the norm, not the exception, and the only question is how much.

Special Topic I: Structural Adjustment Policies and the Environment

Background to structural adjustment The oil price increases of the 1970s, the worldwide recession, and developing country debt crisis of the 1980s, led to the adoption of so-called structural adjustment policies (SAPs). These economic reform packages which included stringent monetary and fiscal measures, sought to restore conditions for growth and development by a combination of short-term ‘stabilization’ and more medium-term ‘adjustment’ policies for the macro-economy. SAPs have not always achieved their economic goals, for a variety of reasons. Of greater relevance is the fact that even where economic gains have been realized through structural adjustment, both environmental and social problems have persisted in several countries. The growing sustainable development literature is seeking to identify and remedy development strategies that lead to the unsustainable use of natural resources and the environment. One key question is whether the very economic policies being prescribed to alleviate economic problems are perhaps undermining the environmental resources and social fabric on which the long-term development of nations will ultimately depend.

Is the secondary market for developing-country debt efficient?: An application of the Dickey-Fuller unit root test

This paper examines weak-level efficiency in the secondary market for four heavily indebted Latin American countries by applying the Dickey-Fuller unit root test to discounted debt prices for the period January 1986 to October 1996. The analysis presented in this paper suggests that in spite of the announcement of the of Brady Plan and subsequent Brady bond restructurings, which were intended to encourage market-based reduction of developing countries' external-debt burden, that the secondary market for developing-country debt continued to be weakly inefficient. The analysis also found that while the secondary market for developing-country debt for two of the four cases examined experienced structural change following the implementation of the Brady Plan, that these markets in fact became more inefficient. The existence of weak-level market inefficiency implies that opportunities existed to earn above average returns by following an investment strategy that exploits observable regularities in prior externaldebt price movements.

Estimating the Likelihood of Mexican Default from the Market Prices of Brady Bonds

Market prices of developing country debt reflect investors' views of country repayment capacity as well as other debt-specific factors. To extract a measure of repayment capacity from debt prices, adjustments need to be made to account for: debt values being a concave function of repayment capacity; the specific terms of the debt agreement; and the presence of third-party guarantees. This paper derives a measure of repayment capacity by constructing a pricing model that takes these factors into account. Applying the model to Brady bonds issued by Mexico, we find that estimated repayment capacity often performs differently from the unadjusted bond prices. We demonstrate that other Mexican bonds can be priced fairly accurately on the basis of this repayment capacity measure.

The Brady-Euro Yield Differential Debate: Why Arbitrage is Infeasible

Brady bonds offer substantially higher returns than Eurobonds. This paper examines the Brady and Eurobond markets for developing country debt and finds that the apparent arbitrage opportunity is not only smaller than it at first appears, but is infeasible given the illiquidity of the Eurobond market. The maturity adjusted return differential between Brady and Eurobonds is smaller than the commonly cited yield spreads. Moreover, the transactions costs of executing a Eurobond short contract render arbitrage a loss-making proposition. Given the many crossover investors who are active in both the Brady and Euro markets, why do Eurobond investors not trade them actively?

The Brady-Euro Yield Differential Debate: Why Arbitrage is Infeasible

Brady bonds offer substantially higher returns than Eurobonds. This paper examines the Brady and Eurobond markets for developing country debt and finds that the apparent arbitrage opportunity is not only smaller than it at first appears, but is infeasible given the illiquidity of the Eurobond market. The maturity adjusted return differential between Brady and Eurobonds is smaller than the commonly cited yield spreads. Moreover, the transactions costs of executing a Eurobond short contract render arbitrage a loss-making proposition. Given the many crossover investors who are active in both the Brady and Euro markets, why do Eurobond investors not trade them actively?

Spectral analysis of secondary market mexican external debt prices

The secondary market for developing country debt currently is one of the fastest growing segments of the fixed income securities market. This paper examines the spectral properties of secondary market Mexican external debt price variations from January 1986–December 1992. The analysis presented in this paper suggests that the secondary market for Mexican external debt may be characterized by the "random-walk with drift" model. Moreover, large (small) spectral density estimates at high (low) periodicities suggest that secondary market price variations were positively autocorrelated and aperiodic in nature, although there is some evidence to suggest the possible presence of short-period harmonic resonances. Cross-spectral analysis of the relationship between the 10-year U.S. Treasury bond interest rate and secondary market Mexican external debt prices appears to verify the theoretical relationship between market determined interest rates for default-free, dollar denominated debt and secondary market debt prices. More importantly, estimated phase-lag relationships suggest that the secondary market for Mexican external debt probably was inefficient at the semi-strong level.