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The Overhang Hangover

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Author Info

  • Jean Imbs

    (University of Lausanne - HEC Lausanne; Centre for Economic Policy Research (CEPR))

  • Romain Rancière

    (International Monetary Fund (IMF))

Abstract

The authors revisit the debt overhang question. They first use nonparametric techniques to isolate a panel of countries on the downward sloping section of a debt Laffer Curve. In particular, overhang countries are ones where a threshold level of debt is reached in sample, beyond which (initial) debt ends up lowering (subsequent) growth. On average, significantly negative coefficients appear when debt face value reaches 60 percent of GDP or 200 percent of exports, and when its present value reaches 40 percent of GDP or 140 percent of exports. Second, the authors depart from reduced form growth regressions and perform direct tests of the theory on the thus selected sample of overhang countries. In the spirit of event studies, they ask whether, as the overhang level of debt is reached: (1) investment falls precipitously as it should when it becomes optimal to default; (2) economic policy deteriorates observably, as it should when debt contracts become unable to elicit effort on the part of the debtor; and (3) the terms of borrowing worsen noticeably, as they should when it becomes optimal for creditors to preempt default and exact punitive interest rates. The authors find a systematic response of investment, particularly when property rights are weakly enforced, some worsening of the policy environment, and a fall in interest rates. This easing of borrowing conditions happens because lending by the private sector virtually disappears in overhang situations, and multilateral agencies step in with concessional rates. Thus, while debt relief is likely to improve economic policy (and especially investment) in overhang countries, it is doubtful that it would ease their terms of borrowing or the burden of debt.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 06-03.

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Date of creation: Aug 2005
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Handle: RePEc:chf:rpseri:rp0603

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Web page: http://www.SwissFinanceInstitute.ch
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Related research

Keywords: Debt Overhang; Kernel Estimation; Debt Contracts; Investment; Debt Relief;

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References

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Citations

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Cited by:
  1. Gul, Adnan, 2008. "Is external debt an effective way of bringing economic reforms?," MPRA Paper 10979, University Library of Munich, Germany.
  2. Marco Arnone & Luca Bandiera & Andrea Presbitero, 2005. "External Debt Sustainability: Theory and Empirical Evidence," International Finance 0512007, EconWPA.
  3. Presbitero, Andrea F., 2007. "The debt-growth nexus in poor countries: a reassessment," Economics Discussion Papers 2007-17, Kiel Institute for the World Economy.
  4. Andrea F. Presbitero, 2009. "Debt-Relief Effectiveness and Institution-Building," Development Policy Review, Overseas Development Institute, vol. 27(5), pages 529-559, 09.
  5. Romero, Alfredo A. & Burkey, Mark L., 2011. "Debt Overhang in the Eurozone: A Spatial Panel Analysis," The Review of Regional Studies, Southern Regional Science Association, vol. 41(1), pages 49-63, Summer.
  6. Ikonen, Pasi, 2010. "Effect of finance on growth through more efficient utilization of technological innovations," Research Discussion Papers 21/2010, Bank of Finland.
  7. Johansson, Pernilla, 2010. "Debt Relief, Investment and Growth," World Development, Elsevier, vol. 38(9), pages 1204-1216, September.
  8. Cordella, Tito & Missaley, Alessandro, 2011. "To give or to forgive ? aid versus debt relief," Policy Research Working Paper Series 5859, The World Bank.
  9. Mahmoud Sami Nabi & Imed Drine, 2009. "External Debt, Informal Economy and Growth," Economics Bulletin, AccessEcon, vol. 29(3), pages 1695-1707.
  10. Raddatz, Claudio, 2009. "Multilateral debt relief through the eyes of financial markets," Policy Research Working Paper Series 4872, The World Bank.
  11. Hélène Poirson & Luca Antonio Ricci & Catherine A. Pattillo, 2002. "External Debt and Growth," IMF Working Papers 02/69, International Monetary Fund.
  12. Brown, Martin & Lane, Philip R., 2011. "Debt overhang in emerging Europe ?," Policy Research Working Paper Series 5784, The World Bank.
  13. Siti Daud & Jan Podivinsky, 2011. "Debt–Growth Nexus: A Spatial Econometrics Approach for Developing Countries," Transition Studies Review, Springer, vol. 18(1), pages 1-15, September.
  14. Drine, Imed & Nabi, M. Sami, 2010. "Public external debt, informality and production efficiency in developing countries," Economic Modelling, Elsevier, vol. 27(2), pages 487-495, March.
  15. Nicolas Depetris Chauvin & Aart Kraay, 2005. "What Has 100 Billion Dollars Worth of Debt Relief Done for Low- Income Countries?," International Finance 0510001, EconWPA.
  16. Bevan, David, 2012. "Aid, Fiscal Policy, Climate Change, and Growth," Working Paper Series UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
  17. Johansson, Pernilla, 2009. "Grants to needy countries? A study of aid composition between 1975 and 2005," Working Papers 2009:19, Lund University, Department of Economics.

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