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External Debt and Political Instability

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  • Ozler, Sule
  • Tabellini, Guido

Abstract

This paper provides a theoretical and empirical analysis of the role played by domestic political incentives in the accumulation of large external debts by developing countries between 1972 and 1981. The theoretical model characterizes two equilibrium regimes. In one the borrower is on its demand curve and changes in the loan size desired by the borrower are accommodated by lenders. In the other regime the borrower is credit rationed, and the loan size is determined by the perceived country risk. Increased political instability increases the equilibrium loan size in the first regime and decreases it in the second. Using out-of-sample evidence, we identify the two regimes in the data. We then find that in the unconstrained regime political instability has a significant effect on the loan size, whereas it has no significant effect in the credit rationing regime. Hence the evidence indicates a positive effect of political instability on the demand for sovereign loans, as predicted by the theory.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 582.

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Date of creation: Oct 1991
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Handle: RePEc:cpr:ceprdp:582

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Related research

Keywords: Developing Countries; External Debt; Investment; Politics;

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References

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  1. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-78, February.
  2. Hajivassiliou, Vassilis A., 1987. "The external debt repayments problems of LDC's : An econometric model based on panel data," Journal of Econometrics, Elsevier, vol. 36(1-2), pages 205-230.
  3. Alex Cukierman & Sebastian Edwards & Guido Tabellini, 1989. "Seigniorage and Political Instability," NBER Working Papers 3199, National Bureau of Economic Research, Inc.
  4. Diwan, Ishac & Verdier, Thierry, 1991. "Distributional aspects of debt adjustment," Policy Research Working Paper Series 657, The World Bank.
  5. Alesina, Alberto & Tabellini, Guido, 1989. "External debt, capital flight and political risk," Journal of International Economics, Elsevier, vol. 27(3-4), pages 199-220, November.
  6. Jeffrey Sachs & Daniel Cohen, 1982. "LDC Borrowing with Default Risk," NBER Working Papers 0925, National Bureau of Economic Research, Inc.
  7. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  8. Mark Gertler & Kenneth Rogoff, 1989. "Developing Country Borrowing and Domestic Wealth," NBER Working Papers 2887, National Bureau of Economic Research, Inc.
  9. Ozler, Sule, 1989. "On the Relation between Reschedulings and Bank Value," American Economic Review, American Economic Association, vol. 79(5), pages 1117-31, December.
  10. Maurice Obstfeld, 1985. "Capital Mobility in the World Economy: Theory and Measurement," NBER Working Papers 1692, National Bureau of Economic Research, Inc.
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