Sovereign Risk and Simple Debt Dynamics in Asia
AbstractIn this paper we develop a simple neoclassical growth model with perfect internationalcapital mobility to analyze the international debt dynamics of developing countries ingeneral and Korea, Malaysia and Thailand in particular. We show that three differentregimes can be distinguished: a stable steady state debtor regime, a stable steady statecreditor regime and an unstable regime. A switch from a stable debtor or a stable creditorposition to an unstable creditor regime may be a sign of forthcoming trouble. Weinvestigate this issue empirically for the three Asian countries in the run-up to the 1997Asia crisis, using data over the period 1975-2000. Over the full sample, the evidencesuggests that debt dynamics evolved according to the stable debtor case in each country.Using a rolling regression technique, we find that indeed occasional switches to theunstable regime occurred. More in particular, we demonstrate that all three countriesinvestigated here were facing deteriorating domestic fundamentals – reflected inpotentially unstable debt dynamics – prior to the breakout of the Asia crisis. As such, ourapproach appears to offer an interesting early warning indicator for financial (debt) crises.
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