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The overhang hangover

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  • Jean Imbs
  • Romain Rancière

Abstract

We revisit the debt overhang question. We first use non-parametric 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, we 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, we ask whether, as overhang level of debt is reached: (i)investment falls precipitously as it should when it becomes optimal to default, (ii) economic policy deteriorates observably, as it should when debt contracts become unable to elicit effort on the part of the debtor, and (iii) the terms of borrowing worsen noticeably, as they should when it becomes optimal for creditors to pre-empt default and exact punitive interest rates. We 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 Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 878.

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Date of creation: Jun 2005
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Handle: RePEc:upf:upfgen:878

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Web page: http://www.econ.upf.edu/

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Keywords: Debt overhang; kernel estimation; debt contracts; investment; debt relief;

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Citations

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Cited by:
  1. Cordella, Tito & Missale, Alessandro, 2013. "To give or to forgive? Aid versus debt relief," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 504-528.
  2. 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.
  3. Catherine Pattillo & Hélène Poirson & Luca Antonio Ricci, 2011. "External Debt and Growth," Review of Economics and Institutions, Università di Perugia, vol. 2(3).
  4. Andrea Filippo Presbitero, 2009. "Debt Relief Effectiveness and Institution Building," Mo.Fi.R. Working Papers 15, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  5. Presbitero, Andrea F., 2007. "The debt-growth nexus in poor countries: a reassessment," Economics Discussion Papers 2007-17, Kiel Institute for the World Economy.
  6. 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.
  7. Raddatz, Claudio, 2009. "Multilateral debt relief through the eyes of financial markets," Policy Research Working Paper Series 4872, The World Bank.
  8. Nicolas Depetris Chauvin & Aart Kraay, 2005. "What Has 100 Billion Dollars Worth of Debt Relief Done for Low- Income Countries?," International Finance 0510001, EconWPA.
  9. Marco Arnone & Luca Bandiera & Andrea Presbitero, 2005. "External Debt Sustainability: Theory and Empirical Evidence," International Finance 0512007, EconWPA.
  10. 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).
  11. Ikonen, Pasi, 2010. "Effect of finance on growth through more efficient utilization of technological innovations," Research Discussion Papers 21/2010, Bank of Finland.
  12. Gul, Adnan, 2008. "Is external debt an effective way of bringing economic reforms?," MPRA Paper 10979, University Library of Munich, Germany.
  13. Brown, Martin & Lane, Philip R., 2011. "Debt overhang in emerging Europe ?," Policy Research Working Paper Series 5784, The World Bank.
  14. Johansson, Pernilla, 2010. "Debt Relief, Investment and Growth," World Development, Elsevier, vol. 38(9), pages 1204-1216, September.
  15. Mahmoud Sami Nabi & Imed Drine, 2009. "External Debt, Informal Economy and Growth," Economics Bulletin, AccessEcon, vol. 29(3), pages 1695-1707.
  16. 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.
  17. 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.

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