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Sovereign debt : a primer


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  • Eaton, Jonathan


The troublesome debts of many developing countries have spawned much literature on why countries borrow, on what debt contributes to growth, on why countries repay, and on how to deal with existing debt. The author provides an analytical primer on the following aspects of sovereign debt : 1) the basic accounting concepts associated with debt and some data associated with external borrowing; 2) debt as a component of an optimizing model of borrowing in a competitive loan market, when the borrower faces an intertemporal budget constraint; 3) debt as a component of recent models of endogenous growth; 4) problems arising from sovereign risk, including problems of liquidity, enforcement, and revenue-raising to finance repayment; 5) incentives to repay; 6) options available to a creditor whose debtor is unwilling to meet current debt-service obligations; and 7) debt buybacks. The author concludes that in the absence of any efficiency cost imposed by outstanding debt, how much a buyback benefits the borrower depends on how much buying back debt reduces what is available for repayment later. The author also concludes that if there are efficiency losses associated with debt, debt forgiveness can benefit both a debtor nation and its creditors. Contrary to claims in the literature, this outcome does not require that a reduction in the face value of debt raise its market value, and the debtor benefits even though the buyback raises the market price of the debt.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 855.

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Date of creation: 29 Feb 1992
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Handle: RePEc:wbk:wbrwps:855

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Keywords: Banks&Banking Reform; Environmental Economics&Policies; Strategic Debt Management; Economic Growth; Economic Theory&Research;

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  1. Herschel I. Grossman & John B. Van Huyck, 1985. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," NBER Working Papers 1673, National Bureau of Economic Research, Inc.
  2. Kletzer, K.M. & Wright, B.D., 1990. "Sovereign Debt Renegotiation In A Consumption-Smoothing Model," Papers, Yale - Economic Growth Center 610, Yale - Economic Growth Center.
  3. Krugman, Paul, 1988. "Financing vs. forgiving a debt overhang," Journal of Development Economics, Elsevier, Elsevier, vol. 29(3), pages 253-268, November.
  4. Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1986. "The Pure Theory of Country Risk," NBER Working Papers 1894, National Bureau of Economic Research, Inc.
  5. Kletzer, Kenneth M, 1984. "Asymmetries of Information and LDC Borrowing with Sovereign Risk," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 94(374), pages 287-307, June.
  6. Diwan, Ishac & Demirguc-Kunt, Asli, 1990. "The menu approach to developing country external debt : an analysis of commercial banks'choice behavior," Policy Research Working Paper Series 530, The World Bank.
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