Fiscal Adjustment and Official Reserves in Sovereign Debt Negotiations
Empirical studies indicate that official reserves increase the creditworthiness of highly indebted countries. This evidence cannot be explained by existing bargaining models of sovereign debt because sovereign immunity shelters official reserves from creditors' seizure. In the model proposed here, to service foreign debt the government must raise revenue through distortionary taxation. Large reserves reduce the fiscal burden of debt service, weakening the bargaining position of the debtor and resulting in larger transfers to foreign creditors. In these circumstances, the debtor country may be better-off repurchasing debt on the secondary market rather than accumulating official reserves. Copyright 1996 by The London School of Economics and Political Science.
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Volume (Year): 63 (1996)
Issue (Month): 249 (February)
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