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Investment Incentives: New Money, Debt Relief, and the Critical Role of Conditionality in the Debt Crisis

  • Claessens, Stijn
  • Diwan, Ishac

External debt depresses investment and lowers economic growth below its potential through its negative effect on liquidity and expected profitability. These effects can pull a country into a downward spiral in which both the debtor country and creditors lose. This article considers the possibilities for revising contracts between a debtor and its creditors once a debt crisis has erupted. The framework that we develop shows how various combinations of new money and cuts in debt and debt service affect a debtor country's welfare, its debt repayments, and the earnings of its creditors. The analysis distinguishes between debtor countries that are willing and able to precommit credibly to an adjustment program and those that are not. This distinction provides the basis for a discussion of conditional lending by the international financial institutions to provide incentives and sanctions that make credible a debtor's promises to invest. Copyright 1990 by Oxford University Press.

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Article provided by World Bank Group in its journal World Bank Economic Review.

Volume (Year): 4 (1990)
Issue (Month): 1 (January)
Pages: 21-41

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Handle: RePEc:oup:wbecrv:v:4:y:1990:i:1:p:21-41
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