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Costs and benefits of debt and debt service reduction

Listed author(s):
  • Fernandez-Arias, Eduardo

The author evaluates the costs and benefits of debt and debt service reduction (DDSR) from the point of view of five countries that have concluded Brady deals: Costa Rica, Mexico, the Philippines, Uruguay, and Venezuela. He concludes that, contrary to widely held views, commercial banks have probably benefited from the operations. Commercial bank participation in DDSR is voluntary, so direct financial savings to the country are probably negative at present values. The benefit from DDSR is not that debt is bought at"bargain prices"at the expense of commercial banks. It appears difficult to justify a DDSR operation on purely financial grounds. A more realistic way to look at a DDSR operation is to view it as a"project"that involves a certain financial cost. The return on such a project is how the DDSR operation improves the macroeconomy, or contributes to development. The main purpose of DDSR is to establish a more efficient arrangement between debtor countries and commercial banks, leading to improved conditions for development. A DDSR operation that does not help development is costly and should not be undertaken. The impact of DDSR on development is usually measured by the increase in the growth rate of GDP, but it is too soon to measure that for these five countries. A suitable alternative is to look at the change in investment patterns. A strong policy framework is needed if debt and debt service reduction are to significantly improve development. In Mexico and, to a lesser extent, Venezuela, improved and sustained strong adjustment policies have generated the greatest development benefits. Gains have been less in smaller countries where policies were not as supportive. The author concludes that for a country to benefit from DDSR, it needs significant indirect benefits (such as increased domestic and foreign savings). Direct benefits are likely to be negative because of the commercial banks'financial gains and because DDSR operations are frontloaded. DDSR operations cannot be justified solely by direct benefits and savings in cash flow.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1169.

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Date of creation: 31 Aug 1993
Handle: RePEc:wbk:wbrwps:1169
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  1. Fernandez-Arias, Eduardo, 1991. "A dynamic bargaining model of sovereign debt," Policy Research Working Paper Series 778, The World Bank.
  2. Diwan, Ishac & Spiegel, Mark M., 1994. "Are buybacks back? Menu-driven debt reduction schemes with heterogeneous creditors," Journal of Monetary Economics, Elsevier, vol. 34(2), pages 279-293, October.
  3. Ishac Diwan & Dani Rodrik, 1992. "Debt Reduction, Adjustment Lending, and Burden Sharing," NBER Working Papers 4007, National Bureau of Economic Research, Inc.
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