Can debt-reduction policies restore investment and economic growth in highly indebted countries? A macroeconomic framework applied to Argentina

The author devised an analytical framework to examine the implications of debt-reduction operations for the economy of a typical middle-income, heavily indebted country. A major finding is that debt-reduction policies can succeed in restoring investment and, consequently, growth in debtor countries. Such policies combine a liquidity effect resulting from the reduction in debt service payments and an incentive effect resulting from debt relief. A simulation designed to analyze the effects of debt-reduction policies in Argentina showed that a 30 percent reduction in debt had a 2.4 percent positive effect on the level of GDP in the first year and a 5.4 percent effect in the fifth year. The model identifies various channels through which a reduction in foreign debt influences investment. The analysis includes a calculation of the debt-reduction and liquidity combination that maximizes Argentina's GDP. The purpose was to determine the best use of a potential loan to the country from international financial institutions. The empirical results suggest the tentative conclusion that a Brady Initiative debt and debt service reduction operation could establish the basis for sustainable growth in Argentina, if combined with appropriate domestic policies.