An Assessment of the incentives for developing country governments to continue servicing sovereign external debt

Newsome, Richard J. P. (1991). An Assessment of the incentives for developing country governments to continue servicing sovereign external debt Honours Thesis, School of Economics, University of Queensland.

       
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Author Newsome, Richard J. P.
Thesis Title An Assessment of the incentives for developing country governments to continue servicing sovereign external debt
School, Centre or Institute School of Economics
Institution University of Queensland
Publication date 1991
Thesis type Honours Thesis
Total pages 168
Language eng
Subjects 14 Economics
Formatted abstract The Third World Debt crisis first entered the mainstream consciousness in 1982 when the Mexican Government threatened to suspend payment on its almost $US90 billion sovereign debt. The conventional wisdom since then has been for creditors to restructure the loans of debtor nations, to provide financial assistance to enable debtors to grow out of their economic problems and to write-down the nominal level of the outstanding debt. However, it is argued below that this approach ignores fundamental microeconomic incentives and their subsequent effects on the macro-behaviour of the sovereign debtors. By agreeing to debt rescheduling, creditors are effectively rewarding debtors for defaulting on their loan repayment obligations. Indeed, it can be argued that increased creditor willingness to agree to debt restructuring has led to a fall in the cost to debtors of defaulting on their loan payments. In microeconomic terms, this fall in the cost of default has led to an increase in the quantity of default demanded by the debtors - effectively a shift along the debtors' demand curve. That is, the actions of creditors have produced incentives for debtors to default on their loans. This thesis builds on preliminary work in this area by P.T. Bauer by providing an econometric foundation for his qualitative arguments8The thesis also extends the theory to the supply side, showing there are legal and economic institutional factors which produce incentives for risk averse commercial creditors to supply debt restructuring rather than risk large potential opportunity costs by enforcing loan contracts with debtor nations. Combining the demand and supply sides of the issue, this thesis assesses the incentives for developing nations to service their sovereign debt and finds that debtors and creditors have made rational decisions that have led to an increase in the incidence of debt default in the third world.

 
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