External debt and creditworthiness: theory with evidence

Amartya Lahiri and Hinh Dinh

Finnish Economic Papers, 1996, vol. 9, issue 2, 110-125

Abstract: The existence of international lending raises the issue of credit worthiness of sovereign debtors. From a lender perspective, it is important to have some prior warnings about potential debt repudiation. We analyze how the fiscal evolution ofa country might contain information about its creditworthiness. In a two good, small open economy theoretical framework, we find that budget deficits and current account developments hold critical information regarding structural imbalances and creditworthiness. The model is also able to account for a number of features which often characterize countries with chronic debt problems including the phenomenon of capital flight and the usefulness of debt relief for stabilizing explosive debt situations. Estimation of a model of debt arrears with cross country data provides general support to the theoretical structure. A major finding of the paper is that it is the efficiency of investment and not the level of investment that is important for creditworthiness purposes. In general, wefind that exports, imports, income inequality, inflation and the efficiency of investment are able to explain about three-fourths ofthe cross-country variation in debt servicing performance. We find that the results are robust to both different specifications as well as alternative measures of country risk such as credit ratings assigned by international creditors.

JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 1996
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Persistent link: https://EconPapers.repec.org/RePEc:fep:journl:v:9:y:1996:i:2:p:110-125

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