Sovereign Debt: A Survey of Some Theoretical and Policy Issues

IMF Working Papers, July 1, 1993

Source details

Canonical URL: Sovereign Debt: A Survey of Some Theoretical and Policy Issues

Surveys the literature on sovereign debt concerning:
- a country’s ability-to-pay,
- a country’s willingness-to-pay,
- policy responses to the debt crisis of the 1980s.
Synthesizes main conclusions on the above issues and evaluates the welfare implications of various restructuring mechanisms.

The existence of an ability-to-pay problem suggests a need for debt reduction.
Plans for debt relief face potential incentive problems.
Sovereign debt repurchases are not always a welfare maximizing method of debt restructuring.
The paper synthesizes the main conclusions on these issues.

With a willingness-to-pay problem, the potential penalties for debt repudiation are important in the endogenous determination of the repayment outcome.
Penalties that are intertemporal in nature have different implications for debt repudiation than do intratemporal penalties.
The asymmetric distribution of the costs of default can lead to a recurrent cycle of debt accumulation and default.

Debt reduction may be necessary when ability-to-pay constraints are present, but debt relief programs must consider incentive problems that can arise from restructuring designs.
Debt repurchases should be evaluated on welfare grounds; they are not universally optimal.
The design of penalties (intertemporal vs intratemporal) affects default incentives and should inform the architecture of enforcement and restructuring regimes.
Addressing the asymmetric distribution of default costs is important to reduce the likelihood of recurrent debt accumulation and default cycles.