The Overhang Hangover

The authors revisit the debt overhang question. They first use nonparametric techniques to isolate a panel of countries on the downward sloping section of a debt Laffer Curve. In particular, overhang countries are ones where a threshold level of debt is reached in sample, beyond which (initial) debt ends up lowering (subsequent) growth. On average, significantly negative coefficients appear when debt face value reaches 60 percent of GDP or 200 percent of exports, and when its present value reaches 40 percent of GDP or 140 percent of exports. Second, the authors depart from reduced form growth regressions and perform direct tests of the theory on the thus selected sample of overhang countries. In the spirit of event studies, they ask whether, as the overhang level of debt is reached: (1) investment falls precipitously as it should when it becomes optimal to default; (2) economic policy deteriorates observably, as it should when debt contracts become unable to elicit effort on the part of the debtor; and (3) the terms of borrowing worsen noticeably, as they should when it becomes optimal for creditors to preempt default and exact punitive interest rates. The authors find a systematic response of investment, particularly when property rights are weakly enforced, some worsening of the policy environment, and a fall in interest rates. This easing of borrowing conditions happens because lending by the private sector virtually disappears in overhang situations, and multilateral agencies step in with concessional rates. Thus, while debt relief is likely to improve economic policy (and especially investment) in overhang countries, it is doubtful that it would ease their terms of borrowing or the burden of debt.

Bibliographic Details

Main Authors:	Imbs, Jean, Ranciere, Romain
Language:	English
Published:	World Bank, Washington, DC 2005-08
Subjects:	ACCOUNTING, BORROWING, BUSINESS CYCLES, CAPITAL ACCUMULATION, CAPITAL FLIGHT, CONTRACTUAL ARRANGEMENTS, CREDITOR, CREDITORS, CROWDING OUT, DEBT, DEBT CONTRACTS, DEBT FINANCING, DEBT LEVEL, DEBT OVERHANG, DEBT RELIEF, DEBT REPUDIATION, DEBT RESCHEDULING, DEBT SERVICE, DEBT SUSTAINABILITY, DEBTORS, DISCOUNT RATES, ECONOMIC DEVELOPMENT, ECONOMIC GROWTH, ECONOMIC OUTLOOK, ECONOMIC PROGRESS, EMPIRICAL EVIDENCE, EXPECTED PRESENT VALUE, EXPORTS, EXTERNAL DEBT, FACE VALUE, FINANCIAL MARKETS, FOREIGN BORROWING, FREE RIDER, FREE RIDER PROBLEM, FUNCTIONAL FORMS, GDP, GLOBAL INTEREST, GOVERNMENT EXPENDITURES, GROWTH RATE, INCOME, INCOME LEVELS, INEFFICIENCY, INFLATION, INTEREST RATE, INTEREST RATES, LAFFER CURVE, MACROECONOMIC POLICY, MACROECONOMICS, MONITORING TECHNOLOGY, MORAL HAZARD, OUTSTANDING DEBT, POLITICAL ECONOMY, POPULATION GROWTH, PRESENT VALUE OF DEBT, PRICE STABILITY, PROPERTY RIGHTS, PUBLIC DEBT, REPAYMENT, RISK MANAGEMENT, TERMS OF TRADE, TRADE SHOCKS, VALUATION,
Online Access:	http://documents.worldbank.org/curated/en/2005/08/6133217/overhang-hangover https://hdl.handle.net/10986/8631
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