ALFRED
P.
WORKING PAPER
SLOAN SCHOOL OF MANAGEMENT
BEYOND THE DEBT CRISIS:
ALTERNATIVE FORMS OF FINANCING GROWTH
Donald
WP#1921-89
R
Lessard
February 1989
MASSACHUSETTS
INSTITUTE OF TECHNOLOGY
50 MEMORIAL DRIVE
CAMBRIDGE, MASSACHUSETTS 02139
J
BEYOND THE DEBT CRISIS:
ALTERNATIVE FORMS OF FINANCING GROWTH
Donald
WP# 192 1-89
R
Lessard
February 1989
BEYOND THE DEBT
CRISIS:
ALTERNATIVE FORMS OF FINANCING GROWTH*
Donald R. Lessard*
Paper Presented
at
World Bank Symposium on Dealing with
The Evolution of Developing Country Debt
Washington, DC.
Revised
Difficulties
1989
Debt
Crisis:
and a Range of Policy Options^
September 22, 1988
February
the
BEYOND THE DEBT
CRISIS:
ALTERNATIVE FORMS OF FINANCING GROWTH
Abstract
paper examines the potential benefits of and obstacles to the inclusion of
to general obligation finance such as direct investment, portfolio equity
investment, quasi-equity investment, and commodity-price indexed debt in the
externa!
financing of LDCs. The advantage and obstacles are first considered for a country starting
with a clean slate, then for a country suffering from a debt overhang in the context of boih
concerted and voluntary exchanges.
This
alternatives
*.
I
am
grateful
**. Professor
50
Memorial
of
to
Jonathan
Eaton
International Finance
Drive, Cambridge,
MA
for
and
comments on an
Management,
02139.
(617)
earlier
MIT
253-6688.
Sloan
draft.
School
of
Management,
Introduction
sight,
As
the
the
structure
debt
are
receiving
of
obligations
the
dominated
greater
swaps
way
groups
Regling
typically
of
out
economists and
LDC
that
believe
there
is
no logical or
somehow
obligations
into
conversions,
it
well
inappropriate
to
with
also
as
debt
the
to
with
is
hand,
alternative
held
private
out
as
the
sector
as
LDCs by many academic
of
interests
depicted
typically
are
Bulow and Rogoff
e.g.
to
Dombusch
[1988],
[1987],
can
through
alternative
finance
obligations,
can
place
in
whether
value
the
Sachs
in
the
through
negotiated
of
shortcomings
finance
on
the
inevitable
not
in
this
reduction.
1
their
However,
[1989]).
should not be
debt
claims
structure
of
Idc
voluntary
exchanges
abuses
or
of
that
general
debt
involving
Therefore,
and
and
claims
and others who
conversion
new money packages.
focuses
or
of
the
place
through
e.g.
of
LDCs
reduction
While
take
potential
the
a
efficiency
reduction.
forms
therefore,
that
the
in
separate
the
order (see
in
reason
forms
take
maintain
to
champions of conversion
the
that
such programs comes from
reduction
precludes
true
is
It
seeking
are
institutional
associate
obligation
countries'
that
alternative
This chapter,
general
crisis
one
the
are
bankers,
the
to
on the false premise that one must choose between
improvement
an
conversion
exchanges
(see
rests
opposition
substantial
that
as
damaging
debate
banks
of the
accompanied by
lenders
exchanges,
observers,
such exchanges
and debt reduction.
include
much
On
buybacks
debt
of voluntary
institutional
other hand,
officials
of this
conversion
programs
by
combine
that
contributed
resolving
agreement.
less
has
it
from
far
is
and Krugman [1988]).
1988],
Much
debt
crisis
much
context
the
in
the
even
or
variants
that
structure
a
few academics (see for example Ganitsky and Lema [1988] and
a
On
[1988]).
inconsequential
Froot
the
LDCs, and
in
other
borrowing
rate
of alternatives in
role
with
but
attention,
and
forms of finance,
potential
that
in
amount
aggregate
acknowledged
floating
end
apparent
their
as
Krugman [1988]) and
[1985],
The
well
as
no
with
continue
increasingly
is
It
general-obligation,
and Williamson
even
debt-equity
leading
by
of the crisis.
severity
receiving
attention.
countries
obligations
countries'
these
increasing
(Lessard
ideal
of
developing
of
crises
it
all
is
voluntary
general.
potential
role
restructuring
restructuring
of
of alternatives
Latin
includes
to
American
significant
debt
What
Commercial
alternatives
modes of finance
projects
or
and,
many
in
this
cases,
includes
that
concessional
Our
modes of finance
all
definition,
provided by
obligation
well
fixed
depend
hand,
prices
or
any
in
contingent
A
overall
ability
element
key
the
analysis
is
an
emphasis on completing markets
However,
along
to
from one group
burden
the
shift
also
this
relevant
the
various
Why Consider
The
from
official
resources
dimensions,
and
simply
financing
Alternative
usual
an
requires
alternative
reason
that
finance
everything
but
borrower,
or
both.
may be
that
floating
libor-linked
whose terms
ability
pay,
to
trade
total
as
to
well
debt
rate
as
whose service does not
etc,
On
borrowing country.
the
directly
the
are
that
such
OECD
to
countries
of export"
"share
as
indexed
commodity
as
among
other
the
some measure of
and
borrowing
the
emphasis on those alternatives that
in
the
to
of
particular
In
other.
currently
assessment
technical
function
political
terms,
to
not
at
currently
are
not
and
those that
implies
this
or
poorly
why markets
the
contrast
in
institutional
all.
complete
obstacles
modes.
Finance?
for
seeking
commercial sources
will
While
commercial
financing
of
provide the possibility of gains to creditors as well as debtors,
simply
activities
pay.
to
in
(i.e.
private
facilities,
countries,
linked
are
that
as
These include most forms of
activity, e.g.
industrialized
in
of
control.
than
terms
a
types
obligations
country's
economic
of external
modes of financing
country's
issuance
general
borrowing
the
production
lender,
traditional
way on outcomes within
include
or indices
including
bonds, note
rate
influence
that
industrial
other
direct
does
it
factors
interest
commercial
on commercial terms.
financing,
and
here
particular
in
portfolio
overall
narrower
is
example, excludes many
for
inherent
risks
responsibility
it
private
a
defined
are
modes of finance ranging from non-recourse
bear
that
involve
that
lenders
private
general
as
or
finance)
of
investment,
foreign
of
country's
sharing
includes
that
direct
to
borrowing
corresponding
a
finance
obligation
sharing
ante
ex
the
in
definition
lending
project
or
general
to
involve
that
enterprises
broad
a
is
Finance?
"Alternative"
is
alternatives
is
the
to
general
perception
not be sufficient to meet LDCs'
that
needs.
obligation
the
supply
borrowing
of these
While undoubtedly
2
correct,
on the
of limitations
limited
the
finance
faced
meet
many
The
than
Therefore,
payments
promised
commitments
external
rather
on
is
external
financing,
We
take
obligations
and
supply
it
and
improve
given
as
provided by
and
provide
amount but also the
well
foreign
as
(1)
reduce
the
that
distort
public
not to
its
A
country.
way
a
in
and
Our
to
that
these
therefore,
basis
of
goal
to
is
the
of a
restore
dynamic
for
interests.
structure
reduce
countries,
of senior
obligations
economic
many LDCs,
an
assets;
finance
can
of
imposed by
financed.
assets
restructuring
acceptable
long-run
size
the
burden
the
of
LDC
for
put
to
of
range
not on
a
country's
level
of growth
development
The primary reasons
of financing are
however, may
pattern
the
obligation
greatly
required
relief
is
appetite
general
performance
economy
and private
that
to
increase
the
that
obligations.
their
expands
less
is
condition
the
to
shifts
the
to
markets and
given country,
thus
focus,
overriding
private
"overhang"
deny
alternatives
the
on
expected
be
not
relative
OECD
supply
elastic
should
circumstances
the
small
are
reduce the degree of debt
(or
the
that
recapitalizing
run
is
reflect
overhang
debt
substantial
result
external
sufficient
meet the terms of
to
particular
a
funds
of
only
•This
to
future
as
debt)
for
they
Rather,
of $20 billion a year
figure
virtually
by recontracting
basis)
domestic
the
a
funds
of
of funds
across
actual
short
already
countries
financing
commitments
how commercial
the
the
credibly
the
problems are not the
finance.
markets or of these markets' potential
financial
it
debt
can back with credibility.
it
increase
in
of funds
current
a
given
developing
face
credible
supply
actual
back on
contract
to
of
net
new sources
supply
its
international
Even an ambitious
countries
make
to
tapping
potential
increase
it
requirements
Individual
able
are
financial
of them.i
financing
institutions.
they
LDCs
percent of the current
10
of
especially
needs,
their
LDCs'
point.
supply
aggregate
of world capital markets.
size
the
the
of particular
ability
to
by
misses
perspective
this
for
involving
changing
not
to:
(official
incentives
within
and commercial bank
the
country
and
including the poorest countries in Latin America,
an debt relief and aid crisis in that, regardless of how restructured, their obligations
outweigh their ability to repay and voluntary external finance will not provide them with a
face
tolerable
level
of growth.
2This result
is
obtained in theoretical models, see for example Eaton, Gersovitz, and
borne out by the fact that newly industrialized countries (NICs) have been
able to achieve very rapid growth in external financing in line with the growth of their economies.
Stiglitz
[1986],
and
is
3
preclude
or
current
potential
simultaneously
potential
agents
order
in
This
chapter
modes
financing
managerial
terms
in
and
control
Part
alternatives.
these
implications
of
those
a
series
and
the
to
separate
of steps
key
that
obtaining
1)
international
are
2)
the
The expected
return
to
and
an
thereby
rates),
and
and
reducing
and participation.
involve
dimensions
of
benefits
in
order to
as
well
with
in
forms
Part
specific
of
the
external
suggests
III
political
examines
IV
to
date,
and
the
of these
feasibility
exchanges,
voluntary
as
several
LDCs' financing
identify
and
and
sharing
alternative
Part
attractiveness
alternative
risk
overhang.
debt
existing
among
responsibilities
classifies
first
implementation.
investors,
V summarizes
Part
should
institutions
emphasizing
the
discussion
of and
is
identifies
by countries, their external creditors,
be
taken
to
support
Commercial
number of
finance.
expected cost,
in
pay over time and
to
the
of
implementation
these
arrangements.
large
a
external
participation
The
general
of concerted
can
I.
There
their
transactions.
financing
alternative
debtors of
to
obligations
which they
to
these
without
for
context
investment,
where linking debt buybacks and the issuance of new obligations
conditions
superior
extent
overhang for the
debt
the
in
their
rewards,
pans.
of their debt crises,
preconditions
alternatives
ability
of diversification
five
in
illustrates
institutional
a
their
interest
of
risks,
benefits
of the
LDCs
onset
the
to
costs
implicit
have not played an important role
alternatives
even prior
of
examines the potential
II
commercial finance for
why
the
organized
is
direct
and
allocation
increase
to
and
value
potential
the
the
obligations
countries'
of noncompliance;
rearrange
(3)
and
explicit
commodity prices
(e.g.
increasing
costs
(project financing,
noncompliance;
future
circumstances
the
limit
to
more closely match
(2)
across
and
investment)
equity
local
claims
junior
of new,
issuance
the
is
It
Financing
alternatives
useful
to
Alternatives
to
classify
obligation
general
3)
degree of managerial
financed.
project
or
cost
comprised of three components: the required expected
is
which may be substantially
case of risky obligations;
the
for
them along three dimensions:
degree of risk sharing or hedging and,
enterprise
borrowing
less
than
deadweight cost or penalty
the
in
the
promised
case
of
rate
in
the
nonperformance;
and
We
forms of finance.
by
given
premium
an
is
obligations
floating-rate
independent
largely
investor
risk
A
premium.'*
the
close
are
of
while,
diversified
than
cost
zero-beta
to
with
assets
aggregate
lenders
impose penalties
to
and
Stiglitz[1986].
cost
to
no
borrowers
not
is
deadweight
expected
nonperformance
on
faith
the
particular
3
returns
and
part
claims.
Stulz
[1988]
assets'
to
there
any
equities,
in
empirical
a
risk
substantial
a
though,
are
have
command
will
analyses
show
that
factors.
depends on the
see
e.g.
to
lenders.
to
ability
Eaton,
deadweight costs,
corresponding gain
of
estimates
its
of
lenders
to
ability
borrowers
derives
require
will
since
result
factors:
consumption
short-term
returns
which
bonds
of nonperformance,
on two
Therefore,
will
general,
in
costs depend
the
of
a
with
Gersovitz,
since
their
However, there
is
model of deadweight costs associated with
accepted
nonperformance nor are
by
offset
return
Therefore,
beta. 3
external
to
credit,
or
cost
risk
command minimal
debt
respect
case
this
the
is
output
output
rate
These penalties generally
generally
similar
the
in
of
investors
to
which
in
particular
whose
of local
portfolio
The enforceability of sovereign
model
copper-linked
aggregate
with
return
with
obligations
indexed
floating
expected
consumption
example,
for
covariance
higher
in
associated
covariance
world
price-level
costs
pricing
asset
of the
a
i.e.
control
required
capital
variations
broadly
slightly
a
or
premiums,
positive
significant
only
consumption,
and
that the
function
increasing
world
aggregate
assume
international
stylized
a
monitoring
the
with
respect
we expect
an
explicit
that
magnitude. 5
the
that
between bad luck
and
bad
meeting their commitments on
these
international
assume
expected incidence of
distinguish
to
We
deadweight costs
Capital
Asset
Pricing
be
will
Model
highest
that
links
betas.
premia are defined here as in the financial economics literature as increments
the expected return on an asset relative to the expected return on a zero-beta asset, not as
adjustments in promised rates to reflect anticipated defaults as is common in the Idc debt
"^Risk
in
literature.
5There
not meet
its
is
a
great deal
obligations.
commercial autarchy for
much
of uncertainty over what penalties a counu-y will face
Most formal models assume that it will be relegated
at least some period. Many observers, though, argue
to
when
financial
that
it
does
and
these penalties
Eichengreen and Portes [1988] infer from data from
the 20's through the 50's that differential impact of default on subsequent access to credit is
small, but this inference is questionable since in the subsequent period all LDCs effectively went
are
into
smaller,
see e.g.
Kaletsky [1985].
commercial and financial autarchy because of the world depression and the associated
of the international commercial and financial system.
collapse
6
noncontingent
for
enhance
general
Monitoring
influence
required
only
they
that
claims
that
influence
at
inherent
Equity
of
a
of firms
domestic
particular
to
risks
whose exports
tries
its
(tin,
contingent
particular
the
covariance
with
of information
frequency
At
and
higher
are
economic
the
entitles
investor
of the
risks
whole.
a
share of the profits
or
exchange or both,
Mexico, Nigeria, and Venezuela
provides
obligation
sharing
consumption
aggregate
national
risk
or
national
a
at
overall
most
is
significantly
are
words,
coun-
Chile
as
(oil).
Whether
a
level
depends
on
exchange
foreign
net
the
to
other
in
dominated by one or two primary products, such
oil)
notes
This attribute
The outstanding examples
level.
risks
shifts
participation
contribute
shifted
are
rata
export
or
as
of foreign
local
a
economy
that
availability
at
bonds
pro
a
to
linked
is
world economy.
the
in
hence
and
situation
other participants
to
level
palm
for
and
information
require
and
we assume
stage
this
which the contractual obligation
commodity-linked
or the
are
Malaysia
(copper),
economy
systematic
are
that
to
borrower's
borrower when the
a
of income
variability
those
at
extent
the
while
firm,
movements.
rate
obligations,
that
projects.
the
example,
for
perform the same role
valuable
or
to
some aspect of
investment,
interest
economy and hence may
the
the
forms of general
all
the
to
in
for
penetrate
level
adverse
obligations
rate
enforcement of particular claims.
the
equal
are
floating
depend on the amount and
costs
for
through
default
sharing refers
Risk
explicitly
of
probability
the
especially
obligations,
transfers.
Hedging
exposure
borrower's
shifts
Hedging
swap
external
in
can
contracts.
independently
to
adverse
economic
Using
of
the
either
supply
of
the
in
exception
6A
the
selection
of the
terms
in
the
such
as
interest
through
these
cost
purchase
the
instruments,
selected
are
of
finance
rates
or
from
resulting
and exchange
of options
the
minimize the
to
rates.
through
borrower can
entry
manage
into
risk
of capital.
Managerial participation
participate
financing
fluctuations
variables,
accomplished
be
when
accomplished
is
of
or
control
investments
World Bank,
this
refers
and/or
to
their
participation
is
the
extent
that
private
management over
virtually
nil
for
agents
time.
With
general
"utility" will be a function of the level and variability of its overall
The impact of a particular obligation
assuming away distributional considerations.
utility with depend on its contribution to the level and variability of net foreign transfers
country's
consumption,
on this
which influence the
level
of consumption.
6
obligation
lenders.
be
will
It
greatest
outcomes of particular projects or firms
of claims that are contingent
case
the
in
such
equities,
as
the
or^
commercial
quasi-equities,
bonds, or project loans.
The positions
along
obligation
financing,
general
(both
shown
are
Figure
in
direct
and
shares
individual
in
dimensions
these
various
funds),
ex
managerial
but
cost,
often,
a
typically
for
obligation
ante basis,
involvement.
and
risk
more focused
are
provide
investment
but
ilities,
over
a
in
managerial
of
integration
no
but
--
where
way on
higher
is
expected
investments
and,
alternatives
Commodity bonds,
involvement,
lender
the
a
Other
operations.
managerial
risk
of
control
an
sharing or
ante
has
dimensions that they provide.
well-defined
participate
to
typically
On
benchmark.
the
involves no ex
also
it
with
sharing
stream that depends in some
provides
origin,
sharing
the
in
risk
quasi-equity
narrow claim
the
at
investment
international
substantial
lending
project
here
foreign
Direct
combines
also
it
example,
equity
financing,
offers the lowest cost, but
it
and
quasi-equity,
investment
equity
portfolio
1.
Figure 1
General
including
alternatives,
investment,
foreign
national
in
of
entitled
while
income
an
to
portfolio
success of the project but with
the
ownership or control.
--
share
narrower range of outcomes than direct
and
risks
a
responsib-
investment.
box
Direct
investment,
the investor to
a
pro
rata
the
Modes
Finance
Alternative
alternative
traditional
share of the distributed
to
profits
sovereign
borrowing,
of the firm.
It
entitles
typically
motivated by the return the parent expects to be able to earn by making use of
existing
in
its
knowhow
global
specific,
country.
in
a
production
operation
local
and
marketing
microeconomic factors
In
some
cases,
as
well
by
and/or
network.
as
to
incorporating
Thus
it
the
responds
local
largely
macroeconomic prospects
however, direct investment also serves
to
in
is
its
operation
to
the
overcome
firm
host
limits
to
of
of
enforceability
the
necessary
the
local
investment,
Unlike
the
investors
deliberately
than
(less
responsibility
The
managerial
may
not
though,
by
control,
general
appointing
on
interests
a
forms
of
control
obtained
of
listings
of
vary
is
or
firms
A
substantially.
management
firm
invests.
it
or
little
may
fund
If
of ownership
no
or
does,
it
and
control
shareholder
represents
that
of
individual
in
index
national
nationality
the
the
offshore
portfolio
involving
as
which
in
of
purchases of locally
local
defined
typically
take
to
the
is
diversified
Investments break open the package of
that
investment
direct
investment
and
to
typically
turnkey
the
contract
foreign
for
those
enterprise
without
allowing
out
the
economically
cannot
that
and
sharing,
single
to
new
agreements,
licensing
production
contracts,
and
These
constituted.
ventures,
joint
sharing
risk
They permit the host country
by
controlled
has
include
contracts,
subcontracting. ^
elsewhere,
LDC
stock
total
penetration
modes involve investments
separate
to
is
of
many LDCs,
in
broadly
a
in
the
management.
its
degrees
a
equity
and avoid being forced
in
only
etc.
management
features
particular
percentage
popular
invests
like direct
seeking
is
many
varying
involve
that
investment
international
international
absence
the
enterprise.
Indeed,
confidence
lose
penetrating
can
practice
local
boards,
franchising,
typically
small
a
governance of the firms
the
in
Quasi-Equity
managerial
too
this
participate
the
can
While portfolio investment
shares.
listed
to
liquidity
they
if
fund)
through offshore
either
shares,
end
Other more
shares.
or
of private
profits
investor
penetrating mode,
least
(closed
trust
firm
the
investment
equity
domestic economy.
domestic
the
in
equity
the
order to maintain
in
saving
for
Portfolio
investment
share
a
holdings
their
restrict
percent),
5
risk
markets,
stock
and not the responsibilities of control.
of profits,
share
to
however,
investor,
direct
country
quoted on public
equities
in
investor
the
entitles
by
institutions.
investment
Portfolio
posed
claims
cross-border
other
control
foreign
be
of the
domestic operation.
Non-recourse
risks
and
enterprises
exposed
to
''For
Project
responsibility
or projects
the
a
to
description
foreign
without
downside
Stand-Alone
or
risks
of these
a
investors
general
of the
Finance
by
provides
linking
guarantee.
In
undertakings being
insu-uments,
see
[1984].
8
another way
borrowing
such
financed,
Lessard and Williamson
the
but
shift
particular
to
cases,
to
in
[1985]
lender
is
contrast
and
Oman
to
9
equity
perspective
is
independent
debt
in
case
Just
some
or
interest
equities
as
rate
or
on
involve
also
Clearly,
such
the
therefore,
on
than
loans
quasi-equities
purchasing
linked
insurance
dependent on,
bonds,
say,
would
service
debt
copper revenues could
or
oil
enforcement leverage, but the
A
remain
sovereign
a
amount of
issue
debt
the
the
require
country that
firms
or
projects
general
heavily
is
with
With
implied
the
under any
service
a
transfer
commodity-linked bonds.
the
rate
obligations.
obligation
would be determined by the price of
circumstances
a
at
service
to
would
lender
the
general
country as a whole.
for the
,
earmarking of project revenues
particular
to
the
borrowing
of as
of the risks of those undertakings to investors, contingent
all
obligations do the same
such
may
It
thought
be
and
success
borrowing.
project
the
promised
higher
fails.
can
From
upside potential.
the
in
financing
project's
the
project
the
servicing
of
does not share
such
borrower,
of the
that
for
claims,
or quasi-equity
^
set
of
commodity.
endbox
II.
Given
expected
most
that
than
costs
over time
and
definition
give
rise
8
the
to
that
the
why
borrowing,
should
and
markets.
terms
in
terms
in
In
of their
contrast
lenders
of their
and
to
distribution
incentive
expected
borrowers,
are
of costs
effects
cost,
these
that
and
which by
dimensions
can
sum combinations.
provide
host
attractive
game between
The exception would be
arrangements
remitted
positive
to
more
financial
local
zero-sum
a
is
are
obligation
The key reasons, which we develop below,
circumstances
across
with
interactions
general
floating-rate,
often
alternatives
Finance
Alternative
of
modes of finance involve somewhat higher
alternative
borrowers ever prefer them?
these
Benefits
Potential
for
a case
debt-service
where the lender is shielded from transfer risk by escrow
payments out of export proceeds before they are
country.
'The exception would be the case where a reduction in current interest
of default, would increase the present value of lenders' claims.
probability
9
rates,
by reducing
Time Profile of Debt Service
Other
with
short-term
maturities,
obligations.
However,
assets
service
ready
the
this
equally
as
access
to
bunching
obligations
new
of
over
Debt
into
has
leaving
perpetuities,
room
dimension. The time matching of LDCs' obligations could
on
a
interest
Profile
one.
real
Automatic
investment
by
involves
being financed.
activity
the
credible threat of default
An
with
oil
producing
general
general
obligation
foreign
exchange
borrowing,
that
is
debt,
--
a
country,
obligation
When
taking.
implicitly
it
a
surpluses,
the
nominal
a
on
gains
improved by
be
annuity
nominal
of the
strategy
that
example,
for
developing
accepts
Losses can be passed on
to
typically
it
the
independent
condition
of the
when
be due
all
of
Floating rate borrowing, in fact,
when nominal
LDCs.
rates
are
is
is
risks
of
itself
financing
income.
its
oil
to
repay
of the
foreign exchange
an
domestic
is
its
scarce
needs
With
amount of
economy.!
as
in
when
l
it
is
a real
be more perverse since debt service will be
likely to coincide with periods of economic
likely
highest which
the
involves deadweight costs.
lOThe difference between the two is that price-level linked financing locks
rate, while inflation-adjusted nominal financing does not.
11
an
finances
lender only by default or
might consider
would be committing
country
virtually
borrowing or with a share of
Thus, the same debt service will
distress
debt
same purpose.!
the
risk
incurring
the
greatest
in
avoiding
further
still
portion
inflation
with
of Costs Across Circumstances
investment project
interest
of the
spreading
for
transforming
thus
basis,
capitalization
would serve roughly
rate
All
either
indexed
price-level
a
be
transformed
effectively
little
should
particular,
in
by
financed
foreign-exchange
and,
anticipated
financed
be
requires
where
debt
for
do with the maturity
to
little
matching
periods
rescheduling
can
matching
the
has
available
should be
activities
level
time
are
resources
projects
trade
country
future
both
or
financing,
LDCs
long-term
practice,
In
possible
maturities.
of
whose time
financing
prefer
profile
current
the
at
will
aggregate level, which
the
financed.
as
of most
recontracting
into
being
the
that
is
while
equivalent
at
country
matches
of thumb
rule
terms of ability to pay
of the
borrowing
a
obligations
The usual
service.
loans
equal,
repayment
of
profile
things
^
for
10
to
servicing
If
not.
earnings,
scarcest,
and vice-versa.
country's
capacity
equal,
cost
such
for
be
to
and hence
obligation
bank
However,
coincide
with
because the
(either
demand
depressing
foreign
such
obligations)
exchange
foreign
On
on average,
since
of
exports
its
financing
lenders
in
country's
general
well-being
the
But
cap.
payments
since
be even higher, but
well-being might
country.
In
holdings
equity
Because
markets differ
Nigeria,
in
for
a
in
Mexico has been
advantage
over the
fact,
the
the
bearing
of
own
its
and hence debt
exchange
to
with
coincide
when
payments
large
be
ante
"cost"
in
in
more costly
be
interest-rate
terms of the borrowing
limited
borrower
a
the
for
"costly"
would
where
periods
in
under a great deal of
is
particular
with
activity
equity
borrowing country's
of the
terms
last
when times
be due
to
decade,
the
cumulative
risks
less
than
and
countries
to
particular
that
of general
investors
good
are
return
to
for
risks.
participate
will
on private
provided
and
Brazil
loans. 12
in
world
capital
comparative
possess
The economies of Mexico, Indonesia and
shifts
in
energy
prices
than
This comparative advantage will be reflected
premium demanded by world
results
who
borrowing
the
investors
obligation
which they are exposed, they
example, are much more exposed to
l2Unpublished
borrower
the
interest-bearing
cap might
premium
less
the
result,
ex
its
likely
substantially
world economy as a whole.
that
other
its
number of highly indebted countries including
borrowing
in
of
likely
is
comparable or lower than the cost of bank credit since the
be
payments would be
largest
swings tend
relatively
The expected cost of financing
pressure.
to
rates
foreign
overall
interest-rate
risk
a
might be
it
market rates are very high and, as a
likely
an
with
would charge
implicit
is
being
things
regardless
interest
in
these
to
involve
will
borrowing
hand,
insurance
financial
market rates
because
or
where
notes,
rate
borrower's
rise
a
to
payments
expected
of
upswings
the
giving
factors
for
terms
floating
that
other
well-being,
its
keyed
obligations
to
is
somewhat higher expected monetary
a
in
or
exchange
foreign
scarcest.
is
other
the
finance
of
over short-term
worsening
a
pay
to
extent
the
to
terms
in
borrowing
spread
specified
a
circumstances.
factors
willing
concessional
promises to pay
situation
be
financing,
general
service
should
it
when
smallest
finance giving rise
costly
less
is
be
will
Clearly,
pay
to
form of a share of net foreign exchange
the
repayments
contrast,
in
take
obligations
investors
for
by Vihang Errunza.
1
1
bearing
oil-price
risks
in
the
the
will
fact
be
substantially
lower than
avoid them.
Thus these
through
would
from
contrast,
In
importers
oil
arrangements
financing
willing
pay
to
to
can gain by laying off some of these risks
exporters
oil
arrangements.
financing
benefit
premium such countries should be
the
that
relate
such
Brazil
as
debt-service
Korea
or
inversely
to
oil
prices.
because
Furthermore,
themselves
exposure
world
interest
accentuate
a
lenders. 13
or
the
terms that
limit
Once
countries
the question
comparative
to
of cost
such
is
should
finance
fraction
of
world economy
--
markets.
financial
term interest
rates,
GNP
A
country
as
a
that
result
debt
borrow,
As
service.
from
benefit
equal,
terms
world
how
financial
price
a
becomes
borrowing
for
work
markets
financial
is
the costs are distributed
taker
those
in
relative
--
shift
has
a
of heavy
the
to
risks
relatively
borrowing,
the
an
issue
of
reasonably
markets,
exposures
its
country where a few commodities
or exports
should seek to
variations
that
variations.
that
A
extent
before
on those terms that most closely align
itself
of the world economy on a whole.
significant
being
extended to one of
Assuming
advantage.
earnings
country
which they
in
find
effective
industrial
the
to
of currencies
things
and that a particular developing country
well
the
other
than
rates
can
countries
greater
a
reinforced
be
rates
appropriate
selecting
interest
foreign-exchange
will,
exposure
their
circumstances,
across
their
them
gives
will
exchange
the
of
volatility
developing
result,
This exposure
or
rates,
nominal
and
real
in
developing
rigidities,
which
exchange,
foreign
variations
to
borrowers
in
of
short
domestic
of
with
it
those
make up
a
of these commodities in
role
of these commodities to world
exposure
negative
high
should
seek
to
short-
forms of financing
with fixed or capped interest rates, and so on.
Performance
In
wealth)
have
addition
important
the
to
over time,
•3This
than
Incentives
is
shifting
financing
macro
or
risks,
and
whose
cost
micro-level
thus
is
stabilizing
linked
incentive
to
effects
a
borrower's
specified
which
net
income (and
circumstances
can
increase
may
the
equivalent to assuming that the country has a greater degree of risk aversion
capital market agent if the country were being modelled as a unitary
representative
actor.
12
expected level of
on
focuses
literature
income or reduce
country's
a
incentive
the
of
effects
makes
since
suffer
will
it
potential
modes of
overhang,
whether there
A
obligation,
the
has
undertakings,
investors
and
performance
variables crucial
obligation
a
is
greater
to
assuring
its
in
lenders
improvement
extreme
debt
case
under
project
in
a
basis
where
wide
an
incentive
service
to
a
success
the
when
the
that
Similarly,
continued
access
contract
impact
credit
the
of
linking
project
range
will
generate
not
of circumstances,
on
effects
investors
promote
that
(typically
firm's
appropriately.
is
General
lenders
or
and
will
a
the
to
outcomes
sufficient
to
any
provide
not
in
interest
if
the
success,
project's
made.
is
has
are
However,
to
loan
an
its
greater
products.
its
the
over
lender/investor
the
have
will
for
control
an
is
the
In
the
service
finance
on
a
killed.
of any
specific
and
oil
success,
financial
to
a
contract
particular
depend on
firm,
it
gives
Because a production-share or
success.
employed on
or
borrowing country
of a
returns
lenders
contrast,
In
foreign
appropriate
is
before
and
projects
some
financed,
obligations
debt-service
general
or part of the yield on
all
obligations
undertaken
analysis
narrower measure of project
dimensions
if
design
a
financed,
credit,
have
investors
markets
to
of
to
This linkage can improve
project
project
the
large
a
is
management.
or
general
For example,
if
Because an equity share
to
of the
regard
outcomes of specific
project.
or
lenders
form
the
design
its
the
of the
success.
seeking
takes
country's
a
and thus the project will be
The incentive
specificity.
to
in
to
without
do not have control over variables relevant
the
invest,
to
there
success of the project
the
in
when
often
lenders,
financing
performance of the
the
country's
fraction
a
important
volume of manufactured exports, lenders
main incentive
the
recourse
project's
to
When
linked
are
risk
satisfactory.
that
potential
tied
a
only
for
IV.
to
intervening
for
in
reduce
interest
management
linked
stake
to
consumption
current
most
section
stake
little
limited
a
the
overhang,
debt
large
capture
will
are
applicable
are
obligations
they
in
overhang.
debt
with
obtain
Since
also
motivation
when debt-service
but
loss,
discussed
lender has
little
forego
to
on
These effects can either be exacerbated or ameliorated by
are
a
is
current
full
effects
willing
less
finance.
they
Incentive
hence
the
benefits.
future
alternative
debt
country
the
of the debt
borrowing
external
macroeconomic choices of the borrowing country.
example,
Most
variability.
its
it
obligation
13
gas
focuses
projects)
incentives
borrowing,
in
investor
links
on
its
investors
risk-
returns
managing those
contrast,
is
not
linked
to
any
only
where
cases
In
undertaking
through
stakeholding
its
be
will
determinant
confront
moral
hazard.
confound
the
incentives
contract.
Since most
them
separate
can
investor
But
add significantly
of
The
or
success
project
facing
involve
activities
such
failure,
both
some form of
participation
foreign
government policies
and
investor
foreign
the
stake,
a
value of an
the
to
markets,
to
of self-serving
risk
with
where domestic policy choices are the
cases
in
lenders
provides
situation.
knowledge base or access
beneficial.
primary
hence
foreign-exchange
foreign
a
and
dimension
risk
overall
country's
a
in
or
project
particular
reduce
of risks,
types
tend
will
the
will
of
credibility
can be beneficial
it
to
the
to
contracting.
in
Impact on Local Financial Markets and Domestic Savings
International
savings.
It
be
will
never
can
finance
a
principal
record
countries
contributor
climates
macroeconomic prospects, high
investment;
discrimination
implicit
foreign-exchange
the
institutional
markets.
LDC
policy
governments
measures
investment
in
to
macroeconomic
the
form
policy
distortions,
general
of
both
their
foreign
domestic
stimulate
forms
of
international
respective
and
domestic
policy
rely
in
each
interest
increasing
14
the
many
rates
in
cases,
provide
security
have
markets
If
the
result,
in
has
many of
the
been
especially
contrast,
on domestic
will
a
formation
capital
finance,
and bonds,
investors,
contexts,
of
borrowing
As
be successful only to the extent that these markets flourish.
by
poor
especially
in
obligation
bypass local financial markets.
equities
This
deepening.
financial
for
to
corporate
been
poor
repressed
as
underinvestment,
an
reflects
required
in
such
has
flight
scope
the
is
many
in
crises.
including
limiting
it
of inflation or other forms of default on
necessary
Certain
neglected.
finance
level
savings
capital
financial
savings
regulations
domestic
also
It
infrastructure
International
allowed
and
contracts;
financial
the
in
external
domestic
and
taxes,
against
and the threat of changes
domestic
to
major problem
Indeed,
formation.
countries'
for
A
formation.
capital
number of
a
to
unattractive
reflects
capital
insufficient
is
complement
a
on the best terms, and employed most usefully, when
available
accompanied by healthy domestic
developing
more than
be
and
portfolio
hence will
such claims are held
other
of these
with
claims.
leverage
in
Completeness of Local Markets and Potential Benefits of External Finance
The optimal
1)
completeness
the
of external
pattern
of
country's
a
between the structure of finance
simplest case
when
is
micro-level
alignment
levels
at
incentive
market.
national
shares
or
case,
this
in
These
index
national
a
sharing
risk
fund
levels
benefits
can be
do not require
and
at
spread
are
within
the
be
will
national
alternatives
that
the
at
world
level
but
through the
obtained
to
create
case
realistic
foreign
case,
appropriate
is
risk
commercial
micro
one where the domestic market
diversification
finance
can
and
of
unnecessary
and/or
of these
efficiency,
not
of
issue
penetrate
the
borne,
this
far
is
complete
the
benefits
from
market
local
in
this
in
that
are
Modes
of
desirable
in
project
not
if
Obstacles
alternative
not
are
and
foreign-exchange
l^Of course,
modes of finance
than
institutional
earnings,
to
the
Alternative
to
necessarily
boundaries
national
in
and
selection
undertaken
and
of
case,
as
the
for
are
obligations
infrastructure.
example,
extent that
this
is
terms of economic
They generally
feasible.
general
Finance
An
ideal
and
diversification
terms
requires
pay
to
of
that
harder
require
they
obligation
in
are
a
matching
a
to
enforce
specific
share
a
of
country's
majority of risky assets
be owned by foreign interests, the governance of these assets might be called into question.
[1988]
and
optimal.
and the costs involved
ideal
inefficiencies
transactions
not complete
is
departures.
they
legal
are
profitable
socially
III.
Even
that
to
The precise
level-incentives.
risks
incentives
serve
depend on the degree of departure from
management,
Lessard
no
has
finance
finance
a
full
economy. 1*
this
domestic
for
and the diversification
which are systematic
level.
of
optimally
The
outcomes.
risks
structure
international
risks
In
across
of
benefit
sole
the
all
on
extent
interaction
provides
that
with
dealt
are
the
economic
is,
of that proportion of the
where the tradeoff between
result
these
large
a
2)
it
the
either
that
and
that
world
interest
real
The more
terms
and
that
to
in
with
domestic
course,
that
complete
economy,
local
investors,
all
effects
In
the
macro-level
or
is
depends
markets
capital
micro
and
discussed
rates
of
world
the
within
among
proportionately
internal
domestic market
the
of risks
diversification
finance
^
for
further
discussion of
this
point.
15
See
payments
hard
with
its
to
pay.
subject
to
the
and
define
to
capacity
available
on
investors,
it
securities
law
conveyance
penetrate
privileged
which few
LDCs
insiders.
Further,
by
reduction
a
national
Country
Risk
Financial
with
have or make
to
across
contracts
the
exception
available
least
partly
may
country
response
in
under
of those
financial
crises
well
as
between
from
policy
impacts,
•5
at
are
debt
and
its
the
to
a
likely
face
to
against
of national
loss
rents
in
to
be opposed by
to
a
legal
--
the
risk
the
Thus,
to
measures
in
many
cases,
there
are
is
commercial
well
as
risks
elements
measures
of
risks
These commercial
as
at
the
measures of other countries.
by
adopted
latter
the
include
policy
not
investments
Equity
risks.
which have thrown many
commercial
of
economy or
foreign
will
debt.
to
technology,
country
the
that
All
risks.
of specified
aside
set
service
of
hierarchy
a
exposures
Examples of the
four factors.
events
and
Policy
austerity
crises,
of their own.
least
risk
costs,
control.
The greater exposure of
results
are
of country policy
series
a
as
managerial
their
country
involving
exchange
market conditions,
export markets.
threaten
perhaps,
and,
investors
impairment
an
in
boundaries
transfer
to
adopt in managing
to
result
Thus they
national
foreign
the
Examples of the former
in
risks
modes of finance
alternative
companies or projects are also subject
specific
changes
include
firm-level
minority
protect
that
state,
of contract
would be
finance
shifts
both
are
constituencies.
firm or project
the
of the
role
exchange earnings, are exposed
loans
may
domestic suppliers of capital.
various
contracts,
the
in
order to
extent
kind
this
that
equity
earnings
on a body of company and
relies
in
the
to
unlikely
it
portfolio
that
possess
economy, they
national
the
sovereignty,
open-ended contract
an
is
while
Similarly,
basis.
this
foreign-exchange
borrowing country's actions,
moral hazard of a degree that makes
presents
or
But because
local
developing
firms
protectionist
countries
into
severe
policies
no clear dividing
that
line
risks. 15
modes of finance
alternative
First,
since they
nonperformance
are
are
to
subject to
significantly
various
a
harder
country
risks
wider variety of
to
define
than
For a discussion of the nature and effects of counu-y risk on general obligations see
Eaton, Gersoviiz and Stiglitz [1986].
Lessard [1988] extends the analysis to alternative modes of
finance.
16
general
with
among
profiles
cartels
due
part
obligation
second
the
to
of
borrowing
the
exacerbating
claims,
because
Fourth,
they
factor,
they
conflict,
this
typically
are
an
face
increased
obligations
them on
put
least
par with
a
cases
would be accepting
lender
be opposed by
will
this
specific
Market-oriented
from
transfer
domestic
financing
from
be
these
and,
choices
many
in
such
who have
those
cases
despite
of the
project.
risk
general
the
heightened
pricing.
expertise
domestic
investors
economy
national
In
that
or
at
some
the
though,
general,
In
i
^
revenues
is
a
the
risks
be
catch
22
credibility
transferred
the
--
in
part
risks.
another
to
same
of most
a
inhibit
on the commercial
can
present
remain
least
at
often
'^There
are
to
factors
steps
with
domestic as well as to foreign investors.
typically
their
more subject
to
the
larger
spectrum
proportional
of country
an importance difference between linking a claim
is
to
a
that
that
might
the
If
exposures
risks
to
than
specified outcome
export proceeds and pledging such proceeds to back a noncontingent claim.
presents
risk
stand-alone
a
fact
emanating
These
take
to
enforcement
undermine
exposures
the
for
export
direct
other risks
to
output
where
transfer
on a limited recourse basis, they
cases,
as
obligations,
generate
not
financed
if
in
by the borrowing country to ameliorate them.
taken
anything,
as
by
and violates the principle of not pledging
do
that
Most of these points apply
the
of opportunism
This can be achieved
regard.
this
obligations,
though escrow mechanisms, there
jurisdiction
create
general
strengthen
to
in
against
borrow on better terms
commercial
Even
lenders
in
for
projects
risk
policy
except
Further,
of claimants.
escrow the export proceeds.
in
to
other creditors
more complex problem.
to
country
a
the
revenues
or
assets
subject
in
general
to
investors
risks,
them
protect
to
by putting
projects
would be possible
than
project
classes
lender
least
at
subordinated
likelihood
country
to
scheduled creditors
might even enable
this
measures
seek
will
some export-oriented
in
of
country.
Because of these heightened exposures
alternative
Third,
contracts.
various
risk/retym
functioning
or
implicitly
among
conflict
the
formation
the
divergent
create
typically
of cross-border
enforceability
the
they
since
undermine
they
investors,
underlie
that
Second,
obligations.
such
Pledging assets
borrower with the worst of both worlds: the revenues of successful projects are
encumbered and hence not fully available to the national treasury, whereas unsuccessful projects
represent a drain on the treasury.
To set aside substantial components of foreign-exchange
earnings
reduces
a
government's
flexibility
in
difficult
creditworthiness.
17
times
and thereby reduces
its
overall
foreigners,
major
as
accompanying
capital
Most
and
First
enforcement
investment,
foremost,
direct
the
investor
country
allow
domestic^
for
institutions,
provide
that
control
to
private
will
of enterprises.
in
order
investors
foreign
firms
if
attract
access
which they
in
the
tax
and
opposed
as
foreign
to
investors,
market,
their
to
with
shareholders
ownership
to
Portfolio
body of corporate and
a
function
share
against
especially
imposes.
it
of the
benefits
only develop and
Further,
allow
to
the
must
investors,
minority
arms-length
in
system
legal
and the sanctions
discriminate
not
must be willing
them
turn,
in
does
and
terms,
economy pose
borrowing
depends on the existence of
practices
environment
regulatory
foreign
the
domestic
the
system
that
to
something close to a pro rata participation
These
penetrate
that
contractual
of
example,
for
and
laws
invest. 1^
of
substitution
flight.
must have access
ones,
securities
the
modes of finance
preconditions.
effective
foreign
capital
alternative
institutional
provide
explaining
in
Preconditions
Institutional
equity
factor
and
to
withdraw
their
funds
when they
new
LDC
equity
funds have been launched over the last two years
feel
opportunities
that
better
are
elsewhere.
The
for
a
fact
that
number of LDCs including China,
Taiwan, Thailand
market
ready
required
equity
acceptance
supply
credible
to
and Turkey
the
demand.
foreign
portfolio
investment.!
Direct
supports
than
rather
attract
suggests
Malaysia, Philippines, South Korea,
India,
that
these
view
that
A
further
investment
obstacles
the
primary
positive
also
located
in
even
because
legislation
a securities
a developed
the
in
form
of
of
linkages
the
market
is
it
is
improve the
cross-border joint
creates
required as well.
is
factor
that
the
context
their
is
steps
for
'SEven when portfolio equity
is
attracted
local
the
quality of disclosure.
this
typically
unaffected by
technology
and
However, the "market" could be
is
domiciled.
by an offshore listing of a local firm's shares,
in major markets are likely to increase
accounting and governance requirements of listings
However,
ventures,
virtually
through
country rather than the country where the firm
the
thus
overcome and
8
investment,
I'^Of course,
be
limiting
factor
does not rely to the same extent on local company law and
securities
can
mode may
also divert trading
reducing the scale and depth of domestic institutions.
18
volume
to
foreign markets,
product
steps
same
sophisticated,
since
they
may
activity
be
financing
these
the
risks
impossible,
only
investors
consider
development of
regarding
general
recoverable
by
With
bearing
profits
but
taxes,
the
affect
traditional
of
price
the
However,
direct
changes
or
include
some of them,
possibility
a
that
the
of the
either
host
in
of
the
equity
This
tax
because
their
foreign
investor.
foreign
of each
risk
investment.
will
form of
by
The degree of
contract,
Again,
naturally
these
investors.
19
host
the
well
as
as
a
of their
other.
These
foreign
investor
the
risks
policies.
arrangement
influence
include
risks
investors,
of foreign
investment,
exposures
not
if
exposure of either party
entail
case
involving
risks
Such
faced
risks
production to
oil
general
risks.
government
more narrowly drawn
circumstances
as
world
in
underproduction,
perhaps,
They also
(or,
in
used
be
difficult,
it
of contract terms.
also
or,
portfolio
whole spectrum of these
oil
number of
a
the
be
will
to
such
risks
because the risks involve a substantial element of moral hazard
of
risks,
The key
developing country.
a
set
they
profitability
and
controls
may
that
inefficient
do not possess a comparative advantage vis-a-vis the host country
detriment
and
no control over the
or
producer of expropriation or some
foreign
the
measures of the other
that
in
field.
mutually agreeable
a
faced
exchange
investors
equity
country
well-defined
arrangements
reserves,
form of reservoir stripping
policy
country)
the
host
the
between the two parties may make
gains
at
windfall
the
in
include
than
must be borne by one party or another
that
boycott of output in the event of a dispute.
faces
to
do not require the
relatively
little
alternative
reserves
oil
investment
an
such
in
of the
obvious ones
home
ability
its
explicit
they
in
certain
to
more
and
infrastructure
institutional
differences,
arrive
to
after-the-fact
to
including
risks
constrain
or
Typically,
obstacles.
and the operating costs of the
distribution
country
narrower
are
even when the investor has
uncertainties
the
markets,
the
expose
credible
see
commercial
the
operations
local
of policy
variety
a
question.
in
To
are
of these
capitalist,
generally
they
since
contracts,
may overcome some
contracts,
for
over
discretion
to
profits.
Quasi-equity
they
remains exposed
it
parent's
the
limit
that
remit
However,
transfers.
outcomes
to
inefficiency,
--
are
its
and
in
or
greater
is,
the
benefit
but
that
such
if
to
the
hence the benefit
depends on the specific
arguments
apply
to
domestic
as
well
Considerations
Political
As
case of equity
the
in
equity
flows
cases,
alternatives
this
may
competitive,
downside
it
have
appears
also
have
they
risks
spumed because of
been
increased quasi-
to
developing countries themselves.
of the
policies
obstacles
the
high
perceived
their
many
that
by
retained
have
countries
financing
underestimated
projects
with
many
In
While
cost.
be justified on the basis that the supply of alternatives
part
in
the
in
lie
many of
investment,
not
is
the
general
of the
cost
obligation
borrowing.
The
reduce
led
fact
over the
control
its
penetrating
that
borrower countries
to
As Frieden [1981] and
alternatives
them or
resist
others
of
allocation
internal
point
increased
the
the
resources,
favor
least
at
out,
bypass
typically
general
should
resources
any
in
who should
debate over
the
that
the
has
borrowing.
The same
of local
allocation
payments on sovereign debt be made
of interest
portion
factor
over resources
use.
its
control
hence
obligation
control
state
provided by sovereign borrowing was a major factor favoring
elements appear today
another
is
and
state,
in
local
currency.
of course,
Finally,
on
restrictions
local
inflows
certain
of penetrating
groups have access
to
private
local
offshore
may
interests
This
finance.
is
also
most
benefit
likely
from
where certain
markets on their own, while most firms are cut
off from such flows.
Country
Investor
Obstacles
While most obstacles
of LDCs,
institutions
and
of
institutions
insurance
schemes
industrialized
countries.
investor
of the
involve
ownership.
taking
risk
and
International
limited
countries,
forms
forms
Finance
of
although
example,
for
of contractual
it
co-financing
Corporation
has
in
the
and
policies
through
policies
the
Tax laws and foreign investment
The World Bank confines
positions,
lie
been created
have
also
European insurance schemes extend
several
financing
obstacles
over more
investment
than
significant
in
modes of finance
alternative
to
is
that
now
20
to
favor
involvement,
to
itself
contractual
exclusively
considering
support
made
tend
although
schemes
to
OPIC and
that
lending
commodity-price
quasi-equity
quasi-equity
direct
investment.
investments
in
do not
rather
linked
The
mining
and
these
have
deals
far,
obligations
if
it
where
the
face
value
and
presence
of this
the
conflicts
regarding
the
exchanges
the
Potential
alternatives
offer
from
45
the
"incentive
incentive
large,
a
possibly
19
of
in
the
financing
due
are
country
improve
and,
third
option
borrowers'
incentives
whether
is
—
recontracting
--
to
a
the
as
turn,
DRLC
and
obligations
Figure
in
specific
for
Laffer curve"2
relief
2A
is
circumstances
the
shift
responsibility
the
country's
of nonpayment
possibility
responsible
is
reflects
future
"debt
that
that
activities
illustrates
(discounted
their
comprised of two
several
incentive
situation
since
for
the
effects.
to
make
a
large
increases,
decline
First,
when
current
part
in
debt
sacrifices
of the
an
curve.
the
the
and
in
This
burden
is
order to
new income
or
See Krugman [1987] for a discussion of financing and forgiving.
20This concept was
has been elaborated by
first
Krugman
the
assuming no incentive effects (DRLC*) which diverges
debt
line
of
ways
in
possibly,
The curve
has less of an
its
recontracting
value
face
of the
in
exacerbates
it
forgiving.! 9
or
context of the
the
wedge" (W) which
wedge,
of
benefits
market value.
degree
viable
tantalizing
the
The key question
obligations
a
same time
changes
The
nonexistent.
raises
It
the
at
and
claimants
of
classes
analysis.
but
or
limited
is
from
discounted
is
debt
a
Recontracting
of
payments
value
the
financing
the
with
countries
for
obligations
their
discount,
the
of their
potential
risk-adjusted)
effects:
some of
structure
between
of
external
its
we reexamine
section
this
modes of finance
voluntary
overall
can be examined
tradeoff
new,
to
should structure
In
slate.
value
various
options
which
market
between
Benefits
The
clean
a
overhang clearly complicates the
involving
existing
under
access
undertakings,
Overhang
Debt
Existing
country
a
alternative
current
of "capturing"
possibility
of
An
With
Finance
feasibility
sector
private
small.
were starting with
overhang,
their
been
typically
only
finance
to
we have focused on how
and
desirability
mandate
its
Alternative
IV.
So
given
but
forest-products,
Krugman [1987] and subsequently
Diwan and Claessens [1988].
applied to the debt issue by
[1988], Froot
[1988], and
21
be captured by
resources generated will
of
investors,
reduce
to
subordinated
on
"taxes"
order to meet the claims of external
in
investment. 2
their
"walk away"
international
when
Third,
1
and
trade
finance
The shape of
debt
is
to
pay,
for example,
where the country
Finally,
and
risks
operation
further
shifting
a
exchange)
that
"capture"
the
in
since
case
the
discounts
that
to
of
all
it
in
its
due
fall
related
to
under
ability
its
DRLC*'
since
a
circumstances
incentive
yield
with
a
a
new
the
participation
in
W,
good
curve,
overall
direct
improves
investments
increase
wedge
of higher payments
will
(investors)
to
new
the
by
existing
exchanging
general
would gain
and
absence of such an
of moderately
are
will
effects
this
recontract
clearly
the
positively
is
structured.
is
participation
selection
and
lead
a
will
to
the
in
DRLC".
could
for
market values,
important,
is
show
country
debtor
particular
curve
of the
creditors
restructuring
assets,
obligations
alternative
This
of
responsibilities
of these
If
providing
if
incentive
poor periods,
in
future
independent of the way debt
not
is
Combined with
relative
lower ones
likely
and hence the expected degree of nonpayment will
Figure 2B.
in
more
to
here
payments
future
pay
to
depend on the
versus
DRLC. 22
able
is
be smaller, as shown
will
promised
and
acts
it
is
some
of
out
curve will shift upward to
"no incentives"
the
of
proportion
periods
about
2
"indexed" to some exogenous variable that
If
which
opting
implicitly
and thus
country
a
report
to
bondholders,
depositors,
large,
is
likely
possibilities.
DRLC, however,
the
more
is
it
senior creditors
burden
the
from current obligations,
Figure
higher
domestic
typically
creditors,
Second,
creditors.
mutually
an
obligations
creditors
exchange
package
efficient
with
identical
would be
to
creditors
Krugman and
exchange covers only some existing obligations,
the
and debtors.
benefit
of the
(pre-
indifferent.
others
overhung countries there are no options
desirable
of
to
Further,
shifting
if
DRLC
2iSee for example Eaton [1987].
However, he
22Krugman's [1988] example would suggest that this would not happen.
assumes that a country is badly "overhung" to the point that it uses all of its foreign exchange
even in good periods.
If one assumes there is headroom in good periods, pareto efficient
recontraciing
will
be
possible.
22
would accrue
Concerted
concerted
very
a
is
prices,
oil
package they
the
face value of
the
concession
price
a
prices
oil
if
mutual
its
if
particular,
creditors
relative
the
to
commit
to
Voluntary
penetrating
to
service
debt
recontracting
claims,
financial
of particular
equity
swaps
private
the
of current debt
reduction
agrees to allow banks to
it
recycle
some of
that
the
in
grant
the
fit.
the
borrower
interest
could
it
more
is
service
they
some
will
some of
forego
"breathing
would otherwise obtain
other
circumstances
in
the
the
a
given
In
space"
induce
order to
it
by
implied
those
as
in
be easy
situation.
they
well
as
The presence of
debt
than
it
"recapture"
recontracting
in
if
same ex ante market value
Under current circumstances,
desired
rate
Recontracting
profits
equity
floating
to
would have linked some fraction of
lenders
does not mean
have
payments
greater
Voluntary
are
off.2 3^
obligations.
traditional
they
would
current
alternatives
be invested or lent as they see
of course,
gain,
that
yielded
and/or to
rise
to
that
obtained.
obligations
its
efficient
myriad conflicts and gaming behaviors present
the
to
at
actually
form of local currency
possible
worse
be
would benefit from
and creditors
borrowers
that
1986 proposal
Mexico can achieve
that
likely
might actually
country
example, would have benefitted both parties
for
have been incorporated
as
the
incorporates
that
Mexico's
obligations.
to
case
strong
recontracting
payments
and
creditors
Recontracting
There
general
existing
to
(or
assets;
exchanges
can
take
typically
two forms:
equity,
at
parties
least
to
the
part
rights
to
of existing
management and
the
Much
of the apparent magic of debt-
any
other
alternative
involving
of the
transaction.
parts:
a
claim),
away
goes
buyback of debt and
secondary market discount being
for
assets
and exit bonds.
broken down into their two component
with
with
exchanges
retained
a
when
sale
of
by the
The benefits of marginal buybacks even
at
the
23This point parallels the debate on the benefits of buybacks, with added gains resulting
from efficient recontracting.
For differing views on the benefits to borrowers of buybacks, from
most pessimistic to most optimistic, see Bulow and Rogoff [1988], Krugman [1988], Dooley [1988],
and Williamson [1988].
23
market
secondary
price
they are limited
that
of
subject
the
are
considerable
with
dispute,
conclusion
the
best.
at
Whether any discount should be offered on equity purchases depends
whether
on
primarily
new,
encouraging
otherwise
economically
improving
by
or
stakes
and
improvement may
or network
expertise
conversion
involves
government.
local
be
firms
aggregate
the
investments
efficiency
of existing
have
incentives
significant
have
This benefit
able
is
been
investors
likely
to
to
not
Equity
improve
to
or
takeovers by
relevant
the
where the
cases
in
by
indirectly
foreign
the
Domestic
firms.
do just as well, with the additional benefit
to
with
performance,
their
be greatest
place
take
investors
bring
also
directly
through
base
would
that
assets.
controlled
limited
not
is
the
if
This effect
that
investment
beneficial
will
linkages.
may be
investors
private
local
in
the
firms
strategic
the
improve
they
that
they
add to the domestic political constituency for allowing a greater role for market
will
forces.
Granting
discount
a
of obligations
structure
in
may
also
the
be
desirable
direction.
"right"
the
if
If
it
exchange
induces
an
investor,
example, to accept a subordinated claim that will pay dividends only
of nature,
states
example,
new investment may be
the
debt
equity
have
no
in
for
such
abuses
the
indirect
market
such
interest
sense,
discount
by
as
on
aggregate
beneficial
breaking
the
effects.
of
conversions
Foreign
auctions
purchases
which
of public
in
the creation
The common argument
some investments overlooks the
of
new claims
fact that the
value of different types of obligations,
justify
investors
often
and
result
may have
focusing
financial
recapture
utilities,
a
that
to
are
appear to make
date
much of
as
where there
is
in
the
part
de facto senior
is
no effective
result
to
the
of his
general
country should not in effect adopt "dual exchange rates"
debt overhang is not neutral in its impact on the
that
for
may
to
many
that
also
swaps
and
logjam
have taken place
that
obligations.
exisung debt
they
Further,
24Helpman's negative conclusion on debt-equity exchanges
assumption that they result
among
assets
good
debt discount
must be recognized
debt-equity
financial
very
in
current
of the
for
country.
when through open
possible.
it
Nevertheless,
existing
the
all
ownership
the
round-tripping.
as
debt-equity
even
shuffle
or
However,
justified. 2 4
merely
potentially
benefits
Many
little
exchanges
some
transferring
aggregate
the
alters
and
that the
same
factors
a similar discount on other claims
24
that lead
subject to the
to
a discount
same country
on the
risks.
technology
appear to
require
add
the
investment
bring
little.
are
likely
foreign
in
of
conflicts
Further,
where
expertise
with exit bonds
issue
creditors
typically
forgiving
part
not
will
grant
is
With
weak
promising,
foreign
in
other
the
regard
to
With
would have no
leaving
the
senior
do not
benefits
forms of
quasi-equity
country's
some of
and
obligations
the
ar^d
inevitable
position
it
new
claim
to
the
general
less
to
substantially
below
the
this
is
existing
that
is
tantamount
beneficial
supply
general
revenues
market
to
a
and,
thus,
would
order
similar.
interest
foreign
might
to
rates
if
in
they
to
without
earnings
are
put
worst, the
would have had,
project
the
highly
was
exchange and thus benefit the
waive
obtain
offset
interested
if
at
the
"overhanging"
their
residual
Consider, for example,
Such options could be sold successfully
commodity plays only
But
unaffected.
creditors
project
otherwise
it
a
impossible
be
go ahead and,
exchange than
of free
in
would
exit
whose creditworthiness
which has
but
(where
financing
project
foreign
is
borrowing,
options.
such
since
country
a
development
project
the
free
the
consider
obligation
whose
project
project
waivers,
may be mutually
security
of existing creditors
Thus
creditors.
senior financing
two cases where the linkage of
least
financing,
stand-alone
would add
new
buyback coupled with the issuance of new project-
a
is
The case with indexed debt
with
of a
avoiding
as
necessary
at
new
cover debt service),
country
existing
a
project
export-oriented
to
successful,
incentive
5,
public,
buyback coupled with the issuance of "indexed"
a
to
sustain
finance.
escrow
One
obstacle.
this
finance,
too
while
well
as
the
There are
of the debt.
buyback and the issuance of
bonds.
needed,
consuming
the
Intermediate,
structure
shifting2
risk
ownership.
foreign
The key
linked
the
even
and
cases.
improve
both
to
many
in
and
investors
shifting
risk
beneficial
and New Financing
Exit Bonds
overcome
the
no
or
little
between
conflicts
of assets
sale
full
new owners,
the
increased
of
possibility
the
by
transfer
by
benefits.
an issue of bonds
commodity price-linked
non-bank
were senior
third
to
parties
general
typically
obligation
25At a general level, the profitability of such investments will depend on world energy
and local levels of aggregate activity.
will be efficient to shift risks tied to
It generally
aggregate output to foreign investors. Thus the desirability of international risk sharing will
depend primarily on the country's net exposure to energy prices.
prices
25
Because of the reduction
debt.
such
grant
did
that
whereas
waivers,
involve
not
general
play
currently
obligations
over
participation
these
in
and
risk
LDCs'
many of
financial
finance,
the
appearance
incentives
a
structures
because
of the
banks
compliance
of
by
the
and
existing
with
The
has
little
terms,
heightened
the
given
this
a
country
some of
the
that
is
any
1)
along more
overhangs,
mutual
are
concerted
efficient
despite
2)
clean
a
financial
done
been
the
carefully
lines
finance
case
the
that
shift
has
to
change
voluntary
with
maintaining
borrower
between
conflicts
overhang.
this
slate,
alternative
to
chapter has
finance
focused on
The
that:
refinancing
arrangements
should
recontracting
include
and
difficulties
designed
of marginal,
voluntary
and managed programs
of concerted
payments
exchanges,
across
return
to
growth of
LDCs
the
exchanges
can
inclusion
circumstances
between levels of current debt service
required
an
country
the face
in
result
of debt
significant
in
benefits.
In
they
factors
problems and opportunities created by the debt overhang.
special
conclusions
general
with
starting
role
including
perverse
the
and
benefits,
crisis
institutions
debt
a
of these
debt
Following a review of the benefits and of and obstacles
for
number
a
international
claimants
prospective
issue
managerial
limited
issuance
their
but
and
The
of access to
and
overhang,
debt
new
quasi-equity,
loss
existing
banks mig^i
Here
sharing
risk
reflects
to
resulting
and
equivalent
a
equity,
infrastructure.
of alternatives,
of
to
of awareness
of obstacles
institutional
times,'
borrowing.
lack
benefits
created
of
classes
series
of
financing
the
preoccupation
the
a
domestic
inadequate
underscored
and
including
obligation
including
"bad
from
There
advantages
external
countries'
power,
of state
in
service.
Get
LDCs
for
general
floating-rate,
debt
to
major
offer
during the years of debt buildup
assertion
How
modes of finance
Alternative
indexed
current
in
Conclusions:
V.
service
would not grant waivers
they
reduction
a
debt
required
in
that
are
can
of alternative
significantly
politically
feasible
close
and
and those that banks will demand as
26
forms of
lead
the
to
gap
the
realistic.
exchanges should take the form not only of debt-equity
Voluntary
exchanges
external
of
such
variables
domestic
government obligations
existing
such
assets,
commodity
as
revenue
as
Given the obstacles
have,
many
in
without
bonds
for
alternatives
that
been exacerbated
case,
changes
significant
international
agencies,
to
or
prices
by
financial
obligations
fee-generating
existed
of
the
indexed
are
to
of
profitability
infrastructure.
and
crisis
not
will
place
take
country
creditor
LDCs
debt
the
to
recontracting
and
institutions,
prior
part
the
that
some formula of
to
this
it,
on
policies
in
new
for
swaps, but also, of
regulatory
We
themselves.
conclude with a brief review of these steps.
Agencies
Regulatory
The
is
current
the
largely
them
allows
loans
and
long
A
equivalents.
Thus,
key
similar
step
benefits
hold
to
or swaps into
sales
shares
some of
or
original
obligations
efficient
recontracting
exchanged
they
if
LDC
government, through the deposit
implicitly
the
banks that
U.S.
for
packages
from economic losses on
loses through
U.S.
the
more
toward
resulting
new money
concerted
system
regulatory
these
system,
regulatory
continue
they
as
obtain
bank
and
impaired capital
of claims.
types
insurance
to
accounting
with
operate
through
restructuring
long as they do not "realize"
as
alternative
as
of an
result
to
of
practice
losses
restructured
their
would be
holdings
their
banks'
these
to
banks
allow
alternative
for
instruments.
Creditor
packages
financing
also
apply
much of
the
contending
with
conflicts
and
governments
country
together,
banks and opportunism on the part of borrowers.
applied
support
to
International
International
Bank
in
general
its
obligations,
alternative
claims.
quasi-equity
A
institutions
adjustment
often
at
the
change
investments
can
leverage
put
among
and should
be
Institutions
financial
structural
free-ridership
to
approaches.
alternative
Financial
This
required
leverage
and
in
role,
have tended
expense
this
project
especially
(IFIs),
to
of foreign
role
could
lending
27
be
which
work
the
in
IMF
and
concert
the
with
World
holders
and domestic holders of
useful
particularly
represent
a
in
middle
promoting
ground
of
between
investments,
equity
program
projects
allow
to
be
transfer
country
implicitly
creating
obligations,
violating
existing
the
does
IFIs
investments.
Rather,
such
prevent
of
case
exchange
and
guarantee
authorities
which
include
lenders need.
provide
and
would
thus
Borrower
as
outfight
efficient
relief.
they
the
taking
covenants
an
by
allow
the
to
a
to
the
capacity
for
quasi-equity
preferred
their
creditor
which can easily
risk
risks.
World
Bank
provide
risks,"
IFIs
authority
under
specialization
such as
investment
requirements
OPIC
MIGA
or
be
that
could
much narrower
co-financing
current
example,
for
IFI,
could
guarantees
its
and
performance
and
Such
no direct foreign
An
problem.
this
features
the
that
projects
relieve
transfer
greater
creditors
supporting
transfer
to
place.
or a guarantee
IFI
against
mitigating
claims
This would
risk-bearing
and
the
new claims without
these
in
strengths,
performance
"political
do much
could
role
such
transfers
net
existing
true
a
addition,
In
enhancing
claims. 2 6
for
of
a
IFIs'
and
basis.
programs,
risk-taking.
in
Governments
The
debt
entail
extended
of
playing
domestically-oriented
Similarly,
guarantees
those
than
from
project
as
from
bearing
for
ideal
transactions
the
In
nature
the
make them
position,
them
preclude
quasi^
cofinancing
its
its
from
seniority
absence
the
of
fraction
financing
future
Thus,
stand-alone
designated
for
facility
of
government-sponsored
in
unbundling by
some
of de facto
agreements.
not
positions
risk
assigning
type
a
assist
case
the
In
mandate of the IFC might be
the
commercial,
a
such
of
benefits
the
shift
by
enhancement
credit
a
to
might
perhaps
risk,
Alternatively,
on
finance.
Bank might extend
quasi-equity
structured
IFI
foreign
World
the
take
to
it
could
that
against
could
example,
for
Bank or regional
World
penetrating
fully
cover such operations.
to
broadened
new
and
arms-length
borrower governments
step
for
to
obtain
forgiveness.
This
first
well
as
structure
of
ready
may
to
it
them with
be the
not
a
rescheduling,
actually
will
will
make
through
present
liabilities
Thus they probably
should be
relief
reduce
first
key element
26Several such proposals have been
made within
28
their
propose
to
in
interest
conflict
a
their
the
seek
actively
to
is
IFIs
to
rate
since
moving
to
power
for
recontracting,
recent months.
more
a
subsequent negotiations.
in
their
or
reductions,
bargaining
such
recontract
but
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_,
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Washington,
D.C.:
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