Chapter

Appendix I

Author(s):
International Monetary Fund
Published Date:
December 1995
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The Debt Overhang in Heavily Indebted Poor Countries

The external debt owed by the heavily indebted poor countries rose substantially during the mid-1980s as significant terms-of-trade declines and a weakening in global demand resulted in an increase in external borrowing (Table A1 and Chart A1. upper panel). 94 This reflected an increase in lending by both bilateral and multilateral creditors during a period when other creditors were reluctant to extend new financing. Although a recovery in export earnings and the impact of debt reductions have resulted in some decline in indebtedness in some countries in recent years, the average debt burden facing these countries remains very high.

This period of increased indebtedness has also been characterized by sluggish aggregate growth (Table A2 and Chart A1. lower panel)95. Among the explanations that have been offered for this is the debt overhang—the depressing effect of large debt burdens on growth and investment.

This section first summarizes the arguments that have been put forward concerning the relationship between the debt burden and investment, and the empirical evidence found in the literature. It then discusses the severity of the debt burden currently facing the heavily indebted poor countries, and the extent to which this has affected growth and investment. Its principal conclusions are:

  • While there is evidence of the debt overhang influencing growth and investment in middle-income developing countries, this relationship would appear weaker for the heavily indebted poor countries. It is difficult to disentangle the role of any debt overhang from other factors that have worked to depress economic growth and investment in these countries.

  • Total net inflows to these countries have remained strongly positive throughout the 1980s and 1990s despite their heavy debt burdens.

  • Several countries, such as Bolivia, Guyana, and Uganda, have experienced rising investment and relatively buoyant growth in the 1990s despite heavy external debt burdens.

  • Nevertheless, heavy debt burdens may have been associated with disincentives to invest, which could have contributed to the relatively poor growth performance of some of these countries,

  • Widespread acceptance of the proposition that debt lev-els for many of these countries go beyond their debt servicing capacity has been instrumental in the Paris Club’s agreeing in implement increasingly conces-sional rescheduling terms for low-income rescheduling countries—involving, most recently, 67 percent NPV reductions for most countries under Naples terms.

Chart A1.Heavily Indebted Poor Countries: External Debt Outstanding and GDP Growth, 1983-93

(In percent of amounts consolidated)

Sources: Tables A1 and A2.

Table A1.Heavily Indebted Poor Countries: External Debt Outstanding, 1983-931(in percent of exports of goods and services including workers’ remittances)
19831984198519861987198819891990199119921993
Benin268249192205212191308251249231317
Bolivia453512651777875711464430433534512
Burkina Faso147155171163183182179157188202235
Burundi3123393543996805757579297619171,205
Cameroon120104104129190198221275257308324
Central African Republic160174188249314482331334443489469
Chad167112193164176160188203246293452
Congo176153248449429434340328397375426
Cote d’Ivoire348282301283353379432462525526596
Equatorial Guinea551426419394526531605440432
Ethiopia214220285265368423367445557563614
Ghana345316331335362319372384381384378
Guinea293321357289292323388435
Guinea-Bissau1,2189481,6861,8821,6101,6621,9621,2361,3852,0881,921
Guyana535518607689640756660760667503531
Honduras261265295290342316312353320325338
Kenya229208265249345313306320317310300
Lao People’s Democratic Republic1,0381,0741,3521,8001,7551,7001,6911,373978672
Liberia215219262330377333291349378328318
Madagascar584577912987838796907879949
Mali408469503534503487486446460456620
Mauri lania359399354383450413394437436411479
Mozambique1,4731,7281.7281.6201,6721,5951,2921,4331,416
Myanmar4585197211,0751,4221,127732702751672620
Nicaragua8131,0321,6842,4552.6303,3272,8712,6582,8353,4082,638
Niger243271379437359396408471454500575
Nigeria171144149324391417316241272242278
Rwanda168170222185350385404469557717766
Sao Tome and Principe3743036546061,0838801,3471.8191,8322,0862,116
Senegal202228282281327290247236238251288
Sierra Leone446354451564553753834751784734840
Sudan6106397339041.1901,0791.3181.8203.4503.2653.238
Tanzania693483466543696706617719688654631
Togo252206230208223211202217232270402
Uganda2642653113575326298191.1971.4561.5081.227
Vietnam31,4561,219879731663
Yemen, Republic of5797178711.1211,032411319396430541472
Zaire296256308354439362390445578795872
Zambia344395477757717557443539622582638
Simple average273256297392463453460449483486515
Source: World Bank Debtor Reporting System.

Angola and Somalia are exeluded due to data limitations.

Includes private transfers for Tanzania.

Includes debt to Russia valued at the official exchange rate.

Source: World Bank Debtor Reporting System.

Angola and Somalia are exeluded due to data limitations.

Includes private transfers for Tanzania.

Includes debt to Russia valued at the official exchange rate.

Table A2.Heavily Indebted Poor Countries: Constant-Price Gross Domestic Product, I971-93 1(Percent change)
Annual Average
1971-831984-881989-9319891990199119921993
Benin3.81.12.52.53.14 73.83.6
Bolivia2.70.33.12.82.64.12.73.2
Burkina Faso-0.35.32.20.9-1.510.02.5-0.8
Burundi3.55.21.41,33.55.02.7-5.7
Cameroon5.828-4.60.8-6.9-7.5-5.2-4.4
Central Afriean Repuhlie1.53.4-0.82.31.0-1.6-2.4-3.0
Chad1.56.32.45.8-2.38.33.9-3.7
Congo8.10.21.42.61.02.22.6-1.6
Core d’Ivoire5.00.5-1.0-1.1-2.1-0.8--1.1
Equatorial Guinea3.01.64.2-1.23.3-1.113.07.1
Ethiopia2.52.3-0.61.2-2.2-1.0-9.88.8
Ghana-0.75.94.55.13.35.33.95.0
Guinea2.63.83.64.04.32.43.04.5
Guinea-Bissau6.84.33.24.53.33.02.82.7
Guyana-0.40.32.5-3.3-5.36.07.87.4
Honduras3.64.03,34.30.13.15.04.0
Kenya5.75.12.54.54.32.30.40.8
Lao People’s Democratic Republic4.73.57.714 16.74.07.06.5
Liberia0.90.2-1.6-10,80.71.61.0-0.4
Madagascar-0.36.70.84.13.1-6.31.11.9
Mali0.71.93.311.80.4-2.57.8-0.8
Mauritiania3.28.11,72.2-1.82.63.02.5
Mozambique1.80.82.55.31.32.6-2.35.6
Myanmar4.5-1.74.23.72.8-0.79.36.0
Nicaragua1.7-4.0-0.5-1.7-0.3-0.20.4-0.5
Niger3.7-0.1-0.60.9-1.32.5-6.51.4
Nigeria2.82.95.37.28.24.83.52.9
Rwanda3.31.8-1.81.00.40.30.4-10.9
Sao Tome and Principe2.60.31.13.1-2.21.51.51 5
Senegal2.92.60.9-1.44.50.72.9-2.0
Sierra Leone2.00.90.72.4-0.10.7-0.81.5
Sudan3.9-4.41.6-0.36.08.96.0
Tanzania4.04.03.63.03.53.84.53.3
Togo1.53.1-4.03 90.1-0.9-9.6-13.4
Uganda1.12.24,86.84.44.33.45.0
Vietnam4.65.07.17.84.96.08.68.1
Yemen. Republic of8.33.72.53.22.0-4.27.44.3
Zaire0.62.8-7.7-1.4-2.3-7.2-11.2-16.6
Zambia1.51.30.21.00.7-2.0-2.84.0
Simple average2.92.5172.61.21.61.91.1
Source: World Economic Outlook database.

Angola and Somalia are excluded due to data limitations

Source: World Economic Outlook database.

Angola and Somalia are excluded due to data limitations

The Debt Overhang Hypothesis

Theoretical Arguments

This hypothesis gained considerable prominence in the mid-1980s, when the lackluster investment and growth behavior of the (mainly middle-in come) countries that were heavily indebted to commercial creditors was attributed by many to their large foreign debt burdens. At that time, several reasons were proposed in the literature to explain why a large debt burden could depress investment.96 These are summarized in Box A1.

Empirical Evidence

Considerable effort has been made at assessing the extent to which the debt overhang has affected investment, though these efforts have largely focused on the heavily indebted middle-income countries. Although large debt burdens appear to have contributed to a weakening in investment in middle-income countries, no clear consensus has been reached regarding the extent to which the debt overhang has affected investment in the heavily indebted poor countries. Much of the empirical evidence to date consists of the observation that a decline in investment in heavily indebted countries occurred coincidentally with the onset of the debt crisis (e.g., Sachs 1989). In addition, several empirical investigations of the determinants of investment in heavily indebted countries during the past 15 to 20 years found that an increase in the external debt burden was associated with a de-cline in both total and private investment (Fry (1989) and Greene and Villanueva (1991) who examined mainly middle-income countries: Hadjimichael and others (1995) for sub-Saharan African countries). However, the methodology used in these studies (pooled time-series analysis on cross-section data) restricted the effect of the debt burden on investment to be the same for every country. Moreover, investment rates were found to have been determined by a vari-ety of other factors in addition to the debt burden, such as the growth in real GDP, the overall budget deficit as a ratio of GDP. changes in the terms of trade, and the real exchange rate.

Box A1.Debt Overhang: Theoretical Arguments

A debt that is so large that a country is unlikely to repay in full acts as a high marginal tax on efforts to expand the country’s foreign exchange earnings through increased output and exports, because potential investors perceive that the bulk of any improvement would benefit past creditors. For such a country, a belief among economic agents that future repayment of the debt will eventually be financed by levying of taxes on domestic capital, or by outright expropriation of assets, or by the imposition of capital controls, could provide a disincentive to investment and encourage the transfer of funds abroad.

When doubts exist about a country’s ability to service its external debt stock, the existence of a debt overhang could also discourage investment by preventing a country from attracting voluntary loans from new creditors in the absence of seniority of such lending,1 As a result of this liquidity constraint, many high-yielding investments in debtor countries could be unexploited because these countries are shut out of credit markets.

These arguments hinge on the assumption that there are significant doubts on the part of potential investors regarding the country’s long-term ability to service its external debt—specifically that the present value of future external debt service arising from its existing debt stock is perceived it) be greater than that of its future revenue stream from net exports. However, large ratios of external debt to exports could depress investment even in the absence of extensive doubts about the likelihood of repayment. In the case of public sector debt, the resources needed to service these obligations may reduce government investment, and, to the extent that Ihcre is a complementarity between public and private investment, could, in addition, discourage private investment. To the extent that difficulties in servicing either public or private sector debl result in a deterioration in relations with creditors, debtors could face a reduction in the availability of new financing, thereby creating a liquidity problem.

1 As argued by Diwan and Rodrick (1992).

A further caveat to the conclusions of these studies that they did not allow for the endogeneity of external debt. For example, a persistent decline in a country’s terms of trade could result in a weakening in economic activity, and a contraction in domestic investment. At the same time, the deterioration in the external current account caused by the decline in the terms of trade could result in increased external borrowing and a buildup of debt. To correct for this shortcoming, Borensztein (1990) directly tested for the existence of a debt overhang for the Philippines by estimating a standard neoclassical investment demand function and testing the significance of the addition of a term representing the extent of the foreign debt burden. His results suggested that the debt overhang did in fact contribute to the decline in gross investment relative to GDP that occurred in the Philippines between 1982 and 1989. A l - though this represents a useful approach, its application to the heavily indebted poor countries is limited by the instability of investment demand in many cases and the absence of data on crucial determinants, such as the marginal product of capital. Indirect efforts at testing the debt overhang hypothesis have consisted of attempts at estimating the “debt Laffer curve” (Box A2).

Debt, Growth, and Investment in Heavily Indebted Poor Countries

Present Value of Debt Stock

As discussed above, a major assumption underlying several of the arguments for why a large debt burden could depress investment is that there are doubts regarding a country’s long-term ability to service its external debt. A more useful indicator of the severity of the debt overhang than one based on the nominal stock of debt is thus one that is based on the present value (PV) of debt, which takes into account the con-cessionality of the debt stock (see Box A3).

Based on this approach, the majority of the heavily indebted poor countries faced very high debl burdens as of the end of 1993 (Table A3, last column).97 The average PV debt-to-exports ratio was about 600 percent, and only three countries—Benin, Burkina Faso, and Senegal—had ratios below 200 percent. For several countries—Guinea-Bissau, Mozambique, Nicaragua, Sao Tome and Principe, and Sudan—PV debt-to-ex-ports ratios were well in excess of 1,000 percent.

Relationships Between Debt Stocks, and GDP Growth and Investment—Cross-Country Analysis

The relationships between growth of real GDP and investment relative to GDP, and PV debt-to-exports ratios from 1989 to 1993 for the heavily indebted poor countries, are plotted in Charts A2 and A3. Overall, while there appears to be a small negative correlation between the stock of debt, economic growth, and investment, considerable variation exists across the countries.98 While many countries with relatively low PV debt-to-exports ratios have been able to achieve high investment rates and rapid growth in economic activity (such as Ghana, Kenya, and the Lao People’s Democratic Republic), others that faced debt burdens of similar magnitudes registered declines in real GDP (such as Cameroon, Liberia, and Togo). Conversely, several countries with PV debt-to-exports ratios well in excess of 500 percent were characterized by buoyant growth (such as Uganda and Vietnam). Equally, some countries have reported extremely high investment rates despite large debts (such as Guyana, Mozambique, Sao Tome and Principe, and Tanzania), although these were not always reflected in rapid growth.

Box A2.Debt Laffer Curve

This concept depicts the relationship between a country’s nominal debt obligations and the market’s expectation of the repayments that these loans will generate; these repayments can be measured by the secondary market price of debt multiplied by the existing stock. A debt overhang would exist when further increases in obligations are discounted at such a high rate (as implied by a sufficiently large fall in the secondary market price) that they are associated with a decline in the market value of the debt stock. At this point, a country is said to be on the back side of the debt Laffer curve, where the disincentive effects on potential investors discussed in the text are so strong that a reduction in the stock of debt would result in an increase in its market value.

Froot and Krugman (1990) attempted to estimate countries’ positions on the debt Laffer curve by examining the relationship between the secondary market price of debt and the face value of claims for a set of 35 heavily indebted countries, 12 of which were low-income countries. Depending on the exact specification of the model that was estimated, the authors found that for 6 to 15 of the countries, debt-to-export ratios were sufficiently high to place these countries on the back side of their debt Laffer curves.1 Among the low-income countries, those that appear to have been affected by debt overhang according to this test were Bolivia, Madagascar, Nicaragua, Sudan, and Zambia.2 The extent to which tests of this nature can be applied to studying other low-income countries is limited by the absence of a secondary market for debt in most of these countries, due in large part to the relatively small proportion of debt owed to commercial creditors.3

1 When the elasticity of the secondary market price with respect to the face value of total claims is greater than I in absolute value, further increases in obligations are associated wilh a decline in the market’s expectation of the total repayments thai a country’s debt stock will generate.2 The other low-income countries included in the sample were Cote d’lvoire, Honduras. Liberia, Nigeria, Senegal, Togo, and Zaire.3 Data on secondary market prices on commercial debt are available only for Bolivia, Cameroon. Cote d’lvoire, Madagascar, Nigeria. Senegal. Sudan, Togo. Uganda. Zaire, and Zambia.

Box A3.Present Value of Debt-to-Exports Ratio

This is defined as the ratio of the discounted present value (PV) of all future debt-service payments due on existing external debt to exports of goods and services.1 The World Bank, which has pioneered the use of PV debt-to-exports ratios, emphasizes that there are no simple rules on what constitutes a sustainable PV debt-to-exports ratio and that the ability of a country to service its debt is a function of dynamic factors such as growth of exports and new financing flows. However, according to the World Bank, as a rule of thumb, ratios in excess of 200 percent have generally proved to be unsustainable in the sense that most countries that have faced such ratios have had difficulty in avoiding reschedulings, and, once having rescheduled, they have had difficulty escaping repeated reschedulings.

1 The assessment of a country’s capacity to repay would be more precisely captured if the denominator was the PV of average annual exports over the period of the existing debt-service obligation. However, this would require the formulation of well-specified medium-term scenarios. This would produce a lower PV debt-to-exports ratio, provided the expected future export growth exceeded the discount factor used.

Relationships Between Debt Stocks, and GDP Growth and Investment—Time Series Analysis

The relationship between the change in average GDP growth and investment rates between 1984 and 1988 and between 1989 and 1993, and the PV debt-to-exports ratio, is shown in Charts A4 and A5.99 For the heavily indebted poor countries as a group, economic activity appears to have weakened slightly between these two periods, as average GDP growth declined from 2.5 percent between 1984 and 1988 to 1.7 percent between 1989 and 1993 (Table A3); the decline appears to have been more pronounced in those countries with relatively high debt stocks.100

However, for several of these countries, the deterioration in macroeconomic performance can clearly be attributed to other factors, such as civil strife (Burundi, Ethiopia, Liberia, Nicaragua, and Sierra Leone), or a deterioration in macroeconomic balances caused by the implementation of lax financial policies that resulted in persistently negative real interest rates and an inadequate generation of private savings (such as in Cameroon, Madagascar, Nigeria, the Republic of Yemen, and Zaire). An even weaker relationship appears to have held between changes in investment and PV debt-to-exports ratios for the most heavily indebted poor countries, as many countries facing extremely high debt-to-exports ratios reported a considerable acceleration in investment.

It is difficult to draw conclusions about the behavior of private investment for the heavily indebted poor countries, owing to the predominance of state-owned public enterprises and the near absence of a private sector in several of these countries, particularly during the 1980s. Subject to this caveat, the relatively weak relationship between debt burdens and total investment described above appears also to hold true for private investment; the data on private investment include that of public enterprises owing to data constraints (Table A4). Private investment as a share of GDP for these countries as a whole rose from 7 percent of GDP between 1984 and 1988 to 10 percent between 1989 and 1993, with many of the severely indebted countries (such as Guyana, Mali, Mozambique, Tanzania, and Uganda) reporting impressive gains during this period.

Chart A2.Heavily Indebted Poor Countries: External Debt and GDP Growth,1989-93 1, 2

Source: Table A3.

1 Guinea-Bissau, Nicaragua, and Sudan are excluded owing to extreme ratios of external debt to exports.

2 Correlation coefficient = 0.05, including countries that are excluded from the chart.

Chart A3.Heavily Indebted Poor Countries: External Debt and Investment, 1989-93 1, 2

Source: Table A3.

1 Guinea-Bissau, Nicaragua, and Sudan are excluded owing to extreme ratios of external debt to exports.

2 Correlation coefficient = 0.02, including countries that are excluded from the chart.

Table A3.Heavily Indebted Poor Countries: External Debt Outstanding, GDP Growth, and Investment. 1983-93 1(In percent)
Memo item
1983Average,1984-88Average 1989-93PV Debt to
ExternalGrowth inGrossExternalGrowth inGrossExternalGrowth inGrossExports24
debt2and GDPinvestment3debt 2and GDPinvestment3debt2and GDPinvestment31993
Benin2683.28.92101.111.82712.513.3178
Bolivia4534.18.67050.39.44743.113.9389
Burkina Faso147-0.816.91715.320.11922.220.2122
Burundi312-5.719.34705.216.79141.418.8527
Cameroon120-22230.11452.828.1277-4.613.1292
Central African Republic160-3.011.22823.412.7413-0.811.5260
Chad167-12.03.11616.38.12762.48.8223
Congo1762.637.93430.225.33731.417.0387
Cote d’Ivoire348-0.817.73200.512.4508-1.010.3548
Equatorial Guinea7.111.03581.615.35074.226.6298
Ethiopia214-12.312.73132.315.5509-0.611.8396
Ghana3455.03.83325.910.73804.514.5234
Guinea4.71943.89.43453.617.6282
Guinea-Bissau1,2182.722.71,5584.328.71.7183.327.01,264
Guyana5358.321.66420.326.36242.554.9398
Honduras2616.016.73024,015.73295.520.8272
Kenya2290.118.32765.119.03112.519.2229
Lao People’s Democratic Republic6.110.31.4043.514.61.2837.715.9207
Liberia21516.93040.212.0333-1.612.1290
Madagascar5841.912.94956.710.98740.812.3724
Mali408-0.812.44991.919.14943.322.2362
Mauritiania3594.917.94008.124.64311.714.2340
Mozambique19.39.91,3100.816.91.4822.545.11.147
Myanmar4586.718.2973-1.713.66954.212.5472
Nicaragua813-1.019.42,226-4.019.22,882-0.519.82.407
Niger2431.418.2368-0.113.6482-0.68.9384
Nigeria1711.620.22862.912.72705.314.7272
Rwanda168-10.914.62621.815.4583-1,812.4362
Sao Tome and Principe3741.311.47050.314.31,8401.127.61,142
Senegal202-2.015.82812.612.72520.913.4199
Sierra Leone4461.512.35350.99.67890.710.7681
Sudan6107.616.6909-12.42.6184.46.52,941
Tanzania6935.113.65794.022.36623.640.3458
Togo252-13.522.82163.124.6265-4.023.2250
Uganda2645.13.54192.27.31.2414.813.7713
Vietnam8.15.010.89897.113.8998
Yemen. Republic of5795.916.58313.711.54322.518.7377
Zaire296-16.610.13442.812.6616-7.77.4752
Zambia3449.213.65811.330.65650.210.2519
Simple average31 91.314.65512.516.17311.717.8572
Sources: World Bank Debtor Reporting System; and World Economic Outtouk database.

Angola and Somalia are excluded due to data limitations.

In percent of exports of goods and services.

In percent of GDP.

Differs from PV ratios shown in Table 8. which are based on average exports for the period between 1991 and 1993.

Sources: World Bank Debtor Reporting System; and World Economic Outtouk database.

Angola and Somalia are excluded due to data limitations.

In percent of exports of goods and services.

In percent of GDP.

Differs from PV ratios shown in Table 8. which are based on average exports for the period between 1991 and 1993.

Chart A4.Heavily Indebted Poor Countries: External Debt and Change in GDP Growth 1, 2

Source: Table A3.

1 Guinea-Bissau, Nicaragua, and Sudan are excluded owing to extreme ratios of external debt to exports.

2 Correlation coefficient = -0.11, including countries that are excluded from the chart.

Chart A5.Heavily Indebted Poor Countries: External Debt and Change in Investment Rates 1, 2

Source: Table A3.

1 Guinea-Bissau, Nicaragua, and Sudan are excluded owing to extreme ratios of external debt to exports.

2 Correlation coefficient = -0.06, including countries that are excluded from the chart.

Table A4.Heavily Indebted Poor Countries: Gross Private Capital Formation, 1984-931(In percent of GDP)
Average
19841985198619871988198919901991199219931984-881989-93
Benin105879699101089
Bolivia756877889878
Burkina Faso715121 11216161514151115
Burundi655745655455
Cameroon16131471312121111121312
Central African Republic232222221122
Chad1-------11-1
Cote d’Ivore7978107678687
Equatorial Guinea1467677206369
Ethtopia10458101336774
Ghana452336554435
Guinea779999899989
Guinea-Bissau321422221122
Guyana13811151017315446571137
Honduras91088111412141615914
Kenya111012121211161211111112
Lao People’s Democratic Republic122-103356935
Madagascar231364924444
Mali141010121213151315713
Mozambique9248121314172121717
Myanmar6644451093758
Nicaragua3117102123171412121116
Niger32154442223
Nigeria7912101112151771012
Rwanda1097789757787
Sao Tome and Principe1322351071219211
Senegal12891010910119101010
Sierra Leone89959121096689
Tanzania101014232530293135271630
Togo8121313191918151231313
Uganda434689109849
Vietnam122-103356935
Zaire566655612263
Zambia633741557955
Simple average6677991010109710
Sources: African Economic Trends database; and World Economic Outlook database.

Angola. I .iberia. Mauritania, Somalia. Sudan, and the Republic of Yemen are excluded due to data limitations.

Sources: African Economic Trends database; and World Economic Outlook database.

Angola. I .iberia. Mauritania, Somalia. Sudan, and the Republic of Yemen are excluded due to data limitations.

Conclusions

A number of broad conclusions can be drawn regarding the relationship between growth and investment and the debt burdens facing the heavily indebted poor countries.

  • It is difficult to disentangle the role of the debt overhang from other factors that have clearly worked to depress economic growth and investment in these countries. This is reflected in the relatively weak relationship between debt and economic growth or investment discussed above in contrast to the stronger relationship found in studies for middle-income countries. While these results should be interpreted with caution, they may reflect the severe structural impediments, including inadequate physical infrastructure, untrained work forces, and weak institutions, that have acted as significant deterrents to investment in heavily indebted poor countries.

  • The recent macroeconomic performance of many of these countries has not been characterized by a decline in investment rates and sluggish ouput growth, notwithstanding their sizable debt burdens. Although Bolivia, Guyana, and Uganda have all experienced a buildup of external debt over the past decade and currently face PV debt-to-exports ratios well in excess of 200 percent, investment rates have risen steadily in these countries in recent years and have contributed to the achievement of relatively buoyant growth since 1989. For these countries, the achievement of increased investment has been facilitated by a marked improvement in macroeconomic stability that resulted from strong adjustment efforts, as well as by the implementation of structural reforms aimed at improving efficiency and resource allocation.

  • In sharp contrast to the experience of other heavily indebted countries in the wake of the debt crisis in the early 1980s, total net flows and net transfers to most of the heavily indebted poor countries have remained strongly positive throughout the 1980s and early 1990s. As a result of the continued availability of new flows, many of these countries {most notably. Ghana. Guyana, Mozambique, Tanzania, and Uganda) have been able to achieve increasing investment rates in recent years, reflecting the substantial contribution of foreign aid to capital expenditures.

  • Although the inability of many of the heavily indebted poor countries to achieve sustained growth is likely attributable to factors other than their large debt burdens, the cash flow needs associated with this debt have necessitated continued reschedulings of debt service in many cases. These repeated reschedulings involve significant costs to policy makers (including the use of scarce governmental/administrative talent), and create uncertainties for economic prospects. These factors in themselves may have contributed to the relatively poor growth performance of some of these countries.

  • While it is difficult to pinpoint a precise relationship between the debt overhang and growth or investment on an individual country basis, there is widespread acceptance of the proposition that debt levels Tor many of the heavily indebted poor countries may be beyond their debt-servicing capacity. Thus. Paris Club creditors have agreed to implement increasingly concessional rescheduling terms—involving NPV reductions—for the low-income rescheduling countries.101 Naples terms adopted in December 1994 involve a 67 percent NPV reduction for eligible debt for most low-income countries, with the prospect of a stock-of-debt operation with the same concessionality for countries that have established good track records under both IMF arrangements and rescheduling agreements. One of the two criteria used by Paris Club creditors to decide whether a low-income country receives a 67 percent or a 50 percent NPV reduction is the level of indebtedness measured by its PV debt-to-exports ratio; the other criterion is a country’s per capita income. Naples terms offer the prospect of an exit from the rescheduling process-and from debt overhangs-for most low-income countries. However, for a country to reap the full benefits from this exit, the other impediments to investment and growth need to be tackled by appropriate and determined adjustment and reform policies.

References

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    BorenszteinEduardo“Debt Overhang, Debt Reduction and Investment: The Case of the Philippines,”IMF Work-ing PaperWP/90/77 (Washington: International Monetary Fund1990).

    DiwanIshac and DaniRodrick“External Debt, Adjustment and Burden Sharing: A United Framework,”Princeton Studies in International FinanceNo. 73 (November1992)

    DooleyMichael P..“An Analysis of the Debt Crisis,”IMF Working Paper WP/86/14 (Washington: International Monetary Fund1986).

    FischerStanley“Macroeconomics. Development, and Growth,” inNBER Macroeconomics Annual (Cambridge, Massachusetts: National Bureau of Economic Research1991) pp. 32964.

    FrootK. and P.Krugman.“Market-Based Debt Reduction for Developing Countries: Principles and Prospects.”IMF SeminarSeries No. 1990–1 (Washington: International Monetary FundJanuary1990).

    FryMaxwell J.“Foreign Debt Instability: An Analysis of National Saving and Domestic Investment Responses to Foreign Debt Accumulation in 28 Developing Countries,”Journal of International Money and Fi-nance.Vol. 8 (September1989) pp. 31544.

    Greeneloshua and DelanoVillanueva“Private Investment in Developing Countries: An Empirical Analysis.”Staff PapersInternational Monetary FundVol. 38 (March1991) pp. 3358.

    HadjimichaelMichael TDhaneshwar GhuraMartin Miihl-eisenRogerNord and E.Murat Ucer.“Sub-Saharan Africa: Growth Savings and Investment 1986-93” Occasional Paper 118 (Washington: International Monetary FundJanuary1995).

    KrugmanPaul“Financing vs. Forgiving a Debt Overhang: Some Analytical Notes,”Journal of Development EconomicsVol. 29 (November1988) pp. 25368.

    SachsJeffrey“The Debt Overhang of Developing Coun-tries,” inDebt Stabilization and Development; Essays in Memory of Carlos Diaz AlejandroVol. 29 (November1989) pp. 80102.

This group is composed of the 32 countries that are classified by the World Bank as severely indebted low-income countries, 7 rescheduling countries that have received concessional terms from the Paris Club, and the Congo, which has recently become IDAeligible. Angola (which has also recently become IDA-eligible) and Somalia were not included due to data limitations.

Cross-country empirical studies of growth performance indicate that African economies have, on average, grown at a slower pace than the rest of the world during the past two to three decades (e.g., Barro (1991) and Fischer (1991)).

Important contributions have been made by Diwan and Rodrick (1992), Dooley (1986), Froot and Krugman (1990)), Krugman (1988), and Sachs (1989).

The PV ratios shown in this appendix are calculated on the basis of 1993 exports, and thus differ from those shown in Table 8, which are based on the average level of exports between 1991 and 1993.

The correlation for all 39 countries between debt and GDP growth was estimated to be 0.05; however, when two extreme outliers are excluded (Sudan and Vietnam), the correlation coefficient is -0.14. A small positive correlation (0.02) appears to exist between the present value of external debt and investment between 1989 and 1993; however, excluding Mozambique, Guinea-Bissau, Sao Tome and Principe, Sudan, and Vietnam because they are extreme observations, the correlation is -0.13.

The investment rates used in this appendix are based on nominal values of investment and GDP. Consequently, a change in the average investment rate between these two periods could occur as a result of a difference in the movement of the price of capital goods relative to the overall GDP deflator. The use of nominal values was necessitated by the lack of data on a constant price basis for several of the countries

The correlation between the changes in average GDP growth during these two periods and the PV debt-to-exports ratios is estimated to be -0.11.

Under the menu of options, creditors have a choice between reductions in the nominal value of their claims outstanding or concessional interest rates to achieve the same NPV reduction of their claims. Only the first of these options reduces the nominal value of the debt outstanding. If economic agents or markets focus on the nominal value of a country’s debt outstanding (rather than its real debt-servicing burden as indicated by the NPV), there is a risk that choice of the concessional interest option will not remove the perception of a debt overhang.

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