Can participation in IMF programs facilitate sovereign debt rescheduling? The role of program size

We develop a theoretical model to explain the possible inverted U-shaped relationship between IMF loan size and the probability of sovereign debt rescheduling. Given that the IMF is a de facto senior creditor, borrowing too much from the IMF leaves a smaller total surplus for the debtor and creditor to share in the future; thus creditors and debtors have less incentive to renegotiate the debt. Empirically, we propose a new identification strategy to isolate the effect of IMF loan size. Our identification strategy is based on Bartik-style instrumental variables that combine changes in the IMF’s liquidity and the country’s historical average IMF loan size. Using panel data from 100 countries over the period between 1977 and 2020, we empirically demonstrate the inverted U-shaped relationship predicted by our theory. While our results confirm the positive role of IMF loans in resolving sovereign debt crises, we note that too much lending can lead to unintended adverse outcomes.