Forgiveness, Buybacks, and Exit Bonds: An Analysis of Alternate Debt Relief Strategiest

The 1980s have seen the issue of Third World debt rise to prominence as one of the foremost concerns for economic policy-makers. The foreign indebtedness of many developing countries has risen to such high levels that the casual observer is forced to wonder if the debt will ever be paid back. Many scholars are now arguing that the debt obligations of some of the most heavily indebted countries (HICs)are so largethat they act as a severedisincentiveto investment.1 Thesedisincentives, in turn, ,reduce growth rates in the HICs, thereby making future repayments even lesslikely. Many explanations for the onslaught of the debt crisishave been offered. The late Seventiesand early Eighties saWa rapid rise in interest rates as well as an equally rapid deterioration of the terms of trade of many HICs. Many sovereign debtors, which had been excellent investment opportunities for creditor banks, were suddenly insolvent. Low output shocks further exacerbated repayment possibilities. Faced with the possibility of non-payment, creditors entered into rescheduling negotiations with sovereign borrowers. These reschedulings have involved bargaining over the amount of repayment that will be made. Unlike domestic borrowers, sovereign debtors do not face bankruptcy proceedings and the liquidation of their assets in the event of a default. What motivation, then, does a sovereign debtor have to repay its debt? Furthermore, why do banks lend to sovereigndebtors in the first place? Eaton and Gersovitz (1981) suggest that international borrowing is a repeated game in which default imposes a cost in terms of future access to capital markets.