Assessing the Appropriate Size of Relief in Sovereign Debt Restructuring

This paper offers a principles based approach for assessing the appropriate size of debt relief in sovereign debt restructuring initiatives. We show how to calculate the amount of debt relief that restores sustainability with high probability subject to the satisfaction of sovereign debt restructuring principles. The amount of debt relief is deemed appropriate if it leads to trajectories of economically and politically feasible fixed points for the primary surplus to GDP ratio that satisfy the government’s intertemporal budget constraint in a “high” percent of possible future states of nature. Economic feasibility is defined by natural economic constraints, and political feasibility is defined by the constraints imposed by the restructuring principles. We also provide evidence that shows that sovereign debt restructuring episodes since 1970 have been often followed by subsequent restructurings or defaults shortly afterwards, suggesting that relief amounts to date may have been ‘too little.