Li Lau, Carmen Angelica
(1991)
Managing sovereign loans: An analytical framework with empirical applications for Latin American countries.
PhD thesis, London School of Economics and Political Science.
Abstract
The motivation for this thesis began with observations of the debate in the media over the implications of the debt crisis, who was to blame and possible solutions. The terminology used (liquidity, solvency, default, repudiation, arrears, etc.) was not considered to be helpful in critically analysing the situation. Indeed, this terminology was likely to create confusion when trying to understand the causes, consequences and alternatives for the debt crisis. What causes debt repayment problems. Why do borrower countries prefer to suspend debt repayments rather than simply repudiate debt. How have lenders coped with this situation. Is there any evidence of an improvement in the situation. For a reader interested and familiar with the debt literature, these questions are not new. What is important is to have an understanding of the possible remedies and be able to design a solution that might resolve the debt crisis in a timely manner rather than allow it to drag on indefinitely with all the costs that that would imply. This thesis explores these questions and shares the views of the advocates of debt relief as part of the solution to the debt problem. In order to place the debt problem in context, the thesis begins with a brief historical account of the borrowing practices of Latin American countries since their independence from Spain. Default is not a new phenomenon. What is new is the source of lending (private banks and not bond holders) and the institutions involved (IMF and World Bank). This has implications for the way debt has been handled which we explore in chapter 1. In addition we review the efforts of researchers in modelling sovereign loans, explaining debt restructuring and searching for the determinants of debt repayment problems. The complexities found when dealing with sovereign loans lie in their nature, or more simply, the lack of collateral. In chapter 2, we take into consideration more explicitly the peculiar nature of sovereign loans and design a two period horizon pure "willingness to pay" model to explore its implications in the loan market equilibrium. If we assume sufficiently risk-averse borrowers and neither adverse selection nor moral hazard, we find that the competitive equilibrium is inefficient. We then reframe this basic model into a bilateral monopoly context and include some bargaining elements. We derive the elements of conflict, the Pareto negotiation locus and discuss possible bargaining solutions in the context of the static axiomatic approach. The design of any solution to the debt crisis requires an understanding of what precipitates a borrower into arrears. Chapter 3 offers an empirical study of LACs during 1971-86 which aims to compare different empirical specifications and trace variables that might usefully be included in our statistical model. Using those results, in chapter 4, we test our empirical model which now includes economic indicators, "crude" political proxies and country heterogeneity fixed effects. Our findings suggest that they are relevant in the assessment of the causes of debt servicing problems. Finally, in chapter 5, we consider the debate concerning "debt overhang" in Latin America. We also provide an account of how the debt problem has been managed and conclude that a prompt solution can not rely on "refinancing" nor on voluntary market debt reduction schemes.
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