Does International Trade Induce or Deter Debt Repayment Capacity of Developing Countries?: Looking Through the Lens of the US Subprime Crisis

Abstract:     
This paper develops a credit risk model that focuses on the repayment capacity of developing countries in the world with specific focus given to international trade. The research is not only innovative but also timely in terms of policy implications chiefly following the adverse effects of the US subprime crisis on the debt states of countries in the world. Should international trade be wealth-promoting for developing countries, then, there will be added incentives for them to foster trade. Otherwise, this would be symptomatic to international trade being mere resource misallocations with poor sustainable policies in the long-term. A pooled estimation approach is employed to disentangle the adverse effects of the world’s worst financial/economic/debt crisis on the repayment capacity of the developing countries. Results show that international trade has been particularly stimulating during the pre crisis periods with a positive effect noted on their debt repayment capacity. However, post the crisis, no such effects prevail. Such a finding adds significant momentum to the fact that the crisis may already be curbing growth prospects via the trade channel for the developing countries with potential rekindling effects on protectionism. Above all, the impotency of international trade metrics on repayment capacity coupled with a highly negative pronounced effect of external debt on the same repayment capacity, both during the crisis period, add up strong evidence of a crisis-induced external debt overhang.

Keywords: Debt Service Coverage Ratio, International Trade, Developing Countries, US Subprime Crisis, External Debt Overhang

JEL Classification: F13, F21, F16

Accepted Paper Series