When is External Debt Sustainable?

Abstract

Kraay and Nehru empirically examine the determinants of "debt distress," which they define as periods in which countries resort to exceptional finance in any of three forms: (1) significant arrears on external debt, (2) Paris Club rescheduling, and (3) nonconcessional International Monetary Fund lending. Using probit regressions, the authors find that three factors explain a substantial fraction of the cross-country and time-series variation in the incidence of debt distress: the debt burden, the quality of policies and institutions, and shocks. They show that these results are robust to a variety of alternative specifications, and that their core specifications have substantial out-of-sample predictive power. The authors also explore the quantitative implications of these results for the lending strategies of official creditors.

This paper - a joint product of Investment Climate, Development Research Group, and Heavily Indebted Poor Countries (Africa and Latin America), Poverty Reduction and Economic Management Network - is part of a larger effort in the Bank to study debt sustainability issues.