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Is Debt Relief Efficient?

Literature › Works

Serkan Arslanalp; Peter Blair Henry (2005). Is Debt Relief Efficient?. The Journal of Finance, Vol. 60, No. 2. Blackwell Publishing for the American Finance Association.
Type journal article
Scope Comparative and methods
Method econometric
Period studied 1982–1999
Regions Developing countries (Latin America, Asia, Africa, Eastern Europe), United States
Themes macro fiscal finance debt, comparative theory, methods data sources
Citation key arslanalp2005

Argument

Using an event study of stock markets, the authors argue that debt relief under the 1989 Brady Plan was efficient: debtor-country equity values rose sharply ahead of announcements, and so did the equity values of US banks exposed to LDC loans. They separate the effect of debt relief from that of economic reforms by contrasting the Baker Plan, which offered reforms without debt relief, with the Brady Plan, which added debt relief. The stock-market gains forecast later improvements in net resource transfers, investment and GDP growth, which is consistent with debt overhang being resolved. They conclude that relief helps middle-income debtors suffering from overhang but cannot be assumed to help highly indebted poor countries. The article says nothing about South Africa beyond listing it as a control-group country.

Evidence and method

Monthly IFC Emerging Markets Data Base stock indices for 10 Brady countries and 16 control countries (South Africa is one of the control countries). It also uses US bank stock returns, World Bank Global Development Finance data on net resource transfers and restructurings, IMF and EIU reform dates, Cline (1995) announcement dates, and Baker and Brady speeches and testimony.

Findings

  • Debtor-country stock markets rose about 60% in real dollar terms on announcement of Brady deals, with no comparable rise in the control group. (p. 2)

    When developing countries announce debt relief agreements under the Brady Plan, their stock markets appreciate by an average of 60% in real dollar terms-a $42 billion increase in shareholder value.

  • Exposed US banks also gained, so relief was not a zero-sum transfer from lenders to borrowers. (p. 4)

    the stock prices of the 11 major U.S. commercial banks with large LDC loan exposure increased by an average of 35%-a $13.3 billion increase in market capitalization.

  • Scale of the restructuring: about $202.8bn restructured, yielding $64.7bn of relief. (p. 8)

    In total, approximately $202.8 billion worth of debt was restructured, result- ing in $64.7 billion of debt relief.

  • The baseline regression gives a significant Brady coefficient and an insignificant control coefficient. (p. 17)

    the coefficient on BRADY for the 12-month window [-12, 0] is 0.05 and is statistically significant at the 1% level. Multiplying the coefficient by 12 gives the total effect, a 60% increase

  • Identification rests on the Baker Plan, which pushed reforms but ruled out debt relief. (p. 13)

    The Baker Plan called on countries to undertake extensive reforms but deliberately excluded any plans for debt relief.

  • Baker's pre-Brady equity gain was only about 22%, versus 60% for Brady, suggesting reform news was already priced in. (p. 21)

    stock market values increased by an average of 22% in real dollar terms over the 12-month period preceding the Baker Plan.

  • IMF programmes unaccompanied by debt relief had no positive stock-market effect. (p. 26)

    There is no evidence that the stock market responds positively to IMF agree- ments that are not associated with a Brady debt relief agreement.

  • Net resource transfers changed sign from negative to positive after Brady deals. (p. 27)

    After the Brady Plan, the NRT turns positive and remains so for the rest of the sample.

  • Capital stock growth more than doubled after debt relief. (p. 27)

    In the 5 years prior to debt relief, the average growth rate of the capital stock in the Brady countries was 1.6% per year. In the 5 years following debt relief, the capital stock grew at a rate of 3.5% per year.

  • Conservative net wealth gain exceeded the cost of the collateral enhancements. (p. 33)

    Whatever estimate one chooses to accept- $25 billion or zero-the cost of the Brady Deal was less than the wealth effect.