THE MARKET FOR DEVELOPING COUNTRY DEBT: The Nature and Importance of Its Shortcomings

There are two problems in the market for developing countrydebt: one is the immediate crisis. What do we do about the largevolume of outstanding debt? A more subtle but no less importantproblem is that because contracts are un-enforceable and lendershave incomplete information about risk, capital is mis-allocated.This article examines the latter problem and reviews the natureand causes of the unenforceability. It shows that unenforceabilityresults in higher interest rates on smaller and shorter-termloans than would otherwise be available and discourages investmentin developing countries. Similarly, unenforce-ability can explainthe perverse timing of capital flows to developing countries,causing credit to flow into the country when income is high,and out when income is low. The article then analyzes the riskassociated with three types of information asymmetries: informationabout the borrowers' ability to repay, willingness to repay,and use of the loan proceeds. These asymmetries, the authorargues, reinforce the effects of unenforceability. The prospectsfor remedying the immediate crisis are discussed, as is theneed to be certain that the proposed solutions do not aggravatethese problems.