Investment Incentives: New Money, Debt Relief, and the Critical Role of Conditionality in the Debt Crisis |
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| Authors: | Claessens Stijn; Diwan Ishac |
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| Institution: | The authors are economists, International Economics Department, World Bank. They thank Daniel Cohen, Guillermo Calvo, Ken Froot, and the referees of this journal for their useful comments. This paper was presented at the World Bank conference, "Dealing with the Debt Crisis", January 1989. A version of this paper is in the proceedings of the conference (Husain and Diwan 1989). |
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| Abstract: | External debt depresses investment and lowers economic growthbelow its potential through its negative effect on liquidityand expected profitability. These effects can pull a countryinto a downward spiral in which both the debtor country andcreditors lose. This article considers the possibilities forrevising contracts between a debtor and its creditors once adebt crisis has erupted. The framework that we develop showshow various combinations of new money and cuts in debt and debtservice affect a debtor country's welfare, its debt repayments,and the earnings of its creditors. The analysis distinguishesbetween debtor countries that are willing and able to precommitcredibly to an adjustment program and those that are not. Thisdistinction provides the basis for a discussion of conditionallending by the international financial institutions to provideincentives and sanctions that make credible a debtor's promisesto invest. |
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