Beyond the Sovereign Debt Crisis: Alternative Forms of Market-Based Debt Restructuring Schemes

The resolution of the international debt crises has stimulated extensive research onhow to design solutions for countries facing external debt overhang problems. Thispaper analyses the benefits for creditors and debtors of the following `market-based'debt restructuring schemes: (i) issue of collateralised new assets inexchange for the old debt; (ii) automatic roll-over of the debt repayment with astate-contingent penalty rate. The first proposal combines the basic debt conversionscheme proposed by Krugman (1989) with Cline's proposal (1995) of self-enhancementson the new claims as a form of risk-compensation for creditors (seealso Williamson, 1988). Under this scheme the debtor country modifies the streamof the debt service payments by voluntarily exchanging the outstanding debt fornew assets with different debt service characteristics where the principal and/or theinterest rate payment can be fully or partially collateralised. The roll-over schemeentitles illiquid countries to extend the outstanding debt for a specified period at apenalty rate which is contingent on a measure of the country's creditworthiness.This solution has the desirable effect of reducing the future contractual obligationsby lowering the penalty rate on the excess of debt rolled over, thus helping thedebtor country to use additional resources to invest in the economy.