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Factors Considered In Designing An External Debt Strategy

Literature Review

Wijnbergen (1989) basically talks about the factors that are considered in designing an external debt strategy. The research question of this paper is what are the tradeoffs between various factors involved in formulating a debt strategy? How could debtor countries achieve high output growth without jeopardizing their credit worthiness? This paper is on the external debt crisis of developing countries with special reference to turkey and has also discussed about various strategies that could be used along with their drawbacks. To reduce its’ fiscal deficit a country has three options either it could go for domestic debt or external debt or it could generate revenue through monetization. But these three sources have certain limits and constraints with their use. The inflation rate, exchange rate and other macroeconomic variables needs to consider while opting for generating revenues through these three above mentioned resources. This paper takes an example of depreciation in a country’s external debt, that could boost its exports which is very obvious and would lead to that country’s creditworthiness but a possible drawback or a side effect for this action would be a further increase in debt burden on that country because now the debtor country would have to pay out more to its’ lenders due to depreciation in its’ currency. The major finding that is mentioned in this paper is that borrowing leads to capital accumulation in a country that would lead to high output growth in it and would bring development in that country, at least that’s what happened with countries like USA and UK. But this thing is missing in today’s debtor countries instead of taking external debt they still could not manage to get high output growth. This paper is based on secondary research, no mathematical or statistical techniques were used in it as such, but it did make use of others’ research papers like the one by “Anand” and the other one by “Wijnberge” this paper did discuss about the strategies that could be designed with reference to the external debt problems in the developing countries but it does not provide a single strategy that could be helpful in solving these problems. Every strategy that he talked about had some drawbacks that made it absolutely worthless to apply it.

Mohanty (1992) basically talks about the Latin American economies and the debt crises they faced during the 1980s. The research question of this paper is what are the strategies that could act as a solution for the Debt crisis? According to Mritiunjoy the rising American currency, high real interest rates and other macroeconomic variables along with the imprudent lending by the lenders caused this debt crisis in 80s. There are four phases of debt crisis that are discussed in this article. The first one is involuntary lending that the banks were forced to make to debtor countries because there was a risk of default for those countries if the banks stopped right there to keep on lending money to those countries. The second strategy was the Baker plan that was initiated in year 1986 when the Mexico’s BOP went negative due to a boom in its imports and declining oil prices. According to this plan much emphasis was placed on World Bank as compared to IMF because World Bank is much concerned with the development of developing countries. When the Baker plan was found to be flawed a new strategy was designed The Market based Menu Approach according to which it was recognized that various banks have different strategies to tackle with crisis. It was also realized that debt restructuring was needed and different options were given so that each bank could chose the best suit to its interests. After this a new strategy was designed that was named baker plan. According to this strategy it was recognized that there is no way out of this crisis until there is some debt reduction. The main reasons why the market based menu approach didn’t work was the hectic legal framework involved in debt restructuring, the second major modification in the previous approach was that multilateral agencies provide guarantees on new instruments being issued. The methodology used in this research paper is based on secondary research; no mathematical or statistical models were used as such, rather it is theoretical in nature. The major factors that affect the external debt and were discussed in this paper are GDP, consumption, Exports, Imports and investment.

Edadan (1997), basically talks about a possible relation between Privatization and the external debt situation of the developing countries. The research question of this paper is that either there is a relationship between the privatization and the indebtedness of a country. The major reasons for the countries to go for privatization are the huge fiscal deficits, negative balance of payments and the borrowings from the external sources. It is also stated in this article that inefficiency and irresponsiveness in public enterprises force countries to allocate huge amounts of funds to support their functions and survival which ultimately leads to high fiscal deficits in that country, or in other words create a need for that country to take external debt. According to this article Pakistan is a medium privatizor country. This paper has talked about the western model of privatization according to which there are two schools of thought the neo-liberals who are in favor of individual freedom and the neo-conservatives who are against the freedom of individual rather focuses on the state as a whole. The paper discussed either this model could be used in developing countries or not. The methodology in this paper shows that according to the log linear regression analysis privatization is influenced by the pressure from the lender countries. This paper used the secondary data and cross analyzed the 28 major privatizor developing countries.

Siddiqui and Siddiqui (2001), did a research on the external debt situation of Pakistan and its severity. According to the World Bank Pakistan is the only severely indebted country in South Asia. The research question of this paper states that what are the factors of debt rescheduling in Pakistan? Pakistan’s per capita debt has exceeded its per capita GDP that means its total debt is much higher than its total GDP. The increase in debt and debt servicing has ruined its creditworthiness in international market. When a country is under a severe indebted condition the debt rescheduling is the only way out of it. There are three main reasons why countries go for debt rescheduling. The first one is that it may help in achieving global efficiency, second it may not in the interest of a creditor country to force debt repayment and last one is rescheduling may help the creditor country achieve its political objectives from the debtor country. A qualitative response model is used in this paper to determine the probability of debt rescheduling in Pakistan using various indicators of debt rescheduling like Debt servicing/ Exports of goods, Debt servicing/ Gross National product and International reserves/ external debt. According to regression analysis these indicators have influence on the probability of external debt rescheduling of Pakistan.

This report by Elixir Securities Pakistan was published in September 2008. It basically talks about the external debt condition of Pakistan. According to the latest data available through the State Bank of Pakistan, Pakistan’s external debt has been rolled up to $55 billion USD. The euro bond payment that was due in late 2000s were not going to affect or increase the debt burden on Pakistan as the debt was rescheduled and the debt servicing burden came to as low as 18%-20% of its exports. The CDS credit default swap on the Eurobonds that Pakistan is holding have increased to 1000 basis point as compared to around 600 in year 2008. That means the market is attaching a higher probability on Pakistan to default on medium term loan. This publication by Elixir securities Pakistan has critically analyzed the External debt situation of Pakistan by using secondary data that is available through State banks Publications. There is no mathematical model used in this publication. The results of this publication shows that the external debt Pakistan is holding is still under sustainable limits and the condition of its debt are much better than they were in 90s.

Gupta (1994), states that external debt cannot be undertaken without taking the domestic public debt under consideration. Three types of budgetary gaps are discussed in this paper starting with the fiscal deficit which is basically the government revenue minus the expenditures. The second is budgetary deficit when the government fills the gap between its income and the expenditures by printing notes and third one is called the revenue deficit, to cover this gap government borrows money internally or externally and is basically meant to cover developmental and capital expenditures. A mathematical model has been used in this paper that provides the projections of the external debt indicators over the coming five years with some assumptions. This model states that the fiscal deficit and the balance of payment are interdependent and are also very much depends on the real interest rates and the exports of the country along with some other macroeconomic variables. This paper is totally based on India and how things are going over there regarding its debt situation, India was the main focus of this research paper. In order to solve the debt crisis India needs to achieve high exports and imports (high imports is only for the case of India as it would bring new technology in their country that would lead in boosting their production), increased capital inflow mainly in the form of FDI, maintaining real exchange rates, wise policy on real interest rates, and finally a careful combination of the sources of borrowing. A high domestic debt would lead to the crowding out effect on the other hand an external debt would lead to some other problems. So a calculated mixing of sources need to be used.

Laurent et al (2003) basically discuss how changes in exchange rates of a country would affect its external debt burden. The research question of this research paper is that how volatility in currency could affect a developing country’s external debt? According to this article external debt in foreign currency (US dollars or in a second major currency Euro) has some attractions for the debtor country the first one is that it carries the lowest interest rates and the second one is that it has much more value for them as compared to get it in their domestic currency. Along with these attractions it has some negative effects attached to it as it would increase the exchange rate risk which could be handled using debt management policy. The variations in the exchange rates and the interest rates are very important for determining the external debt dynamics of the developing countries. This paper has used a simple mathematical model that could help in stabilizing the domestic value of a country’s external debt using the exchange rate reference basket, currency composition and the geographical pattern of its trade. The findings of this paper states that if country wants to enhance its currency as an international currency it has to be used by other countries as a transaction currency the bigger the weight of its currency in trade the higher would be the incentive for countries to accept external debt in that particular country’s currency.

Hasan (winter 1999) basically talks about the condition of Pakistan’s external debt during 90s the research question of this paper is to find out the nature of Pakistan’s debt problem and a solution to its high debt problem. During the year 1996 Pakistan was at the verge of defaulting on its external debt as it froze its foreign currency deposits. But since then situation got better and never went to that level again up till now. And this all happened with debt rescheduling and debt restructuring under London and Paris clubs. This paper clearly states that there is a need to look at both types of debt sources (domestic debt and the external debt) so there should be different strategies for handling these two. The methodology of paper is secondary and theoretical in nature; no mathematical or statistical method has been used in it. Various debt indicators have been used in this article to analyze the external debt condition of Pakistan.

The main findings of this paper shows that external debt problems that are being faced by Pakistan along with debtor countries cannot be faced without considering other macroeconomic variables like the interest rate, the exchange rate, exports etc.

Bajpai (1994) basically focuses on India’s external debt condition in the 1990s and the reasons for the surge of its external debt and debt servicing. The basic research question of this paper states that what are the reasons for the upsurge of external debt in India? As compared to the Latin American countries on whom a lot of research has been done regarding their external debt problems. Their major focus was on the debt owned the commercial banks in the developed countries rather than official lenders. While on the low income countries like Pakistan, India etc a very little research has been done as they were usually indebted by official creditors rather than commercials. The methodology used in this article is totally theoretical in nature. Secondary data was used in conducting this research, mainly the publications available from the State Bank of India (Reserve Bank of India). No mathematical or statistical methods have been used in this paper. This paper has used few in indicators like Debt/GNP, Debt/Exports etc as the indicators for the external debt.

Arslanalp and Henry (2006), focuses on the importance of debt relief and how it could be helpful for the highly indebted countries in designing debt restructuring and debt rescheduling strategies. A debt relief would provide an indebted country opportunities to improve its efficiency and in stimulating its output growth. This paper basically discusses the Brady plan designed by brady during debt crisis of Latin American countries, the debt relief plan initiated by the IMF and World Bank for highly indebted countries and the Gleneagles proposal. This paper is totally theoretical in nature that used secondary data and various other publications that were available in journals. There is not any use of a mathematical or a statistical model. The main finding of this article is that the highly poor and indebted countries cannot be benefited with these proposal mentioned above, because for stimulating output growth a country has to have some infrastructure required which these highly indebted countries obviously do not have.

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