Lending to developing countries revisited: changing nature of lenders and payment problems

Economic Systems 28 (2004) 235–256 www.elsevier.com/locate/ecosys

Lending to developing countries revisited: changing nature of lenders and payment problems Ays¸e Y. Evrensel* Department of Economics, Portland State University, Portland, OR 97207-0751, USA Received 2 January 2004; received in revised form 12 June 2004; accepted 2 August 2004

Abstract A review of the lending literature shows the lack of a general study regarding the changing nature of the coexistence among the various sources of disbursement. Empirical evidence from 110 developing countries indicates that, during the past three decades, some sources of disbursement have lost their relevance. During the post-debt crisis period, there has been a substantial reduction in the low-income countries’ access to private capital markets in favor of official lending. In the middleand high-income countries, the decline in commercial bank lending has been replaced by bonds, portfolio, and FDI flows. In terms of payment problems, while default represented the major concern during the debt crisis period, the likelihood of arrears has increased substantially during the postcrisis period. The paper argues that the changing nature of lenders and payment problems have important policy implications. # 2004 Elsevier B.V. All rights reserved. JEL classification: F34; F39 Keywords: International lending; Multilateral organizations; Payment problems; The debt crisis

* Tel.: +1 503 725 3925; fax: +1 503 725 3945. E-mail address: [email protected]. 0939-3625/$ – see front matter # 2004 Elsevier B.V. All rights reserved. doi:10.1016/j.ecosys.2004.08.001

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1. Introduction It has been almost two decades since the beginning and a little over a decade since the end of the debt crisis.1 This event, during which many developing countries defaulted or rescheduled their external debt, was a milestone in international lending as well as in the academic treatment of this subject. A close look at the literature on international lending reveals a change in the academic focus from the pre- to the post-debt crisis period. Until the debt crisis, both theoretical and empirical research focused on understanding the borrowerrelated dynamics of capital flows to developing countries. During the debt crisis, the initial focus of explaining the reasons for the debt crisis shifted to formulating suggestions to deal with the crisis. Most important, as soon as the IMF became involved in debt negotiations as a mediator, much attention was paid to the possible effects of the IMF’s involvement in rescheduling existing debt and providing new lines of credit to debtor countries. During the 1990s, IMF-related themes have remained at the center of the international lending literature, including catalytic effects of IMF programs (program countries’ improved access to private capital markets), the IMF’s position on capital account convertibility, portfolio flows to emerging economies (made possible by the IMF’s effort in the implementation of capital account convertibility), and the IMF’s involvement in countries that experienced currency crises in the 1990s. There is no question that these issues are substantial concerns for academicians and policymakers. However, there are other interesting questions that have not been revisited. For example, one often hears about portfolio flows; however, there has not been much talk about commercial banks that once were at the center of all discussions about international lending. Have commercial banks lost their relevance as a source of disbursement in developing countries? We constantly hear about emerging countries; however, there is not much talk about low-income countries in regard to their lenders, except for frequent initiatives that propose to write off their debt. Where do low-income countries receive their external funding from? In terms of payment problems, even though default was the major payment problem during the debt crisis period, this problem seems to be disappeared during the post-debt crisis period. Are payment problems no longer an issue? The above questions and concerns are relevant, among others, for three reasons that are closely related. First, because multilateral financial organizations provide low-cost loans to developing countries, the increased share of multilateral lending may reduce the share of private lending that is more expensive. Second, incentives associated with multilateral, official, and private funds may be different. If developing countries were more likely to use multilateral or multilateral-induced official funds to cover current expenses or finance irrelevant projects, increases in multilateral and official lending may not be desirable. Third, because multilateral and official lending does not punish badly-behaving borrowers as much as private lenders, the likelihood of payment problems may increase, as the relevance of multilateral and official lending to developing countries increases. 1 As to the start of the debt crisis, Eaton (1990) suggests 1983. As to the end, while some suggest 1990 when voluntary lending to developing countries started, Cottarelli and Giannini (2002) suggest 1993, when significant reduction in developing country debt was achieved due to the Brady plan that was suggested by U.S. Treasury Secretary Brady.

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This paper provides empirical evidence regarding the changing nature of the coexistence among the various sources of disbursement and its relation to payment problems in developing countries in the past three decades. The empirical analysis covers the 1970–1998 period and includes 110 developing countries. I examine the changes in the shares of various disbursement types and the relationship between these shares, as well as the changing nature of payment problems during the pre-debt crisis, debt crisis, and postdebt crisis periods. The rest of the paper is organized as follows. Section 2 provides a literature review on international lending to developing countries. Section 3 presents the results of the empirical analysis with respect to the sources of lending, country ratings, and repayment problems. Section 4 concludes.

2. Review of international lending literature In this section, I provide a review of the literature on international lending, which is divided into three periods: the pre-debt crisis, the debt crisis, and the post-debt crisis periods. 2.1. Pre-debt crisis period During the pre-debt crisis period, rapidly increasing lending to developing countries and associated concerns about countries’ ability to service their external debt resulted in a large number of theoretical studies. For example, the question as to what makes a country a net lender or borrower attracted attention (Hanson, 1974; Buiter, 1981). Many years before the debt crisis, the sustainability of foreign borrowing became an issue. Domar’s (1944) approach to the assessment of domestic debt burden was extended to external debt (Domar, 1950; Solomon, 1977). Some compared the response of domestic savings and foreign borrowing to external shocks (McCabe and Sibley, 1976), while others applied the framework of imperfect information and credit rationing to international lending (Jaffee and Russell, 1976; Hellwig, 1977). Due to the increasing number of rescheduling between 1965 and 1976, macroeconomic policies of borrowing countries, such as exchange rate regimes and resulting balance of payments and repayment problems, attracted attention. It was argued that competition among lenders weakened the financial discipline in borrowing countries and, as a result, the availability of external funds motivated borrowing countries to postpone real adjustments. Concerns were raised about the sustainability of a balance of payments financed by high levels of foreign borrowing, which would increase future debt services and the probability of arrears (Dhonte, 1975; Frank Jr. and Cline, 1971; Feder and Just, 1977; Sargen, 1977; Eaton and Gersovitz, 1981). 2.2. Debt crisis period During this period, researchers mainly investigated the reasons of the debt crisis, default and its consequences, and the role of the IMF in debt negotiations. As to the reasons of the

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crisis, the focus was on the characteristics of the world economy, international capital markets, and recipient countries’ domestic policies during the pre-debt crisis period. It was suggested that, following the first oil-price hike in the early 1970s, there was a substantial increase in commercial bank lending, which was due to current account surpluses and deficits accumulated by oil-exporting and oil-importing countries, respectively (Krueger, 1987). Even though lending to developing countries appeared to be robust, international capital markets were suspect of Ponzi schemes, especially during the 1970s, implying that borrowers may have met their debt service obligations through additional borrowing (Eaton, 1990). As an additional pressure, short-term debt increased substantially during the influx of lending to developing countries (Krueger, 1987; Eaton, 1990). Borrowers’ macroeconomic policies were suspect as well. Often, recipient countries engaged in unrealistic macroeconomic policies and exhibited domestic mismanagement, such as exchange rate misalignments, fiscal deficits, and import protection (Kharas, 1984; Dornbush, 1989; Eaton, 1990). Additionally, there was the issue of the government involvement in recipient economies through state enterprises and regulations, which meant that governments were engaged in the provision of output and employment. The term ‘‘loan pushers’’ was used to describe the commercial bank behavior, which implied that commercial banks did not have much concerns about how private borrowers used borrowed funds. It was argued that the reason for this behavior lied in commercial banks’ perception that they could force the governments to make good on private sector loans (DiazAlejandro, 1985). Various ideas were offered to explain the occurrence of the debt crisis. Some argued that the increase in world interest rates and the decline in developing countries’ terms of trade led to debt service difficulties in recipient countries, which resulted in the debt crisis (Eaton, 1990). Instead of country-specific and global problems, structural interpretations of the debt crisis were provided as well. It was argued that the debt crisis was the consequence of an incomplete international capital market with moral hazard and risk of repudiation. Under these assumptions, the optimal contract implies capital outflow and a decline in consumption, investment, and output in recipient countries, which was observed during the debt crisis period (Atkeson, 1991). As default and other payment problems appeared, researchers focused on various aspects of these problems (Edwards, 1984). They were interested in the question of when debtor countries may decide to repudiate their debt. Because the borrower has to forgo domestic resources to make payments on his debt, the benefit of default to borrowers is greater as the discounted net value of contractual obligations that are refused to be paid increases. It was suggested that default could be made more costly through sanctions (trade embargos, for example) that may be imposed by creditors on the recipient (Nunnenkamp, 1990). Instead of repudiating their debt service obligations unilaterally, recipient countries could threaten default to press the banks to participate in debt negotiations and rescheduling, which typically involves new lending (Krugman, 1988). This reasoning suggests that the bargaining power of debtors in negotiations increases, if accumulated debt is high enough to pose a serious threat to creditors, especially when creditors’ threat of sanctions is not credible (Bulow and Rogoff, 1986). However, the lender would realize that additional loans would not always protect the existing claims. Especially in the case of a

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debt overhang, additional lending may not be profitable to the lender, and the lender may still reduce capital inflows to a country, even if the borrowing country has implemented necessary policy reforms (Krugman, 1989).2 Related to the default game discussed above, the question of how to extract signals regarding the borrower’s willingness to either pay or repudiate his debt became one of the favorite topics. Some argued that a small country cannot establish reputation (Bulow and Rogoff, 1989), while others showed that reputation matters, especially over time ¨ zler, 1993). (Diamond, 1989). Empirical evidence verifies the relevance of reputation (O Apparently, the relationship between the availability of funds and the borrower’s creditworthiness depends upon the nature of the period. During periods of widespread payment problems, robust creditworthiness has a weaker effect on the provision of loans. However, during periods of buoyancy, lenders tend to discriminate among countries ¨ zler, 1993). according to their past payment record (O In addition to the examination of payment problems, the debt crisis introduced a new focus in the international lending literature on multilateral organizations, especially the IMF and, to a lesser extent, the World Bank, because these organizations became mediators in debt negotiations. The term ‘‘involuntary lending’’ was used to describe the IMF’s role in debt negotiations, which implied the IMF’s pressure on commercial banks to continue or increase lending to major borrowers (Nunnenkamp, 1990). Additionally, the Paris and London Clubs agreed to debt rescheduling or reduction, provided that borrowers accepted an IMF program (Rieffel, 1985).3 Because IMF loans impose certain policy changes on the borrower as implied by the IMF’s conditionality, a program country was expected to signal discipline and predictability to private capital markets, which is defined as catalytic effects of IMF lending (Dhonte, 1997). The nature of multilateral agencies’ influence on sovereign debt negotiations divided economists between an interventionist camp that advocated debt reduction financed by developed countries and a market-based camp that favored debt reduction through market mechanisms, such as debt-for-equity swaps and exit bonds (Wells, 1993). Others questioned the role of the IMF as mediator in the reduction of collection costs, because the amounts collected by multilateral organizations would be much less than what private lenders could have collected. The argument was that, as bargaining models of debt payment indicate, even if sanctions are costly to impose, there are circumstances under which they are credible (Eaton, 1990). The IMF instituted the policy of ‘‘lending in arrears’’, which was adopted from the Brady Plan and was not particularly supported by commercial banks, because it implied disbursement of IMF funds, regardless of whether an agreement has been reached with creditors or not. Theoretical analysis indicates that the 2 Debt overhang implies that the expected present value of future debt service payments is substantially below the contractual value of the country’s external debt. 3 While Paris Club refers to the association of sovereign lenders, London Club is the association of private lenders. Rieffel (1985) examines the cooperation between these clubs and the IMF. During the debt crisis, in order to decide about rescheduling, Paris Club estimated the likelihood of default using the IMF’s balance of payments projections. After establishing the debtor country’s need for debt relief, the creditors’ concern was to make sure that the country was able to service its debt on schedule. The Paris Club investigated the causes of the country’s debt problem, and insisted on an IMF program (a standby arrangement) before rescheduling the existing debt (Rieffel, 1985).

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difference between ‘‘lending in arrears’’ and ‘‘no lending in arrears’’ comes down to which participant has more payoff to enjoy (Wells, 1993).4 During the debt crisis, the focus was on subjects associated with borrowers, while the implications of payment problems for the lender were rarely considered. In one of these ¨ zler, 1989). rare cases, the effects of rescheduling on banks’ value were investigated (O Apparently, rescheduling of commercial bank debt does not have the same effect on banks’ values every time rescheduling occurs. In fact, empirical evidence suggests that, while commercial bank rescheduling prior to the debt crisis increased banks’ value, rescheduling during the debt crisis period decreased it. Payments associated with rescheduled debt may have been less than the expectations of commercial banks, which may have been induced ¨ zler, by the weak bargaining position of commercial banks early on during the debt crisis (O 1989). 2.3. Post-debt crisis period The representation of IMF-related subjects in lending literature has remained strong during the post-debt crisis period. Catalytic effects of IMF lending have been one of the most widely investigated topics in international lending during the post debt crisis period. Such effects imply that program countries may have an easier access to private capital markets (commercial bank loans, FDI, bond, and portfolio flows), because IMF programs signal macroeconomic discipline and predictability to these markets. Empirical studies on catalytic effects of IMF-supported programs have been relatively limited until recently. Empirical results do not verify the existence of catalytic effects associated with IMF programs. For example, while Rodrik (1995) shows that IMF programs have statistically significantly negative effects on portfolio flows, Bird and Rowlands (1997, 2000) conclude that the catalytic effects of IMF programs on private capital flows are either negative or insignificant. A recent review concludes that a Fund program does not guarantee an improved access to private capital markets (Cottarelli and Giannini, 2002). In fact, frequent use of Fund programs sends an adverse signal to private capital markets. Large programs may signal stronger commitment on the part of the country and the Fund. Precautionary programs may help boost program countries’ access to private capital markets. However, the most common result of studies on catalytic effects is that private creditors are willing to provide funds to program countries only when they perceive the reforms implemented by these countries as credible (Cottarelli and Giannini, 2002). In addition to catalytic effects, some recent studies revisit the issue of imperfect information in international lending. A recent study examines the determinants of capital flows to emerging countries during the 1990s using an imperfect information framework (Mody and Taylor, 2002). Assuming information asymmetries, the econometric analysis is 4 Wells (1993) uses a bargaining model with asymmetric information and concludes that, relative to no IMF intervention, ‘‘no lending in arrears’’ increases creditors’ payoff, decreases the expected efficiency of an agreement, hardens the bargaining strategy of creditors, and thereby increasing the price paid for debt, given the total payoff. Relative to no IMF intervention, an announced policy of intent to lend in arrears decreases creditors’ payoff, increases the expected efficiency of any agreement, and therefore decreasing the price paid for debt, given the total payoff (Wells, 1993).

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based on a disequilibrium framework in which supply and demand are not necessarily equal and the actual amount of the flow is determined by the short side of the market (Mody and Taylor, 2002). As discussed previously, while the pre-debt crisis literature took a theoretical interest in this subject, during the debt crisis period, the interventionist camp asserted that a mediator may reduce the information asymmetry between lenders and borrowers, facilitate negotiations, and enable participants to come to a mutually beneficial agreement faster. The renewed interest in asymmetric information in international lending may represent the continuation of these ideas. 2.4. Motivation of the empirical analysis The previous review clearly indicates the changes in the focus of the international lending literature. While borrowing countries’ macroeconomic characteristics constituted the main focus during the pre-debt crisis period, the emphasis was shifted to the examination of default and rescheduling during the debt crisis period. Since the debt crisis, the IMF and catalytic effects of IMF lending have been the main areas of research in international lending. Additionally, lending to emerging countries has dominated discussions on international lending. Without undermining the relevance of the current focus, I would like to raise other issues that contain important information about international lending, but have been largely overlooked. For example, there is not much talk about low-income countries in regard to their lenders, except for frequent initiatives that propose to write off their debt. Where do lowincome countries receive their external funding from? Because of the focus on emerging countries, one often hears about portfolio and bond flows into these countries. Based on the intensity of interest in these flows, one may think that these flows constitute the major source of external funds to emerging economies. The reality may be different. Additionally, until the late 1980s, commercial banks were at the center of all discussions about international lending. However, the academic interest in them has faded away. Have commercial banks lost their relevance as a source of disbursement in developing countries? In terms of payment problems, even though default was the major payment problem during the debt crisis period, this problem seems to have disappeared during the post-debt crisis period. Are there no payment problems anymore? The answers to these questions may contribute to our understanding of the changing structure of international lending. It is possible that multilateral organizations initiate official funds to low-income countries with weak or no conditionality at low or no cost, which would weaken the relationship between these countries and private capital markets. Because of the availability of official funds, countries may not be motivated to implement policies that would improve their creditworthiness. Finally, as the relevance of official and multilateral lending increases, one would expect an increase in payment problems, because of the lower cost of arrears or rescheduling associated with official lending. In addition to the low-income countries, the characteristics of international lending may have changed in the middle- and high-income countries as well. For example, bond and portfolio flows to emerging countries have received much attention in recent years. Emerging countries may have been engaged in policy reforms to further attract portfolio flows. If this is the case, a divergent tendency may exist among developing

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countries. While the low-income countries would become increasingly distant from private capital markets, the middle- and high-income developing countries would make more use of private capital markets.

3. Empirical analysis The main source of data is the World Bank’s Global Development Finance CD-ROM of 2000, which provides annual observations and covers the period 1970–1998. Country ratings are based on various issues of Institutional Investor. The data include 110 developing countries. Most results are reported for low-, middle-, and high-income countries. The reason for dividing the sample into three income categories is based on the fact that the extent of financial sector development is highly correlated with income levels. Sources of funds may have different shares among various income categories. For example, lower-income countries are expected to receive more official and multilateral funds than higher-income countries. Similarly, the likelihood of various types of payment problems may differ among the income categories. Income categories are defined based on the share of the country’s GDP in the GDP of the U.S. Low-, middle-, and high-income countries have less than 20%, between 20 and 40%, and more than 40% of the U.S. GDP, respectively. For all countries, income categories are defined each year to account for the possibility that some countries may move between different income categories over time. Even though some sources of disbursement or payment problems may be more relevant for certain income categories, it is important to observe changes in these variables over time. Therefore, results are reported for the pre-1982 period (pre-debt crisis period), debt crisis years (1982–1989), and the post-debt crisis period (after 1989). Changes in variables refer to decreases or increases between the pre- and post-debt crisis period, unless indicated otherwise. The main goal of the empirical analysis is to describe the changes in sources of disbursement and payment problems in the past three decades. First, the results regarding sources of disbursement, correlations between country ratings and sources of disbursement, and payment problems are presented. Then, feasible generalized least squares regressions and a logit model are used to provide estimations regarding sources of disbursement and payment problems, respectively. Finally, empirical results and their policy implications are discussed. 3.1. Sources of disbursement Table 1 shows the mean shares of various sources of disbursement in total disbursement for countries in different income categories. The shares of multilateral disbursement, bilateral disbursement, and grants in total disbursement become smaller, as the income level increases. This tendency is most apparent in grants. During the post-debt crisis period, the share of grants in total disbursement is about 48% in the low-income countries, while it is only over 3% in the high-income countries. The share of private disbursement in total disbursement, on the other hand, increases with the income level. During the post-debt

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Table 1 Mean shares of various types of disbursement in total disbursement (in %) Source of disbursementa

Private Bonds Commercial banks FDIb Portfolio Multilateral IBRDc IDAd IMFe Bilateral Grants

Low-income countries

Middle-income countries

High-income countries

Before 1982

Debt crisis

After 1989

Before 1982

Debt crisis

After 1989

Before 1982

Debt crisis

After 1989

19.6 1.2 10.2 8.2 .0 17.5 4.4 7.7 5.4 22.3 40.6

11.1 .0 5.7 5.4 .0 19.9 2.2 11.8 5.9 24.4 44.6

13.7 .44 2.6 10.6 .06 16.3 .1 12.1 4.1 22.4 47.6

40.3 1.2 25.3 13.7 .1 11.4 4.9 2.4 4.1 22.1 26.2

35.2 .09 15.9 19.2 .01 13.1 6.9 2.3 3.9 24.2 27.5

43.9 2.8 11.7 27.5 1.9 9.7 4.2 2.1 3.4 26.5 19.9

68.2 4.7 41.2 22.2 .1 11.6 5.7 .4 5.5 12.9 7.3

63.5 8.7 36.1 17.2 1.5 19.2 4.8 .1 14.3 11.2 6.1

74.5 16.1 26.1 23.8 8.5 8.1 4.7 .0 3.4 14.2 3.2

a

All disbursements are in gross terms except for FDI that is reported in net terms. FDI stands for Foreign Direct Investment, which is defined by the World Bank as investment that is made to acquire a lasting management interest (usually 10% of voting stock) in an enterprise operating in a country other than that of the investor. c IBRD stands for disbursements from the International Bank for Reconstruction and Development, which is a World Bank organization. d IDA stands for disbursements from the International Development Agency, which is a World Bank organization. e IMF stands for disbursements from the International Monetary Fund. b

crisis period, the share of private disbursement is about 14% in the low-income countries, while it is almost 75% in the high-income countries. Table 1 also shows substantial changes that have taken place since the debt crisis, especially in the low-income countries. In these countries, there has been a decline in private disbursement. For example, commercial bank credits declined from 10 to almost 3%. In terms of multilateral disbursement, there has been a change in the representation of various multilateral agencies. It seems that IDA disbursements have increased at the expense of funds provided by the IBRD and the IMF (from almost 8 to 12%). This reflects the division of labor between the World Bank’s two banks such that the IDA focuses predominantly on the low-income countries. While bilateral disbursements have remained around 22% of total disbursements, grants’ share has increased from 41 to 48%. In the middle-income countries, private disbursements have increased from 40 to 44%. However, the most important change has occurred among various types of private disbursement. For example, the increase in FDI flows (from 14 to 28%) has been considerable, while commercial banks’ share has declined by half. Multilateral lending and grants have declined slightly. Bilateral lending has increased from 22 to 27%. In the high-income countries, private disbursements have increased from 68 to 75%. There have been important changes among the various sources of private disbursements. While the share of commercial banks has declined almost by half, bonds and portfolio flows have increased substantially (from 5 to 16% and .1 to 8.5%, respectively).

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Multilateral lending and grants have declined slightly. Bilateral lending has increased from 13 to 14%. The results indicate a divergence between countries in different income categories with respect to the sources of disbursement. While non-private disbursements, in particular grants, have increased their share in total disbursement in the low-income countries, certain types of private disbursement have become more relevant in the middle- and high-income countries. The decline in commercial bank credits has been offset by substantial increases in FDI (middle-income countries), as well as in bonds and portfolio flows (high-income countries). 3.2. Correlations of country ratings and sources of disbursement The examination of the relationship between country ratings and sources of disbursement is important for two reasons. First, Table 1 indicates that the shares of official sources in total disbursement, especially grants, have been increasing in the lowincome countries. One would expect that country ratings have lost their relevance in these countries. Second, the finding that FDI, bonds, and portfolio flows to the middle- and highincome countries have been increasing and commercial bank lending has been decreasing raises questions regarding the relationship between country ratings and sources of disbursement in these countries. Table 2 shows the correlation coefficients on country ratings and sources of disbursement. Overall, private disbursements are positively and statistically significantly correlated with country ratings in all income categories. One of the interesting results concerns the

Table 2 Correlations between country ratings and shares of disbursementa Low-income countries Before 1982 Private .739***,b Bonds n.a. Commercial banks .648*** FDI .081 Portfolio n.a. Multilateral
.099 IBRD .451** IDA .293 IMF
.279 Bilateral
.497*** Grants
.361*

Debt crisis

Middle-income countries After 1986

.614*** .366***
.071
.413 .751*** .507*** .142 .072 n.a. .372** * .206 .191*** .539*** .275** .014 .012
.128 .081
.195* .156**
.392***
.512***

High-income countries

Before 1982

Debt crisis

After 1986

Before Debt 1982 crisis

.441*** .365 .405**
.042 n.a.
.189 .084
.215
.038
.259*
.424***

.483*** .455** .428***
.047 n.a.
.145* .009
.022
.092
.208**
.488***

.349***
.113 .308*** .019 .067
.051 .084
.297***
.162*
.107**
.502***

.185 .437 .099 .157 n.a.
.005
.504 n.a.
.657
.167
.205

.538***
.073 .359*** .177 .411
.721***
.399***
.521
.818*** .082
.406***

After 1986 .419***
.165* .278***
.096 .116
.572***
.536*** n.a.
.036
.013
.278***

a Country ratings are based on Institutional Investor’s country credit ratings of various years. Country ratings are expressed as numbers between 0 and 100, and higher numbers are associated with higher creditworthiness. Unmarked correlation coefficients are not statistically significant. Insufficient or no observation is indicated by n.a. b The signs *, **, and *** imply 10, 5, and 1 percent significance level, respectively.

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low-income countries. While the correlation coefficient is .739 before the debt crisis, it declines to .366 during the post-debt crisis period. This finding indicates that, although the low-income countries had a better access to private lending prior to the debt crisis, provided that they were creditworthy, their access has become weaker following the debt crisis. To a lesser extent, the same is true for the middle-income countries. However, in the highincome countries, the relationship between ratings and access to private lending has become much stronger following the debt crisis (from .185 to .419). With respect to multilateral lending, correlation coefficients are generally negative, small, and mostly statistically insignificant, and suggest that the share of multilateral lending increases with declining creditworthiness. Even the high-income countries received more multilateral lending during the debt crisis, when their ratings were lower. In these countries, the correlation coefficients are
.721 and
.572 during the debt crisis and post-debt crisis period, respectively. In terms of individual multilateral lenders, an interesting result is observed with respect to the IBRD. It seems that, when the pre-debt crisis period is considered, the IBRD provided more funds to the low-income countries when their ratings were higher (.451). The same relationship was true during the debt crisis (.539). However, the IBRD has provided funds to the high-income countries when their ratings decline. The relationship between lending by the IDA and country ratings seems to be weak, except for the high-income countries during the debt crisis (
.521). Similarly, the relationship between lending by the IMF and country ratings is weak, except for the highincome countries during the debt crisis (
.818). Bilateral disbursement and grants are generally negatively correlated with country ratings as well. With respect to bilateral disbursement, the highest and statistically significant correlations occur in the low-income countries during the pre-debt crisis period (
.497). The rest of the correlation coefficients are either small or statistically insignificant. In terms of grants, the correlation coefficient is larger in the low-income countries, especially during the post-debt crisis period (
.512). Overall, the relationship between country ratings and private disbursement is positive, while this relationship is overwhelmingly negative with respect to official disbursement. Clearly, countries receive more official disbursement when their creditworthiness is weaker. There is an interesting result concerning the low-income countries. Prior to the debt crisis, country ratings and private disbursement were highly and positively correlated, which indicates that even the low-income countries can access private capital markets, as long as they are creditworthy. Unfortunately, this relationship has disappeared during the post-debt crisis period. 3.3. Payment problems Table 3 reports the relative frequencies of payment problems for the income categories based on the contingency tables. The Pearson x2 statistics that test for the independence between payment problems and income categories indicate that these two variables are not independent. The occurrence of debt, interest, and principle forgiven seems to have started during the post-debt crisis period. Probabilities associated with these events are higher for the lowincome countries (.1562, .1044, and .1467, respectively). Similarly, the probability of

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Table 3 Relative frequencies of arrear, default, and reschedulinga Low-income countries

Middle-income countries

High-income countries

Before 1982

Debt crisis

After 1986

Before 1982

Debt crisis

After 1986

Before 1982

Debt crisis

After 1986

Forgivenb Debt Interest Principle

.0000 .0000 .0000

.0000 .0000 .0000

.1562 .1044 .1467

.0000 .0000 .0000

.0000 .0000 .0000

.1118 .0437 .1011

.0000 .0000 .0000

.0000 .0000 .0000

.1129 .0000 .0207

Reschedulingc Debt

.0000

.0000

.0164

.0000

.0000

.0258

.0000

.0000

.0253

Interest All loans Official loans Private loans

.0000 .0000 .0000

.0000 .0000 .0000

.1245 .1202 .0778

.0000 .0000 .0000

.0000 .0000 .0000

.0889 .0817 .0753

.0000 .0000 .0000

.0000 .0000 .0000

.0461 .0369 .0438

Principle All loans Official loans Private loans

.0000 .0000 .0000

.0000 .0000 .0000

.1259 .1221 .0862

.0000 .0000 .0000

.0000 .0000 .0000

.0925 .0875 .0774

.0000 .0000 .0000

.0000 .0000 .0000

.0534 .0461 .0532

Arrearsd Interest All loans Official loans Private loans

.1543 .1417 .1101

.1176 .1101 .1018

.3409 .3397 .2669

.0832 .0624 .0533

.0932 .0853 .0717

.2774 .2602 .2373

.0645 .0346 .0461

.0507 .0346 .0507

.1429 .1293 .1083

Principle All loans Official loans Private loans

.1708 .1482 .1233

.1241 .1107 .1113

.3472 .3462 .2808

.1142 .0853 .0753

.1039 .0889 .0817

.2953 .2796 .2609

.0806 .0668 .0461

.0484 .0392 .0415

.1406 .1359 .1083

Default

.0013

.0044

.0005

.0072

.0051

.0003

.0023

.0161

.0001

a

Probabilities are based on x2 (contingency) tables. The Pearson x2 statistics indicate that payment problems and income levels are not independent at the 1% significance level. Data are based on the World Bank’ Global ¨ zler (1989). Development Finance CD-ROM (2000), except for default information, which is from O b Debt forgiven shows the change in debt stock due to debt forgiveness. Interest forgiven is the amount of interest due or in arrears that was written off or forgiven in any given year. Principal forgiven is the amount of principle due or in arrears that was written off or forgiven in any given year. c Debt rescheduled is the amount of debt outstanding rescheduled in any given year. Interest rescheduled is the amount of interest due or in arrears that was rescheduled in any given year. Principal rescheduled is the amount of principal due or in arrears that was rescheduled in any given year. d Interest in arrears on the total outstanding long-term debt is defined as interest payment due but not paid, on a cumulative basis. Principle in arrears is defined as principal repayment due on total outstanding long-term debt, but not paid at the end of the year, on a cumulative basis.

rescheduling increases, as the income level declines. For example, while the probability of interest rescheduling is .1245 for the low-income countries, it is .0461 for the high-income countries. As in the case of debt, interest, and principle forgiven, these three types of rescheduling have started during the post-debt crisis period.

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Arrears have become the most likely payment problems during the post-debt crisis period. As in the case of forgiven or rescheduled payments, the probability of arrears increases, as the income level decreases. However, the likelihood of arrears has increased substantially in all income categories and, in some cases, it has more than doubled. For example, the probability of interest arrears in the low-income countries has increased from .1543 to .3409. Considering all three types of payment problems (forgiven, rescheduling, and arrears), the probabilities are higher in official disbursements. Compared to the pre-debt crisis period, the probability of default increased substantially during the debt crisis, especially for the low- and high-income countries. While the probability of default increased from .0013 to .0044 in the low-income countries, it increased from .0023 to .0161 in the high-income countries. However, during the post-debt crisis period, default has rarely occurred. In terms of payment problems, the results point out two characteristics of international lending. First, in all income categories, various types of official disbursement have a higher probability of being forgiven, rescheduled, or in arrears. This result is important, because it suggests that efforts to increase the share of official lending may lead to greater payment problems. Second, even though default has become a rare event during the post-debt crisis period, arrears have become a much larger problem. Even though the previous summary of the data with respect to the sources of disbursement, country ratings, and payment problems is informative, in the following, I present the results of the panel-data estimations to complement the results obtained until now. Estimations regarding the sources of disbursement are provided using a feasible generalized least squares framework. Estimations regarding payments problems are obtained from a fixed-effect logit analysis. 3.4. Estimations regarding sources of disbursement Fixed-effects regressions represent one of the techniques that can be applied to panel data, which controls for variables that may differ across countries, but remain constant over time. Even though they represent a solution to the potential problem of country-specific omitted variables in the panel data, fixed-effects regressions may lead to misspecification problems. In fact, when these regressions were applied to the data, the null hypothesis of Hausman’s test that the difference between the fixed and random effects coefficients is not systematic was rejected at a high level of significance. Alternatively, as in Ferrucci et al. (2004), disbursements may be modeled as seemingly unrelated regressions. For each country i, it is assumed that yit ¼

J X bj Xjit þ eit ;

i ¼ 1; 2; . . . ; N; t ¼ 1; 2; . . . ; T

(1)

j¼1

where yit is a T  1 vector of observations on the dependent variable for country i at time t, Xjit is a T  J matrix of observations on j explanatory variables for country i at time t, bj is a J  1 vector of coefficients, and eit is a T  1 vector of disturbances. The feasible generalized least squares (FGLS) can be employed to estimate disbursement equations. The FGLS method allows for different assumptions regarding

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the error structure across panels and autocorrelation within panels. As far as the error structure is concerned, across-panel homoscedasticity or heteroscedasticity with or without across-panel correlations may be assumed. In terms of the autocorrelation structure within panels, the model can be specified without auto correlations, with AR(1) autocorrelation that is common to all panels, or with panel-specific AR(1). However, the FGLS procedure that corrects for panel-specific AR(1) requires balanced panel data. Because of missing observations in the data, this procedure could not be employed in this paper. The relevant equations are estimated for various combinations of assumptions regarding the acrosspanel error structure and within-panel autocorrelations. In terms of the sign, size, and statistical significance of the estimated coefficients as well as the diagnostic tests, these models yield similar results. The results that are presented in the paper are based on the model that specifies a heteroscedastic across-panel error structure with no across-panel correlation and a panel-specific AR(1) process. Estimations are provided for official and private lending, as well as for their subcategories. Both types of lending are considered to be a function of other types of disbursement, country ratings, income level, and two debt crisis-related dummies. Variables that are related to various sources of disbursement are defined as shares of total disbursement. Country ratings are lagged 1 year to account for the effect of the last period’s economic performance on this period’s disbursement. They are used as a proxy for variables that are commonly employed in the literature, such as economic growth, the debt service/exports ratio, the total debt/exports ratio, the reserves/imports ratio, etc. (Berg and Sachs, 1988; Ferrucci et al., 2004; Mody and Murshid, 2002; Mody and Saravia, 2003). As discussed before, income level is defined based on the share of the country’s GDP in the GDP of the U.S. The debt crisis dummy takes a value of one during the period 1982–1989 and zero otherwise. Similarly, the post-debt crisis dummy takes a value of 1 for the post1989 period and zero otherwise. The results presented in Tables 1 and 2 summarize the data regarding the sources of disbursement and the relationship between the sources of disbursement and country ratings, which can be used to identify the expected signs of the FGLS coefficients. In terms of official lending, multilateral lending from various sources is expected to increase official lending to developing countries. There should be a negative relationship between official lending and country ratings. Similarly, as income levels decline, the share of official lending in total lending should increase. During the debt crisis and post-debt crisis period, official lending to developing countries is expected to increase as well. Private lending is expected to be negatively related to various types of official lending and positively related to country ratings and income levels. Table 4 summarizes the FGLS estimations regarding various sources of disbursement. In the following, unless indicated otherwise, only statistically significant results are reported. The results indicate that official lending is negatively related to private lending and country ratings, and positively related to income. The debt crisis and post-debt crisis periods are associated with an increase in official lending. Various types of official lending (bilateral, multilateral, and grants) are negatively related to various types of private lending as well. While country ratings do not statistically significantly explain bilateral and multilateral lending, lower country ratings lead to increased grants. Changes in all three types of official lending were not statistically significant during the debt crisis period.

Table 4 Feasible generalized least squares estimations of sources of disbursement Source of lendinga

Official lending Total

Diagnostics Log likelihood Wald x2 Pr > x2 a b

***,b

.74

***

.41

Multilateral ***

.28

Grants .51

Total ***

Commercial banks ***

.73
.14***

*

FDI

Portfolio ***

-.01**

.05

.98


.0001


.01***


.001

.16***
.13**
.13*
.05**


.06**
.03*
.02*
.12**


.03
.008
.003
.006

.007***
.002***
.01
.09***


.009***
.001
.04* .001

.0005***
.0002 .006 .01***


.18***


.001*** .002*** .03* .04** 769.24 8970.14 .0000


.05**
.03*
.003*
.001**
.001**
.03
.07*** 756.95 1020.72 .0000


.021**
.18***
.07** .001*
.003***
.02
.06*** 777.08 580.21 .0000


.07**
.06**
.09**
.004***
.002***
.04*** .01 521.99 2181.4 .0000

.001*** .004*** .02 .07*** .630.29 8957.28 .0000

600.59 1128.35 .0000

479.99 3128.54 .0000

A.Y. Evrensel / Economic Systems 28 (2004) 235–256

Constant Total official Bilateral Multilateral IBRD IDA IMF Grants Total private Commercial banks FDI Portfolio Country ratings (
1) Income level (
1) Debt crisis period Post-debt crisis period

Private lending Bilateral

2216.35 64.21 .0000

Sources of lending are expressed as shares of total lending. The signs *, **, and *** imply 10, 5, and 1 percent significance level, respectively.

249

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A.Y. Evrensel / Economic Systems 28 (2004) 235–256

However, the results indicate that bilateral and multilateral lending has declined during the post-debt crisis period. Private lending increases with declining official lending. Higher country ratings and income level lead to increases in private lending as well. Both debt crisis and post-debt crisis periods are associated with higher private lending. As far as the various types of private disbursement are concerned, the results suggest that, except for the IBRD, multilateral lending (IDA and IMF) is negatively related to commercial bank lending and FDI flows. IBRD lending seems to increase commercial bank lending. Higher country ratings increase all types of private lending, except for FDI. Changes in income levels do not explain the changes in various types of private lending; however, the results show that higher income levels lead to higher total private lending. With respect to debt crisis-related dummies, the post-debt crisis dummy in portfolio flows and commercial bank lending equations is statistically significant. It seems that, while portfolio flows have increased during the post-debt crisis period, commercial bank lending has declined. 3.5. Payment problems: fixed-effects logistic regression A fixed-effects (conditional) logistic regression is employed to estimate the incidence rate at which various types of payment problems occur. The conditional logistic model is different from the regular logistic model, because, in the presence of panel data, the likelihood of a particular payment problem is calculated relative to each country. This model can be written as Prðpit ¼ 1jXit Þ ¼ Fðai þ Xit bÞ

(2)

which indicates the probability of payment problems (pit) conditional to some explanatory variables (Xit). F represents the cumulative logistic distribution FðzÞ ¼

exp ðzÞ 1 þ exp ðzÞ

(3)

where z indicates (a + Xitb). Explanatory variables (Xit) include various sources of multilateral lending, private lending, country ratings, income level, and debt crisis-related dummies. Variables are defined as previously. Based on the results in Table 3, expected signs of the estimated coefficients can be summarized as follows. While multilateral lending from various sources is expected to increase the likelihood of payment problems, private lending is expected to decrease it. Increased creditworthiness and higher income levels should reduce the likelihood of payment problems. During the debt crisis and post-debt crisis period, the likelihood of repayment problems is expected to increase. Table 5 shows the results of the fixed-effects logistic regressions. In the following, only statistically significant results are reported, unless indicated otherwise. In terms of the relationship between payment problems and sources of lending, generally speaking, 1-year lagged multilateral and private lending does not predict the probability of payment problems. However, results regarding IDA indicate that 1-year lagged IDA lending decreases the probability of arrears and increases the probability of repayment forgiven.

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251

Table 5 Fixed-effects logit estimations of payment problems Arrearsa IBRD (
1) IDA (
1) IMF (
1) Private lending (
1) Ratings Income level Debt crisis Post-debt crisis Diagnostics LR chi-squared Pr > x2 Log likelihood

3.9582
8.8144
1.1756 .2256
.0546 .0495 .7929 1.7204

Forgiven *,b,c

(.061) (.006)*** (.282) (.621) (.001)*** (.201) (.096)* (.001)***

46.35 .0000
166.45


1.072 (.401) 3.2466 (.056)*
.6644 (.543) .0986 (.691)
.0082 (.641)
.1056 (.055)* .2027 (.139) 3.2702 (.116) 291.85 .0000
262.19

Rescheduling .5309 1.4531 1.3681 .4383
.0539
.1878 .1529 7.9045

(.698) (.469) (.298) (.321) (.015)** (.006)*** (.112) (.0000)***

258.45 .0000
188.03

a Arrears implies both interest and principle arrears. Forgiven implies debt stock, principle, and interest forgiven. Rescheduling implies interest rescheduling. These variables take a value of 1, when the relevant payment problem occurs and zero otherwise. b Numbers in parenthesis are p-values associated with z-statistic. c The signs *, **, and *** imply 10, 5, and 1 percent significance level, respectively.

IBRD lending increases the likelihood of arrears. Declining country ratings predict all three types of payment problems. With respect to payment forgiven and rescheduling, lower income levels lead to an increase in the likelihood of these payment problems. In terms of the relevance of the debt crisis dummies, the probability of arrears and forgiven increased during the debt crisis period. However, the debt crisis period predicts a declining probability of rescheduling. The probability of all three types of repayment problems has increased during the post-debt crisis period. 3.6. Discussion of empirical results The empirical results regarding sources of disbursement point out to a divergence between lower- and higher-income countries since the debt crisis. While the low-income countries have become more dependent on official disbursements, especially grants, the middle- and high-income countries have received more private disbursement. Additionally, higher-income countries have experienced different changes regarding the types of private disbursements. Commercial bank lending has been partially replaced by increases in FDI flows in the middle-income countries and increases in portfolio and bond flows in the highincome countries. All three types of multilateral lending (IBRD, IDA, and IMF) have a negative effect on private lending. In terms of the relationship between country ratings and types of disbursement, country ratings and all types of private disbursement (except for FDI) are positively related. This relationship changes with the types of official disbursement. While there is a negative association between country ratings and grants, there is no statistically significant association between country ratings and bilateral or multilateral disbursements. Additionally, the results contradict the belief that the low-income countries cannot have

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access to private capital markets, no matter what kind of policies they implement. Before the debt crisis, there was a positive association between country ratings and private disbursement in the low-income countries. The empirical results regarding payments problems suggest that the probability of arrears, forgiven, and rescheduling has increased during the post-debt crisis period. Higher country ratings and income levels are associated with declining likelihood of payment problems. It seems that IDA disbursements are positively associated with payments forgiven and negatively associated with arrears. IBRD disbursements are positively associated with arrears. There is an important reason why we should care about these results. It seems that, as in many other areas of economic development, lower- and higher-income countries have been growing apart in terms of international lending. This issue has been recently recognized. For example, Easterly (2002) views multilateral organizations and official lenders as loan cartels because they provide financial assistance to developing countries at low or no cost. In addition to multilateral institutions’ own lending to developing countries, if these institutions are able to persuade developed countries to provide more bilateral loans and grants to the low-income countries, multilateral institutions may in fact be viewed as lowcost loan cartels. Therefore, as opposed to a cartel that increases the price and decreases the quantity of its product, multilateral organizations may have decreased the price and increased the quantity of official loans. If this trend continues, one may argue that incentives to implement reforms in the low-income countries will be further reduced. The preference for private capital flows lies in the fact that reputation and creditworthiness matter in private capital markets, which would motivate countries to adopt consistent and credible policies. The current emphasis, however, continues to be on what multilateral organizations can do for borrowing countries. For example, Marchesi (2003) suggests that countries with an IMF program are more likely to obtain a rescheduling of their external debt than others. It is, however, questionable whether this result can be interpreted as a signal of the program country’s good intention and the lenders’ reward for this intention, as suggested in Marchesi (2003). Rescheduling is a payment problem, and as such, it cannot represent a signal of credibility. The lender would prefer timely payment to arrears or rescheduling. From the lender’s viewpoint, only default is worse than arrears or rescheduling. Clearly, private disbursements require a much more stable economic environment and credible macroeconomic policies. Empirical results indicate that the middle- and highincome countries have experienced substantial increases in their bond, portfolio, and FDI flows. Because FDI flows have a larger permanent component than other types of private flows (Sarno and Taylor, 1999a, 1999b), the middle-income countries must have provided a sense of long-term security to investors to be able to increase FDI flows. Similarly, the fact that portfolio and bond flows have increased in the high-income countries since the debt crisis indicates that these countries have demonstrated some credibility in their macroeconomic policies to attract these flows. In addition to the improvements in macroeconomic policies, both the middle- and high-income countries must have introduced substantial structural reforms to attract private disbursements. Even though the debt crises of the 1990s demonstrated the highly reversible nature of portfolio and bond

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flows, increases in these types of disbursement have been improving both economic policies and the economic structure in the middle- and high-income countries. It seems that, as middle- and high-income countries’ incentives to pay more attention to their policies have been increasing, low-income countries’ incentives to improve their economic policies and introduce reforms have been declining. These divergent changes between different income groups have been introducing different dynamics into individual countries, as well as into the international community. The argument that the low-income countries cannot enjoy improved access to private capital markets implies a static view of the world. As it happened during the pre-debt crisis period, when the low-income countries with higher country ratings received higher levels of private disbursement, the dynamics of international lending can change again for today’s low-income countries, provided countries become more credibility-conscious. Therefore, the primary conclusion of this paper is that, especially in the low-income countries, the academic focus should include countries’ economic policies and the use of borrowed funds. Currently, the dynamics between official lending and domestic policies have been examined in terms of the effectiveness of IMF programs and the possibility of moral hazard associated with these programs (for example, Evrensel, 2002; Dreher and Vaubel, 2004). Certainly, this is a substantial subject and should not be underestimated. This paper argues, however, that the current focus should be complemented by emphasizing the relationship between other types of official lending (non-IMF multilateral, bilateral, and grants) and domestic policies in the low-income countries. The results presented in this paper point out another interesting issue. Even though the IMF has been in the center of the discussions on international lending in recent years, the World Bank has been largely overlooked. The results indicate that the World Bank has taken an important presence in the low-income countries, and both IBRD- and IDA-lending are associated with payment problems. Therefore, the World Bank-related lending should receive more attention in future research.

4. Conclusions A review of the literature on international lending reveals that the debt crisis of 1982 had a significant effect on the focus of the literature. While the pre-debt crisis literature was primarily focused on debtor countries’ economic conditions, two new subjects appeared during the debt crisis period: prediction of payment ability or intentions and the role of the IMF in debt talks as mediator. It seems that the IMF’s role in enhancing program countries’ access to private capital markets has been carried over to the post-debt crisis period. This paper points out some of the subjects related to international lending that have been neglected during the post-debt crisis period. The results of the empirical analysis suggest that, during the past three decades, the sources of disbursement in developing countries have changed. The low-income countries have lost their access to private capital markets substantially in favor of official lending (grants, bilateral, and multilateral lending). In the middle- and high-income countries, the decline in commercial bank lending has been replaced by portfolio, bonds, and FDI flows.

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The relevance of the changing nature of various disbursement types lies in the fact that the representation of disbursement types in countries may affect their economic policies. Because the low-income countries have become increasingly dependent on official flows, their incentives to improve their economic policies and introduce reforms may have been declining. The middle- and high-income countries, on the other hand, have incentives in implementing credible policies and introducing structural reforms to attract portfolio, bonds, and FDI flows. Additionally, the results indicate that official lending is associated with higher probabilities of payment problems. Because official lending has a larger share in the lowincome countries, the likelihood of payment problems is higher in these countries. During the post-debt crisis period, the probability of arrears and rescheduling is 50% and 20%, respectively. Developing countries may be experiencing a de facto debt crisis that may have been fueled, especially in the low-income countries, by substantial increases in official lending during the post-debt crisis period. More important is the possibility that official lenders may be those who have been trying to prevent the de facto debt crisis from becoming the de jura debt crisis. Based on the above results, this paper argues that the changes in disbursement types and payment problems reveal divergent dynamics that have taken place among developing countries of various income groups. While the low-income countries may have entered the official funds–worse policies vicious cycle, the middle- and high-income countries may be enjoying the private funds–better policies virtuous cycle. These remarks do neither underestimate the problems associated with private flows, such as the currency crises of the 1990s, nor do they imply the futility of official lending in the form of short-term crisis lending or grants. The only relevant issue is the possibility that certain types of disbursement may magnify the existing domestic inefficiencies of borrowers. Therefore, this paper proposes a renewed interest in borrowers’ economic policies and in the dynamic relationship between disbursement types and economic policies, especially in the lowincome countries. Additionally, the paper points out that, compared to the IMF, the role of the World Bank in international lending has been largely overlooked. The results indicate that the World Bank has taken an important presence in the low-income countries. Therefore, future research should focus on the World Bank-related lending as well. Based on the results presented in this paper, one may question the success of recent proposals that additional borrowing and further rescheduling of existing debt would be required to reduce developing country debt. There have been suggestions, some of which made by the IMF and the World Bank, regarding the need of an international lender of last resort, an international bankruptcy court, or debt forgiveness. Adding new responsibilities to existing multilateral institutions may not represent a solution, particularly if there is still much to learn about the dynamics among the various sources of lending to developing countries.

Acknowledgments I thank Ali M. Kutan, Myles Wallace, Sushanta Mallick, and three anonymous referees for their helpful and insightful comments on this paper. The usual disclaimer applies.

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