Is Debt Relief Efficient?

Abstract

When Less Developed Countries (LDCs) announce debt relief agreements under the Brady Plan, their stock markets appreciate by an average of 60 percent in real dollar terms—a $42 billion increase in shareholder value. In contrast, there is no significant stock market increase for a control group of LDCs that do not sign Brady agreements. The results persist after controlling for IMF programs, trade liberalizations, capital account liberalizations, and privatization programs.

The stock market appreciations successfully forecast higher future net resource transfers, investment and growth. Creditors also benefit from the Brady Plan. Controlling for other factors, stock prices of US commercial banks with significant LDC loan exposure rise by 35 percent—a $13 billion increase in shareholder value. The results suggest that debt relief can generate large efficiency gains when the borrower suffers from debt overhang.