Sovereign Debt Overhang, Expenditure Composition and Debt Restructurings

Abstract

Sovereigns' public capital influences sovereign debt crises and resolution. We compile a dataset on public expenditure composition around restructurings with private external creditors. We show that during restructurings, public investment (i) experiences severe decline and slow recovery, (ii) differs from public consumption and transfers, (iii) reduces share in public expenditure, and (iv) relates with restructuring delays. We develop a theoretical model of defaultable debt that embeds endogenous public capital accumulation, expenditure composition, production and multi-round debt renegotiations. The model quantitatively shows severe decline and slow recovery in public investment-"sovereign debt overhang"-delay debt settlement. Data support these theoretical predictions.

The Bribe Rate and Long Run Differences in Sovereign Borrowing Costs

“…In contrast, in Arellano and Bai (2017), the tax rate cannot be changed but the level of debt and government spending can be changed. Asonuma and Joo (2019) incorporate different forms of public expenditure while also keeping the tax rate fixed and show that the model can deliver declines in public investment during restructurings which is a feature of the data. The models differ in several respects from our work, especially that government revenue in our model is exogenous whereas in their model it depends on the interaction of given tax rates and endogenous income and consumption.…”

Climate Defaults and Financial Adaptation

“…Our paper also integrates best estimates of cyclone damages from the empirical climate economics literature, including Nordhaus (2010), Mendelsohn et al (2012), Hsiang and Jina (2014), Hsiang and Jina (2015), and Bakkensen and Barrage (2022). 4 Our paper connects the climate economics literature to the growing literature on sovereign default, including Eaton and Gersovitz (1981), Bulow and Rogoff (1989), Aguiar and Gopinath (2006), Arellano (2008), Yue (2010), Mendoza and Yue (2012), Bai and Zhang (2012), Chatterjee and Eyigungor (2015), Hatchondo et al (2016), Phan (2016Phan ( , 2017b, Park (2017), Dovis (2019), Bianchi et al (2019), Joo (2020), andda Rocha et al (2022). 5 A related paper is Mallucci (2022), which introduces hurricane risk and CAT bonds into a quantitative endowment economy framework with long-term debt carefully calibrated to a sample of Caribbean countries and provides a refined discussion of the impact of disaster risk on spreads.…”