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© 1991 International Bank for Reconstruction and Development / The World Bank

research-article

THE MARKET FOR DEVELOPING COUNTRY DEBT: The Nature and Importance of Its Shortcomings

John Wakeman-Linn

There are two problems in the market for developing country debt: one is the immediate crisis. What do we do about the large volume of outstanding debt? A more subtle but no less important problem is that because contracts are un-enforceable and lenders have incomplete information about risk, capital is mis-allocated. This article examines the latter problem and reviews the nature and causes of the unenforceability. It shows that unenforceability results in higher interest rates on smaller and shorter-term loans than would otherwise be available and discourages investment in developing countries. Similarly, unenforce-ability can explain the perverse timing of capital flows to developing countries, causing credit to flow into the country when income is high, and out when income is low. The article then analyzes the risk associated with three types of information asymmetries: information about the borrowers' ability to repay, willingness to repay, and use of the loan proceeds. These asymmetries, the author argues, reinforce the effects of unenforceability. The prospects for remedying the immediate crisis are discussed, as is the need to be certain that the proposed solutions do not aggravate these problems.


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