The Overhang Hangover

• Authors: Jean Imbs and Romain Rancière.
• BSE Working Paper: 219 | September 15
• Keywords: investments , Debt Overhang , Kernel Estimation , Debt Contracts , Debt Relief
• JEL codes: E62, F34, F43, H63
• investments
• Debt Overhang
• Kernel Estimation
• Debt Contracts
• Debt Relief

We revisit the debt overhang question. We first use non-parametric techniques to isolate a panel of countries on the downward sloping section of a debt Laffer curve. In particular, overhang countries are ones where a threshold level of debt is reached in sample, beyond which (initial) debt ends up lowering subsequent growth. On average, significantly negative coefficients appear when its present value reaches 60 percent of GDP or 200 percent of exports. second, we depart from reduced from growth regressions and perform direct tests of the theory on the thus selected sample of overhang countries. In the spirit of event studies, we ask whether, as the overhang level of debt is reached: (i) investment falls precipitously as it should when it becomes optimal to default, (ii) economic policy deteriorates observably, as it should when debt contracts become unable to elicit effort on the part of the debtor, and (iii) the terms of borrowing worsen noticeably, as they should when it becomes optimal for creditors to pre-empt default and exact punitive interest rates. We find a systematic response of investment, particularly when property rights are weakly enforced, some worsening of the policy environment, and a fall in interest rates. This easing of borrowing conditions happens because lending by the private sector virtually disappears in overhang situations, an multilateral agencies step in with conditional rates. thus, while debts relief is likely to improve economic policy (and specially investment) in overhang countries, it is doubtful that it would ease their terms of borrowing, or the burden of debt.