Disincentive to invest in over-indebted countries

The debt overhang remains an obstacle to growth in debtor countries and a threat to the world economy. Where countries are unable to service their debt in full, actual payments tend to depend upon a country's economic performance. If exports increase as a result of policy reforms or further investment, most of the benefit usually then accrues to creditors (in the form of larger debt-service payments) rather than to the country itself. This depresses the returns to the country from fixed capital investment and thereby weakens the incentive to invest even if finance is available. Even in those cases when all of the country's foreign debt is held by the government, the disincentive effects of debt overhang will spill over into private investment, because the government has then no reason to encourage investment of any kind when most of the gains will be absorbed by higher debt payments. Such disincentive effects may be so strong that they give rise to a condition in which forgiveness by creditors could even raise the actual repayments they receive.

The emergence of serious and widespread debt-servicing difficulties began in 1982. The response of the international financial community was a retreat of commercial banks from lending to heavily indebted countries.

Investment in heavily indebted countries has been weak since 1982, both by historical standards and in relation to other countries. For example in Argentina the ration of investment to GDP fell from 25% to 15% between 1982 and 1988, and in Venezuela from 33% to 18%. By comparison, in a range of developing countries that are free of debt problems, the investment ratio typically increased over that period. Preliminary analysis by the IMF in 1989 concludes that such disincentive effects have contributed significantly to the fall in investment in debtor countries. In the 73 developing countries experiencing recent debt problems, the investment ratio fell from 27% in the late 1970s to 18% in 1988. In those without problems, the ratio rose from 26% to 28%.