Swapping debts

Debt-equity swaps are a variation on foreign direct investment (FDI). They convert foreign currency debt into domestic currency investment, rather than serve as a channel for new money. Such swaps alter the debtors' obligation and reduce their interest-bearing external debt. However, since domestic currency is usually offered at a discount to investors, swaps can distort the allocation of resources: investments of marginal economic return may be undertaken. In addition the increase in the domestic money supply resulting from the conversion of foreign currencies may prove inflationary. On balance, though, if used carefully, debt-equity swaps can help to revive the momentum of productive investment. They can be used as "exits" by existing creditors if the original loan is sold to a third party before the swap, and they can provide a vehicle for repatriating flight capital.

As discussed in the World Development Report 1987, debt-equity swaps have covered substantial amounts of debt, especially in Chile and Mexico.