HIPC Debt Relief and Policy Reform Incentives

Abstract

Towards the end of the debt crisis decade, a vast literature on the issue of debt overhang emerged, which significantly influenced policy thinking and decisions concerning debt relief programmes in favour of developing countries. In a nutshell, the argument of this literature was that too heavy a debt burden was creating disincentives in the indebted countries, which in turn impeded adjustment and reform policies. According to this analysis, debt service obligations acted as an implicit taxation on all future returns on investments and reforms, therefore limiting the willingness of governments to implement the appropriate policies needed to promote economic growth. As a consequence, high debt implied low growth and, in the absence of a major debt relief initiative, heavily indebted countries were meant to stay trapped in a low equilibrium.