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In March 1989, the US announced the `Brady plan' for the reduction of
Mexico's external debt, and it justified its support for this breach of
contract on the grounds that it was essential to the restoration of
growth and stability. This proved a spectacular success: interest rates
on local currency debt fell by 20 percentage points within days of the
agreement's conclusion, private investment boomed, and growth took off
for the first time since 1982. The `debt overhang' hypothesis suggests
that debt relief exerts its main impact on future growth through the
reduced tax burden, but Mexico's debt relief of $12 billion in net
present value terms could have reduced its corporate tax rate by only
1.5 percentage points on a permanent basis at most, which could not
account for the 14% average real growth of private investment observed
for two years after the plan's implementation. In Discussion Paper No.
904, Stijn Claessens, Daniel Oks and Research Fellow Sweder
van Wijnbergen note that the deal not only reduced but also smoothed
Mexico's debt service obligations, so the spectre of recurring crises
associated with particular peaks in repayments therefore lost much of
its threat. They find that the reduced variance of repayments explains
most of the deal's effect, while a proxy for the effect of debt overhang
has no explanatory power. Their econometric evidence confirms that debt
relief has potentially beneficial macroeconomic effects, which operate
mainly through the reduction of uncertainty concerning future exchange
rate crises. |