FOREIGN DEBT, ECONOMIC GROWTH, AND THE PROBABILITY OF DEFAULT (HONDURAS)

Most less developed countries are dependent on external borrowing to achieve high sustained economic growth. However, external borrowing requires fixed payments independent of the actual return on the invested funds. If a country either invests the money inefficiently or is subject to unexpected difficulties, it may not be able to meet contracted service payments. Potential debt servicing problems have existed for many years, and recently, the actual occurrence of service interruptions has become much more frequent. Despite the difficulty of servicing debt, it is optimal, in an economic sense, for less developed countries to borrow abroad. Foreign capital goods are usually scarce in less developed countries so their productivity is relatively high. Foreign borrowing allows more imports of capital without forcing down consumption. As long as the productivity of the capital exceeds its cost, debt servicing problems should not arise. A study of Honduras indicates that real GDP growth can be increased through foreign borrowing. However, the higher level of debt raises the likelihood of debt servicing difficulties. Even when the use of debt is efficient, a heavier debt burden makes Honduras more susceptible to unexpected shocks. But if GDP growth is not overly ambitious, the debt servicing burden stabilizes and may eventually begin to decline. The greatest danger arises when future debt servicing requirements are ignored. A sharp increase in external debt may allow high GDP growth in the short run but eventually the resulting debt service will become unsustainable