An evaluation of the international debt crisis: The case of Mexico, 1973-1989

Recent debates on the external debt situations of the heavily indebted developing countries have focussed on the existence of a "Debt Laffer Curve" in these countries and the need for debt reduction in order to alleviate their debt servicing difficulties. In addition, the diversity of commercial bank creditors of the heavily indebted countries and differences in their motivations for dealing with their debtors, partly due to the tax, accounting and regulatory regimes in the host country of each creditor bank, has called for the need to formulate a debt reduction "package" consisting of a market-based menu of options for each developing country debtor.This study begins with an overview of the trends in external indebtedness of the developing countries, in general, and those in Latin America, in particular. A detailed evaluation of an economy that allegedly suffers from a debt overhang problem, i.e. Mexico, is provided. Thereafter, the optimization problem faced by a policy maker in a country with a debt overhang situation is evaluated on the basis of an inter-temporal welfare maximizing model. The optimum level of investment in such an economy is directly influenced by the amount of debt relief and "New Money" that is granted by commercial bank creditors. There are several factors which influence the ultimate mix of options banks may grant a country in order to attain the required amount of debt relief. The theoretical framework is extended to incorporate some of these factors in order to compare the attractiveness of each option of a debt reduction package on the basis of a common benchmark. Two options representing the two extremes in the market-based menu of options, namely a debt buyback and a concessional rescheduling of existing loans, are specifically evaluated. Finally, the existence of a debt overhang in Mexico is econometrically examined and policy recommendations provided.U of I OnlyETDs are only available to UIUC Users without author permissio