Debt Buybacks Signal Sovereign Countries' Creditworthiness: Theory and Tests

Basic analytics of multilateral lending and surveillance

“…The fact that the IMF in particular is putting increased emphasis on enhancing members' access to international capital markets makes this a highly relevant investigation. 12 The second is that Acharya and Diwan (1993) have shown that a debtor buying back its debt might signal its willingness to invest to creditors. In order to concentrate on the multilaterals' strategic role I therefore assume that the country has no accumulated debt.…”

“…1 The changing character of international financial markets has created a debate over the raison d'être of multilateral institutions such as the IMF and the World Bank. Given that the resources at their disposal are now dwarfed by the size of capital markets, do they still have a role to play in international lending?…”

Buybacks of Domestic Debt in Public Debt Management

“…In principle, contracts between a debtor and its creditors forbid debtor governments to engage in these market buybacks without receiving special permission (Rotemberg, 1991), but in practise these transactions have been common. 1 Bulow and Rogo¤ (1988,1991) provide a formal statement of the critique to buybacks. They argue that buybacks, even at existing secondary prices ("average value," as in their paper) are a costly mistake for the debtor, and that the country should be prepared to pay no more than the "marginal" value of its debt, which the authors argue is much lower.…”

“…They argue that buybacks, even at existing secondary prices ("average value," as in their paper) are a costly mistake for the debtor, and that the country should be prepared to pay no more than the "marginal" value of its debt, which the authors argue is much lower. 2 Other authors, instead, see buybacks with favour: a di¤erent set of motives for buybacks is given, among the others, by Krugman (1989), Froot (1989), Rotemberg (1991), Acharya and Diwan (1993), Cohen and Verdier (1995), Thomas (1996), Marchesi and Thomas (1999).…”

“…As Missale (1999) points out how policy-makers approach to debt management implies a tradeo¤ between cost and risk minimisation, he argues that policy-makers have so far been mainly concerned with the minimisation of borrowing costs ("without taking too much risk") while the correct approach should be the opposite, provided that risk premia on government securities are "fair", that is they re ‡ect only their risk-return characteristics. In sum, the objective of reducing interest costs should 1 For example, Brazilian state …rms eliminated nearly $7 billion of external debt in 1988 alone through discounted buybacks. Bolivia, in 1988, o¤ered an example of a buyback of commercial bank debt at the secondary market prices (it took four years to complete).…”