Beyond the sovereign debt crisis: Alternative forms of market-based debt restructuring schemes

The resolution of the international debt crises has stimulated extensive research on how to design solutions for countries facing external debt overhang problems. This paper analyses the benefits for creditors and debtors of the following 'market-based' debt restructuring schemes: (i) issue of collateralised new assets in exchange for the old debt; (ii) automatic roll-over of the debt repayment with a state-contingent penalty rate. The first proposal combines the basic debt conversion scheme proposed by Krugman (1989) with Cline's proposal (1995) of self-enhancements on the new claims as a form of risk-compensation for creditors (see also Williamson, 1988). Under this scheme the debtor country modifies the stream of the debt service payments by voluntarily exchanging the outstanding debt for new assets with different debt service characteristics where the principal and/or the interest rate payment can be fully or partially collateralised. The roll-over scheme entitles illiquid countries to extend the outstanding debt for a specified period at a penalty rate which is contingent on a measure of the country's creditworthiness. This solution has the desirable effect of reducing the future contractual obligations by lowering the penalty rate on the excess of debt rolled over, thus helping the debtor country to use additional resources to invest' in the economy.