A country suffers from debt overhang if it owes more money to its creditors than it is able to pay (Krugman 1988).
The term “debt overhang” means a situation in which a firm’s debt becomes so large that any earnings generated by new investment projects are entirely occupied by its existing debt holders, and hence even projects with a positive net present value cannot reduce the firm’s present stock of debt or increase the value of the firm.
The concept of debt overhang came to the international finance literature in the mid-1980s, when the debt crisis provoked a series of important papers by Krugman (1988, 1989) and Sachs (1989). Debt overhang puts a country in to a situation in which its future debt burden is supposed to be so…show more content… Debt service is considered as an implicit tax as it increases the future tax burden of the private sector. Therefore debt overhang by discouraging investment and retarding economic growth of any country makes it impossible for highly indebted countries to make development and to escape poverty. It suggests that if there is any possibility of the external debt to be larger than the country’s repayment ability, than the debt-service cost would discourage domestic and foreign investment and also harm the economic growth of the country. High debt-service burden as increases the future taxes on the private sector and also lowers the private investment. In addition debt overhang can worsen economic performance of a country by changing its quality of…show more content… Sixteen countries of the world whose economies suffered from debt overhang in the 1980 are Argentina, Bolivia , brazil ,Bulgaria ,Costa Rica, The Dominican Republic, Ecuador ,Jordan , Mexico, Nigeria, Panama , Peru, Philippines, Poland ,Uruguay and Venezuela are the called the Brady countries. The debt overhang of these countries was improved by the debt relief plan engineered by former US treasury Nicholas Brady. Under the Brady plan, the international commercial banks agreed to write down a considerable portion of the debt owed to them by the Brady countries.
Debt relief helped the Brady countries in 1980, because it removed an obstacle of debt overhang that was standing in the way of its economic development, new lending, investment and growth. The major problem of the Brady countries was that they cannot efficiently service their debt in 1982 which increases the riskiness of the bank’s loan in these countries. Creditors at once got worried and rushed to collect on their loans which created a short-term payment burden of the debtors. Now their economy suffered from debt overhang with no new investment and their economic growth came to an abrupt stop. Once the debt was relieved the path was clear for new