The paradox of external debt: Lessons from two decades of debt relief

The Heavily Indebted Poor Countries Initiative was adopted in 1996 to address what appeared to be a paradox; many Low Income Countries were struggling with large stock of external debt and declining economic growth despite two decades of debt relief initiatives. It appeared those policies had failed to resolve the difficulties faced by these countries in servicing their external debt and had failed to improve their economic performance. This study raises the following questions: Is there an incentive effect on performance from debt relief under the Heavily Indebted Poor Countries Initiative (HIPC)? Why have HIPCs remained heavily indebted? What are the critical variables that could explain the variation of external debt accumulation in low income countries?;The first chapter of this dissertation introduces the study and presents a background of external debt reforms and external debt evolution. The second chapter entitled "External Debt Relief and Economic Performance in LICs", analyses the recommended policy options for an indebted country which exhibits rent seeking and corrupt behavior. The framework applied shows that the best policy is to condition external debt reduction on policy reforms aimed at reducing 'bad' behavior. The effect of the HIPC Initiative on investment and economic growth is assessed empirically using a Regression Discontinuity and a System GMM. The results from the estimations show evidence of a marginal improvement in both investment and growth following the introduction of the initiative. There is also evidence that completion point countries have experienced a better performance than non-completion point HIPCs.;Chapter 3 entitled "External debt variation and accumulation in LICs", empirically investigates the determinants of external debt accumulation and variation using a system GMM. The objective is to assess the political theories that have been advanced to explain the varying nature of external debt accumulation. The main result shows that undemocratic regimes accumulate more external debt. This is robust to inclusion of different measures of political regimes. There is also evidence that debt rescheduling Low Income Countries accumulated more external debt. Other results show that GDP per capita negatively affects external debt accumulation while economic openness has a positive impact on external debt accumulation.;Chapter 4 summarizes the results and presents prospects for future research.