Does Debt Relief Burden Recipients? An Empirical Inquiry into Moral Hazard, Government Cost of Capital and the Real Winners Following HIPC Initiatives

Abstract

This paper examines the effects of HIPC iniatitives’ large-scale debt reliefs on recipient governments’ yield spreads. Due to scarce availability of existing measures, we originate raw data on 3,498 individual fixed-income securities to construct yield spread indices. We find evidence that HIPC governments carry an average yield spread premium of 298 bps on USD-denominated bonds and 128-333 bps on local-currency bonds compared to similar countries. The premium is orthogonal to most common risk factors. We suggest that creditors observe HIPC governments’ incentives for post-relief moral hazard and price this in a pooling equilibrium, but find few indications of actual moral hazard by HIPC governments. We estimate that HIPC governments have paid excess interests of USD 24.3bn or roughly 19.2 pct of their relief. These payments have instead financed excess investor returns