Tolerance of Arrearages: How IMF Loan Policy Can Affect Debt-Reduction

Abstract

A model of bargaining with asymmetric information is applied to the case of sovereign debt and IMF intervention. Debtors and creditors are assumed to bargain over the "price" to be paid by the debtors for their outstanding debt, and the ability of the debtors to delay an agreement is private information. It is shown that an IMF policy of "no lending in arrears" increases the price of the deby, increases any delay to agreement, and increases the likelihood that the creditor will demand the highest price. An IMF policy of "lending in arrears," in contrast, decreases the price of the debt, decreases the delay time to agreement, and may increase the likelihood that the creditor accepts the lowest price as it shifts the locus of bargaining power. Predictions of the model are consistent with results from recent debt agreements, and implications for current debate on debt-reduction strategies are discussed.