Chronicle of a Default Foretold: Asymmetric Debt Response to Predictable Shocks

This paper extends the analysis of sovereign debts to the incidence of foreseeable, permanent negative terms-of-trade shocks. Although the prospect of permanent drops in coffee prices was common knowledge in 1989, even the most coffee-dependent countries continued to accumulate debts as fast as non-coffee exporters. The waves of defaults ensued. However, private creditors did reduce exposure in a rational manner, while public creditors did not. Curiously, the latter engineered the “coffee crisis” in the first place, yet failed to respond to the predictable shocks of their own making. Policy implications include: (i) public creditors should not rely on in-house economic forecasts; (ii) foreign aid projects need the assessment of product-market impacts, to avoid unintended financial-market consequences; and (iii) intranational policy coordination is desirable for successful international cooperation.