The analysis of the potential externalities affecting the borrowing behaviour of developing countries

This paper deals with the externalities associated with the individual developing country’s cost of credit and borrowing level. As long as the supply curve of credit is positively sloped, the interest rate charged on credit extended to a particular developing country is affected by the aggregate borrowing level of the rest of the countries. Moreover, the relatively high level of indebtedness of big developing countries and their problems to service their external debts, might adversely affect the reputation of the developing countries as a whole and reduce their financial credibility. The estimation of the interest rate equations confirms the significant role of these externalities in explaining the cost of credit to individual countries in the three distinct developing regions of Latin America, sub-Saharan Africa, and Asia-Pacific. Furthermore, since the individual country's information about the borrowing of the other debtor countries is not perfect, this country perceives the interest rate on loans taken as a random variable, and hence might suffer from substantial costs of risk bearing. The implications of this type of externality on the borrowing behaviour of developing countries are analyzed within the context of a stochastic framework in which countries borrowing large amount of money behave like Stackelberg leaders. The estimation of the derived borrowing equations are found to be statistically significant in the cases of Latin America and Asia-Pacific. *The author is a member of the Department of Economics at Ben-Gurion University, Beer-Sheva 84105, Israel, and the Department of Economics at The University of Wollongong, Wollongong, New South Wales 2500, Australia. The author is grateful to Mark Freeman for a meticulous research assistantship in data collection and statistical analysis.