Methodological issues in evaluating debt - reducing deals

The Brady Initiative has introduced official support for debt reduction. This new phase in the debt strategy requires a new set of tools to analyze debt deals and to study the impact of a deal on the debtor country. This paper discusses first the methodological issues involved in evaluating the different individual components of a debt deal, i.e., in a market-based context, and shows that the evaluation can be reduced to a tradeoff in two dimensions: debt reduction versus liquidity. The paper presents a specific model to evaluate a debt deal consisting of multiple components, i.e., new money and debt reduction instruments. The paper argues that creditors not participating in any debt reduction free-ride on the increase in value of the remaining debt. The paper presents the building blocks for an analysis of debt deals, discusses some common pitfalls and introduces the concept of the debt value curve. The different instruments available for debt reduction are analyzed. The paper also discusses three recent debt deals in Mexico, Philippines and Costa Rica.