Private Investment and External Debt: The Debt Overhang Hypothesis Revisited

Recent empirical papers dealing with the debt crisis and its impact on the rate of investment (especially the private investment to GDP ratio) report conflicting results. However, none of the studies account for the fact that the market for investment loans may not have been in equilibrium. This paper tries to address that issue and carries out an empirical exercise to determine the causal links between indebtedness and private investment in a disequilibrium framework over the period 1971 to 1992. The results indicate that, the increase in debt stock and debt service ratios since 1982 reduced both demand for private investment and the supply of credit.