Debt Relief and Gain to Creditors in the 1997 Korean Crisis

1. P=price of debt security=0.5 P’=new price of debt security=0.56 Gain to creditors (sellers & holders)= Debt relief=50-42=8 The externally funded costs=

2. Cross Section

4. Gain to sellers Gain to holdout creditors Total gain to creditors

5. Emerging Markets 1997 Korean Crisis (1997): Liberalization of capital account was associated with $120 billions of capital inflows, 1992-1997. Reversals of flows in second half of 1997 thru 1998 generated a downturn in the economy and debt problem but this time mostly to private sector and financial intermediaries- although there was a substantial Intl bail out.

6. Brady Bonds Deal • A country issues new bonds (Brady Bonds) with a reduced rate of interest, and with Industrial Country Coovts guarantees. Thus the market will purchase these bonds since they are credit worthy. • Resources obtained from the Brady Bonds’ issue will be used to buy back the country old debt. (on which the country was not credit worthy) Thus, the real amount to a combination of external funding (not thru grants but through good credit) that finances a buy back of old debt.

7. Price 1 New price 0.56 Old price AV 0.5 MV Nominal debt 25 75 100

8. Knocked DownSecondary-market debt prices,September, 1991, % of face value

9. International Cross-Section Regression P=price D=Nominal Debt X=Exports G=Growth rate

10. At D*

11. Debt Reduction and Expected Repayments: Effect on probabilities. D=face value V=pD+(1-p)d Marginal change in probability of good state when face value increases by 1 unit <0 • Thus the debt reduction raises AV for 2 reasons: • Relative payments d/D, rise • P rises.

12. AV= Average of debt =0.5 (price) MV=Marginal value of debt=0.33 (1/3) MV<AV Mv is the change in the market value of debt (=Expected repayment to creditors) if the NOMINAL debt is increased by 1 unit.

13. PD=V Debt relief Laffer Curve D* D 1 P* AV D D* MV