Institutional investment and multilateral debt relief

In 1996, the IMF and the World Bank launched the Heavily Indebted Poor Countries (HIPC) Initiative. The program provided a multilateral debt relief to assure sustainable debt levels. To obtain the relief, HIPC had to show a track record of institutional investments to improve institutional quality. In this paper, I analyze the effectiveness of the HIPC Initiative through the behavior of private lending markets after HIPC relief. I propose two proxies for institutional quality perceived by private investors: the amount of funds lent and the sovereign default on those loans. Using data from 30 HIPC in the Sub-Saharan African region, I find that receiving the relief is positively correlated with lending from private investors, and negatively correlated with sovereign default in private sector funds. Since default expectations are key determinants of lending decisions and countries could self-select into the HIPC Initiative, I build a structural sequential dynamic discrete choice model with multiple sequential choices that includes observed and unobserved heterogeneity. Agents raise funds from multilateral and private sources and decide on institutional investment, default or repayment, the type of default, and the optimal debt allocations. The model captures a reduction in sovereign default on private bonds as an explanation of the equilibrium increase in the bonds’ level. Robust analyses describe the importance of the design of the relief program into institutional quality improvements.