A New Look at Debt Rescheduling Indicators and Models

Author(s): John B. Morgan

Source: Journal of International Business Studies, Vol. 17, No. 2 (Summer, 1986), pp. 37-54
Published by: Palgrave Macmillan Journals
Stable URL: http://www.jstor.org/stable/154582
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 A NEW LOOK AT DEBT RESCHEDULING
INDICATORS AND MODELS

John B. Morgan*
Data Resources, Inc.

Abstract. This paper presents logit and discriminant models of

debt rescheduling. The models incorporated new short-term debt
data and variables representing economic shocks. The 30-country
database covered the period from 1975 to 1982 and contained
the largest number of debt rescheduling observations of any pre-
vious database. Because of the new indicators and more recent
data, the models captured the effects of the changes that have
occurred in the world economy since the oil price shocks and the
period of rapid debt accumulation by the developing countries.
Compared to the earlier research models, the models have proven
to be efficient in forecasting debt reschedulings.

Following the wave of debt reschedulings by more than thirty countries

from 1981 to 1984, there was a pressing need to reassess country risk
techniques used by international commercial banks. Before 1980, the
amount of risk associated with lending to a country was usually discussed
in general terms and was not quantified. Comparisons of risk between
countries and regions were often very difficult. Upon reexamination of
country risk techniques, it became evident that economic indicators
needed to be found that distinguish countries that reschedule their debts
from other countries. Next, after those indicators were identified, a model
needed to be constructed that would forecast countries that are likely to
reschedule their debts.
Earlier research on debt rescheduling helped to identify a few of the
important indicators, such as the debt service ratio and the imports to
reserves ratio. However, the earliermodels of debt rescheduling [i.e., Frank
and Cline (1971) and Feder and Just (1977)] did not appear to be repre-
sentative of the current international debt environment. First, the earlier

* John B. Morganis the InternationalManagingConsultantin the Washingtonoffice

of Data Resources, Inc. He is responsiblefor economic projects, contract researchand
consultingefforts involvingeconometric anddataapplicationsfor a numberof agencies
includingthe Departmentof State, Treasury,and Commerce,the IMF, and other inter-
national organizations.Previously,he was a Vice Presidentand InternationalEconom-
ist at Texas CommerceBank, Houston. He receiveda Ph.D. from Rice University.
Date Received: February 1985; Revised: October 1985; Accepted: December 1985.

37
38 JOURNAL OF INTERNATIONAL BUSINESS STUDIES, SUMMER 1986

models were based on the period of the sixties and seventies which con-
tained only a few cases of debt reschedulings and were estimated before
the period of vast debt accumulation. Second, the earlier models did not
reflect the important changes which occurred during the seventies in the
structure of the indebtedness in the developing countries and in the
world economy. For instance, the maturity structure of external debt
had been altered with the rapid expansion of short-term debt. The usage
of variable interest-rate loans had increased which made the debtor
countries more vulnerable to changes in international interest rates. Two
oil price shocks had altered trade relationships and had distorted the
balance of payments of some non-oil developing countries. Hence, events
which caused debt reschedulings in the late sixties and early seventies
may be entirely different from those which caused reschedulings in the
early eighties.
Economic indicators used in some of the earlier research models may or
may not be useful in analyzing and forecasting debt reschedulings in the
early eighties. With the recent wave of debt reschedulings, a model util-
izing the larger number of debt rescheduling observations and newly avail-
able short-term debt data and other economic indicators could be more
meaningful and efficient in forecasting debt reschedulings. This model,
in conjunction with other early warning techniques, then could be used
to manage country risk and to set commercial bank lending limits.' Know-
ing that a country has a high probability of rescheduling can enable the
lender to reduce credit exposure and to avoid costly and lengthy re-
schedulings.
This paper first reviews the results of the earlier debt rescheduling indi-
cators and models. In the second section, logit models which utilize new
short-term debt data and variables representing economic shocks are pre-
sented. The 30-country data base (see Table 1) used for the logit models
covers the period from 1975 to 1982 and contains the largest number of
debt reschedulings observations of any previous model. The results of the
logit models are then discussed in the third section. Different methods
of evaluating the logit scores are also examined. The logit models were
found to be very efficient in forecasting debt reschedulings. In the fourth
section, a discriminant model is derived utilizing the same database as
the logit models. The results of the two analytical methods were very
similar. Concluding remarks are presented in the last section.

REVIEWOF EARLIERMODELS
There have been several attempts to estimate empirically debt service capa-
city and to distinguish countries that are likely to reschedule or repudiate
their debts from those unlikely to do so. Several methods have been used
to separate the two types of countries. Discriminant analysis was used by
Frank and Cline (1971), Sargen (1977), and Saini and Bates (1978). Logit
analysis was used by Feder and Just (1977), Saini and Bates (1978), Mayo
and Barrett (1978), Feder, Just and Ross (1981), and Cline (1983).
DEBT RESCHEDULING 39

TABLE1

DevelopingCountriesRankedby BankDebt, December1982

($ Millions)

Country Amount Date of Rescheduling

Mexico $62,888 1982-83

Brazil 60,45 3 1982-83
Venezuela 27,474 1983
Argentina 25,681 1976, 1982-83
South Korea 23,245
Philippines 12,554 1983
Chile 11,610 1975, 1982-83
Portugal 10,004
Greece 9,988
Indonesia 9,948
Yugoslavia 9,821 1980, 1982-83
Nigeria 8,527 1983
Algeria 7,685
Israel 6,669
Malaysia 6,627
Colombia 6,312
Peru 5,353 1976, 1978-79, 1982-83
Egypt 4,932
Thailand 4,921
Ecuador 4,488 1982-83
Turkey 3,971 1978-80, 1982
Morocco 3,882 1983
Ivory Coast 3,387 1983
India 2,603
Uruguay 1,531 1982-83
Costa Rica 1,261 1982-83
Sudan 1,119 1979-83
Tunisia 1,059
Cameroon 1,049
Bolivia 940 1981-83

Source: Bank of International Settlements, "The Maturity Distribution of International Bank

Lending;" Euromoney, August 1982; and World Bank, WorldDevelopment Report 1983.

Frank and Cline (1971) were the first to attempt to quantify the different
country risk and debt capacity indicators. They compiled data on eight in-
dicators for 26 countries from 1960 to 1968. Eight countries (Argentina,
Brazil, Chile, Ghana, India, Indonesia, Turkey, and Egypt) rescheduled
their debt 13 times during the nine-year period. Of the eight variables test-
ed, only the debt service ratio, the amortization to debt ratio, and the im-
ports to reserves ratio were statistically significant at the 5 percent level.
Utilizing only these three variables, their model was able to identify 10 of
the 13 rescheduling cases and 118 of the 132 nonrescheduling cases.
Sargen (1977) used data from 1960 to 1975 for 44 countries, in his
discriminant study. His results indicated that the change in consumer
prices and the debt service ratio were by far the most important explana-
tory variables. The final function also included the export growth rate,
40 JOURNAL OF INTERNATIONAL BUSINESS STUDIES, SUMMER 1986

the money supply growth rate, the real GNP growth rate, and the devia-
tion from the purchasing power parity value.
Saini and Bates (1978) used nondebt variablesin their discriminant analy-
sis study. The authors objected to the use of debt data because the data
had a two-year lag, did not include short-term debt, and did not include pri-
vate nonguaranteed debt. As a proxy for debt variables, Saini and Bates
used the current account balance minus the increase in international re-
serves divided by exports, the net foreign assets of the banking system
divided by the money supply, and the rate of growth in international re-
serves. The authors found that inflation, money supply growth, the
cumulative current account balance to exports ratio, and growth in inter-
national reserves consistently exhibited the greatest explanatory ability.
Overall, their error rates were higher than in some of the earlier studies.
The authors also ran their data using logit analysis. They concluded that
there were no significant differences in the error rates or in the indicators
from their discriminant analysis and logit analysis.
Feder and Just (1977) used logit analysis to determine a country's debt
capacity. They maintained that logit analysis was more suitable when
using continuous data. With logit analysis, the probability of rescheduling
should increase as the date of the rescheduling approaches. Hence, the
country would not suddenly become a member of the rescheduling group,
as is the case with discriminant analysis. Their sample included data from
41 countries from 1965 to 1972. There were 21 observations of countries
rescheduling during that timeframe. Generally, data for a country that re-
scheduled were not included for at least two years after the rescheduling.
Their results confirmed that the debt service ratio, imports to reserves
and amortization to debt were significant. In addition, export growth, per
capita income, and capital inflows to debt service were also significant.
Using a cutoff of .40, they obtained 5 percent of Type I errors and 2.4
percent Type II errors.
In 1981, Feder, Just and Ross updated their previous logit analysis study.
The database was expanded to cover the years 1965 to 1976 and contain-
ed 56 countries. Out of the 580 observations, there were 40 cases of re-
scheduling. Using a cutoff .20 percent, the error rates were 20 percent
for Type I and 6 percent for Type II.
An extensive study was done for the EXIM Bank by Mayo and Barrett
(1978). The database included 50 basic variables for 48 countries and
covered the period from 1960 to 1975 with projections extending to
1980. The focus of the study was to predict the occurrence of reschedul-
ings up to five years. In their final logit model, six variables (debt/exports,
reserves/imports, imports/GDP, IMF reserve position/imports, investment/
GDP and the inflation rate) were found to be significant. No error rates
were given.
A more recent study was done by Cline in 1983. Cline divided his re-
scheduling indicators into either demand- or supply-related, although
some indicators were considered both. His logit model used data for 58
DEBT RESCHEDULING 41

countries for the period 1967 to 1982. During that time, there were 22
cases of debt rescheduling, or 3 percent of the sample. Of the variables
tested, the debt service ratio, reserves to imports, and LDC borrowings to
imports were the most significant indicators. Cline's errorswere in the 10
to 14 percentage range.
The earlier models made significant contributions to the country risk field.
However, there are several problems associated with the studies and their
models. The models did not accurately forecast the debt reschedulings of
the late seventies and early eighties. Using economic and debt data from
1975 to 1982 of the 30 most indebted developing countries (see Table 1),
the two seminal models of Frank and Cline (1971) and Feder and Just
(1977) were tested. Using the more recent data, the model estimated by
Frank and Cline had an overall accuracy of 62.1 percent using their criti-
cal value of 5.295. The model overestimated the number of debt re-
schedulings, predicting 125 debt reschedulings out of 240 observations.
Raising the critical value to 7.665, which equalized the error rates, yielded
a 75-percent accuracy rate (10 Type I errors and 50 Type II errors).
The overestimation problem associated with the Frank and Cline model
basically reflects the changes in their indicators. The average debt service
ratio for the 30 most indebted countries has risen from 8.3 in 1965 to
29.1 in 1982. (See Table 2.) Thus, what was thought to be the debt ser-
vice threshold in 1971 by Frank and Cline was the norm in 1982. The
imports to reserves ratio also has risen dramatically since 1960. During
the period Frank and Cline tested, most developing countries had reserves
equal to about one-third of their imports. By 1980, imports on average
were 14 times greater than reserves. Note that the imports to reserves
ratio tends to distort the equation when reserves are extemely low. For
example, many African countries have very low levels of reserves. As a
result, the Frank and Cline model usually predicted debt reschedulings
for these countries. (Later studies have used the inverse of this ratio to
avoid the problem.) The final variable used in their model, the amortiza-
tion to debt ratio, also has increased in value since 1960. The trend is
due to the shortening of maturities of the debt of the developing coun-
tries and larger interest payments resulting from higher interest rates in
the early eighties.
The Feder and Just model underestimated the number of debt reschedul-
ings from 1975 to 1982. Using a cutoff point of 0.40, their model pre-
dicted only 8 of the 40 debt reschedulings observations. Again, the prob-
lem with the forecasting record of the model related to the indicators.
Feder and Just used per capita income (measured in current dollars) in
the model. As a result of increased real growth and inflation, the average
per capita income of the 30 most indebted countries increased from $330
in 1965 to $1,809 in 1980, as shown in Table 2. Thus, the model tends to
underestimate debt reschedulings. (Feder, Just and Ross (1981) used the
ratio of per capita income to U.S. per capita income to avoid this prob-
lem.) High export growth rates also led to forecasting problems. Export
42 JOURNALOF INTERNATIONALBUSINESSSTUDIES, SUMMER1986

TABLE2

MajorDebt ReschedulingIndicatorsof
The 30 Most IndebtedCountries
(UnweightedAverages)

Indicator Used by1 1960 1965 1970 1975 1980 1982

Debt Service Ratio a, b, c, f,g NA 8.31 11.60 14.10 17.65 29.14

Imports/Reserves2 a, c, d, e, f, g, h 2,20 2.95 3.68 8.81 14.41 18.05
Debt Service/Debt3 a, c, g, h NA .087 .093 .106 .153 .183
Per Capita GDP c, g $272 330 458 890 1809 1772
(Current Dollars)
Growth of Per Capita4 b, c, g 1.70 2.40 3.59 3.41 2.86 0.74
Real GDP (4 year average)
Export Growth Rate5 b, c, g 3.46 9.69 10.43 28.55 23.00 6.85
(3 year average)
Change in Consumer6 b, d, e 5.96 7.70 9.50 19.98 25.93 30.50
Prices (3 year average)
Debt/Exports7 d, g, h NA 1.13 1.49 1.29 1.16 1.47
Current Debt Service Ratio h NA NA NA 38.19e 51.52 77.84
Short-term Debt/imports h NA NA NA .17e .29 .36
Real GDP Growth h 6.54 5.26 6.24 4.29 3.87 1.18
(1 year)
Exports/Imports h NA .94 .81 .78 .89 .77

Notes:
1. Key to Studies: (a) Frank& Cline (1971), (b) Sargen (1977), (c) Feder & just (1977), (d) Mayo
& Barrett (1977), (e) Saini & Bates (1978), (f) Feder, Just & Ross (1981), (g) Cline (1983)
and (h) Morgan (1986).
2. Reserves include gold. Studies, (e), (f), (g) and (h) used the Inverse of the ratio.
3. Also referred to as the amortization rate. Studies (g) and (h) included principal payments only
in debt service.
4. Studies (b) and (g) used a 3 year average; study (c) used a 4 year average.
5. Study (c) used an 8 year average.
6. Debt includes medium- and long-term debt. Studies (g) and (h) included short-term debt in
total debt.
7. Argentina and Chile were excluded from the average.
Sources: IMF, International Financial Statistics Yearbook; World Bank, World Debt Tables and
World Tables; and Bank of International Settlements, Maturity Dlstributlon of Interna-
tional Bank Lending.

growth rates three-year average and measured in current dollars) averaged

about 28 percent in 1975 versus 9.6 percent in 1965. Many of the oil
exporting nations experienced 30 to 40 percent increases in exports during
the mid-seventies. One problem with this indicator is that it only tells one
side of the trade picture. It does not reflect changes in imports or the net
of exports and imports. Variables such as the current account to exports
or exports/imports give a better indication of the trade position of a coun-
try. Another variable that Feder and Just used was capital flows/debt
service. This variable tends to behave somewhat erratic. Because it mea-
sures capital flows, it can go from positive to negative, year to year.
DEBT RESCHEDULING 43

Besides the forecast record of the earlier models, there are other prob-
lems. During the sixties and early seventies, there were only a small num-
ber of countries that rescheduled their debts. For example, Feder and
Just (1977) had only 21 observations of debt reschedulings, out of 238
observations. Hence, they were testing for a rather unusual event. Con-
versely in the early eighties, there were a number of debt reschedulings
and indicators that are common with the debt reschedulings are likely
to be different. Another problem relates to the pooling of observations
across a number of years. For example, the Sargen study covered the
years from 1960 to 1976. The values of many of the indicators tended
to change over the years. For example, real GDP growth of 5 percent in
1966 during the boom of the sixties is not comparable to a 5-percent
growth in 1975 during a recession. Inflation rates also tended to increase
worldwide during the seventies, and the pooling of the nominal data (i.e.,
per capita income) across time would not reflect that trend. Finally, there
have been structural economic changes (i.e., oil price shocks, increased in-
debtedness of the LDCs and changes in their debt structures) which have
occurred since the publication of the earlier studies. These factors have
changed the picture of indebtedness of the developing countries and
altered some of the relationships of the debt rescheduling indicators.
These changes are not properly reflected in their models.

THE SETUP OF THE MODEL

The database of the logit model contained nine variables for 30 countries
and covered the period from 1975 to 1982. This timeframe was chosen
because it contained the economic period since the two oil price shocks
and the last two recessions. By limiting the timeframe of the model from
1975 to 1982, the model captured this important economic transition
period. The time period from 1975 to 1982 also encompassed the build-
up of commercial bank debt and utilized new data available on short-
term debt.
The study included the 30 largest debtor countries. Generally, commercial
banks consider loan requests only from the large, well-known developing
countries. Because banks have to monitor the economic and political situa-
tions in each country in which loans are outstanding, there is a certain
amount of economies of scale in concentrating their lending to the larger
developing countries. Also, there would be more lending opportunities in
the larger countries. Most of the indebtedness of the developing countries
is concentrated among a few borrowers. Five borrowers (Mexico, Brazil,
Argentina, South Korea, and Venezuela) account for more than half of
the total debt owed to international banks by the developing countries.
The 30 countries included in the study account for 88 percent of the debt
of the developing countries. Only countries that have complete economic
data and comparable debt data were used. Because of data restrictions, the
study excluded oil-rich countries such as Kuwait, U.A.E., Saudi Arabia,
and Iran, and communist countries such as Poland, Hungary, Romania and
44 JOURNAL OF INTERNATIONAL BUSINESS STUDIES, SUMMER 1986

China. Table 1 lists the 30 most indebted countries, the amount of bank
debts as of 1982 and the dates of reschedulings. Note the dates of re-
scheduling begin when the country announces the intention to reschedule
and end after an agreement has been signed.
The variables which were tested can be divided among demand, supply
and exogenous shock indicators. On the demand side, the current account
balance and international reserves are a function of the demand for ex-
ternal borrowing. The ratio of exports to imports was used as a proxy for
the current account balance.2 Since it is possible that a country might
use international reserves to fund a current account deficit (instead of
borrowing), the ratio of international reservesto imports was also included
in the model. Because of variations in its value, gold was not included in
international reserves.
On the supply side, four measures of debt were used. It was assumed that
bankers or lenders would be aware of these basic measures of debt and
that the indicators would affect their perceptions of risk in lending to the
country. The four measures of debt used in the study are: total debt to
exports, short-term debt to imports, principal payments to total debt and
the current debt service ratio. Total debt (medium- and long-term public
and private debt plus short-term debt) to total exports is a measure of the
overall size of debt compared to the country's ability to earn foreign ex-
change. The ratio of short-term debt to imports usually is related to trade
financing. This is important because excessive short-term debt of more
than 90-days worth of imports often indicates that short-term debt is
being used to supplement medium- and long-term debt. Since short-term
debt must be rolled over or renewed periodically at the discretion of the
lender, a country with a large amount of short-term debt, in relation to its
imports, is vulnerable to a sudden change in international credit condi-
tions. Many countries contracted large amounts of short-term debt during
the period of high interest rates in 1980 to 1982. The third indicator,
ratio of principal payments to total debt (called the amortization rate),
was found to be significant in the early studies by Frank and Cline (1971)
and Feder and Just (1977). The amortization rate reflects the maturity
structure of a country's debt. Finally, the current debt service ratio was
included as the fourth measure of debt. This ratio, which is similar to the
debt service ratio, includes debt service from medium- and long-term debt
plus short-term debt. The sum was then divided by total exports. With the
inclusion of short-term debt, the current debt service ratio better reflects
the country's total debt servicing requirements than the traditional debt
service ratio.
In the Sachs and Cohen (1982) model of borrowing, shocks to the do-
mestic economy cause sudden declines in the nation's income and may
lead to a situation where the country cannot meet its debt service pay-
ments. Thus, countries that are vulnerable to exogenous shocks are likely
to be candidates for debt reschedulings or defaults. Shocks to this model
were incorporated by three indicators. First, the percent of variableinterest-
DEBT RESCHEDULING 45

rate loans to total medium- and long-term debt multiplied by the U.S.
prime rate was used as a measure of interest-rate shocks to the country.
If a large portion of the debt has a variable or floating rate feature, then
debt service payments increase directly with increases in interest rates.
Note that variable interest-rate loans became more prevalent during the
sample period. The percentage of floating rate loans to total loans rose
from 15.7 percent in 1974 to 37.4 percent in 1981. Second, a decline in
international lending would have been a shock to a country that was
accustomed to ready access to international funds. Bank lending did
decline significantly from 1980 to 1982. The ratio of total bank lending
to the non-oil developing countries divided by the total current account
deficits of the non-oil developing countries was used to capture this
shock. Finally, real GDP growth was used as an indication of a decline in
national income or an economic recession. This indicator reflects external
and internal shocks that may disturb the country's debt servicing cap-
abilities. It should be noted that the earlier models tended to use 3-to-5
year averages for many of their indicators and thus did not incorporate
the concept of shocks to their models.
The total database contained 240 observations of nine indicators.3 There
were 40 observations (16.6 percent) of debt reschedulings, as shown in
Table 1. All indicators were lagged one year. In other words, economic
data from 1982 were used to determine the probability of rescheduling
in 1983. Logit analysis was used to estimate the probability of a country
rescheduling.

RESULTSOF THE LOGITMODELS

Two models (A and B) were derived from various combinations of the
variables. Model A, as shown in Table 3, includes two of the shock vari-
ables (real GDP growth and bank lending), the exports to imports ratio
and two debt measures (current debt service ratio and the amortization
rate). Model B contains three of the shock variables (real GDP growth,
bank lending and the interest-rate sensitivity indicator), the reserves to
imports ratio, and two debt indicators (total debt to exports and short-
term debt to imports).
All the variables in Model A were significant at the .95 level, except for
the exports to imports ratio.4 (The exports to imports ratio was signifi-
cant at the .80 level.) Overall, the current debt service ratio was the most
significant variable in Model A. This ratio which includes debt service pay-
ments and short-term bank debt represents the total annual external fi-
nancing requirements in relation to the foreign exchange earnings.5 Coun-
tries which rescheduled their debts in 1983 had current debt service ratios
of 82 percent, compared to 39 percent for other countries.
Real GDP growth had a negative relationship to reschedulings. Hence, a
slow growing or declining economy appearsto be more likely to reschedule
than a fast growing one. Real GDP growth rates of the developing countries
did decline substantially in the early eighties. Slower or negative growth
 46 JOURNALOF INTERNATIONALBUSINESSSTUDIES, SUMMER1986

TABLE3

Estimatesof Logit ModelsA and B

Variable ModelA ModelB

Exportsto Imports -2.70

(1.98)
Reservesto Imports -6.64
(2.66)
Total Debt to Exports 1.45
(0.42)
Short-termDebt to Imports 1.96
(1.87)
AmortizationRate -14.75
(6.70)
CurrentDebt ServiceRatio 3.96
(0.89)
InterestRateSensitivityIndicator .0014
(.0008)
BankLending -.062 -.058
(0.022) (0.024)
RealGDPGrowthRate -.29 -,22
(0.073) (0.081)
Constant 3.08 -1.15
(1.94) (1.30)
Logof LikelihoodFunction -56.12 -50.07

Standarderrorsare in parentheses.

rates might also indicate a sudden shock to national income that would
increase a country's external borrowing needs, as hypothesized by Eaton
and Gersovitz (1981). Feder and Just (1977) and Cline (1983) also found
a strong relationship between countries rescheduling and economic
growth.6
The amoritzation rate of Model A was negatively related to debt resched-
ulings. This negative relationship was also found by Feder and Just (1977).
Bank lending, as a percentage of the aggregatecurrent account deficits, was
significant. When commercial bank lending decreased, as was the case
from 1980 to 1982, the number of reschedulings increased.7
Countries that rescheduled their debts had lower exports to imports
ratios (.75 versus .84 in nonrescheduling countries). Thus, countries
that rescheduled were under a great deal of pressure to find additional
foreign exchange, on averageequivalent to a third of their export revenues.
Model B was devised to highlight other variables. It is also of interest
because it was used in the discriminant model presented in the next
section. Four of the indicators in Model B (reserves to imports, total debt
DEBT RESCHEDULING 47

to exports, bank lending and real GDP growth) were significant at the .95
percent level. The interest sensitivity rate was significant at the .90 level,
while short-term debt to imports was significant at the .70-percent level.
Total debt to exports was the most significant variable in Model B.
Countries that rescheduled their debts in 1983 had total debt to exports
ratios which averaged 254.7 percent in 1982 versus 136.7 percent for
other countries. The total debt to exports ratio has been used more in
recent analyses as an indicator of a country's ability to service its debt
and as an indicator of the likelihood of debt rescheduling.
The reserves to imports ratio was found to be significant in Model B. This
ratio is inversely related to debt reschedulings. International reserves can
be used as a substitute for borrowing, as hypothesized by Eaton and
Gersovitz (1980). The lower the level of reserves, the more likely the
country is to reschedule. The ratio was first used by Frank and Cline
(1971) and has been found to be significant by most later studies.
The interest-rate sensitivity indicator was somewhat significant in Model
B. Countries that rescheduled their debts had a higher portion of their
debt based on floating interest rates. When interest rates increased in 1980
to 1982, their interest payments increased significantly. For example, it
was estimated by Mexican officials in 1983 that every one percentage
point increase in the prime rate increased Mexico's annual debt service
payments by $650 million.
Table 4 lists the logit scores for Model A. The scores are stated as proba-
bilities of rescheduling. This table is arrangedby data years. For example,
based on the 1981 data, Brazil had a .93 probability of rescheduling in
1982. For some countries, the probability of rescheduling increased sub-
stantially as the date of rescheduling approached. For example, economic
data in 1976 indicated that Argentina had a .04 probabilty of rescheduling
its debts in 1977. That probability continued to rise, reaching .54 in data
year 1980 and .97 in data year 1981.
There are a number of ways to evaluate the logit scores and determine
the errors of the model. For example, assume .50 is selected as the cutoff
point. If the score was above .50, the model predicted a debt rescheduling.
If a country rescheduled its debts and scored below .50, a Type 1 error
was recorded. If a country had a score above .50 and did not reschedule,
a Type II error was recorded. Using .50 as a cutoff point, Model A had an
overall accuracy rate of 89.6 percent with 19 Type I and 6 Type II errors.
The cutoff point of .50 yields a greater number of Type I errors than
Type II errors. By altering the cutoff point, the distribution of the errors
can be changed, as shown in Table 5. For example, if an equal number of
errors (in this case 10) is desired, the cutoff point would be .39. If one
assumes that Type I errors (misclassifying a country that rescheduled) is
twice as costly for the lender as Type II, then the cutoff point would
be .33. This would yield 7 Type I errors and 14 Type II errors with an
overall accuracy of 91.3 percent.8 Another method of selecting the
48 JOURNAL OF INTERNATIONAL BUSINESS STUDIES, SUMMER 1986

TABLE4

Logit ProbabilityScores, Model A

DATA YEARS
COUNTRY 1975 1976 1977 1978 1979 1980 1981 1982
* | , ' ~~~~~
t t ~ ~~~~
~~~~~~~1, ~ ~~
' -' - '' -' .' I .

Mexico .222 .231 .724 .049 .016 .093 .373 .903

Brazil .195 .032 .252 .323 .176 .240 .931 .983
Venezuela ,000 .002 .022 .275 .134 .097 .146 .697
Argentina .154 .043 .006 .060 .023 .541 .973 .970
South Korea .026 .001 .004 .001 .006 .389 .037 .170

Philippines .020 .021 .053 .019 .027 .165 .377 .911

Chile .984 .023 .009 .016 .008 .027 .447 .999
Portugal .262 .005 .024 .019 .006 .017 .168 .330
Greece .024 .004 .017 .006 .008 .059 .190 .460
Indonesia .032 .008 ,007 .003 .028 .002 .010 .160

Yugoslavia .004 .002 ,003 .003 .002 .015 .039 .107

Nigeria .005 .000 .198 .128 .006 .018 .138 .499
Algeria .035 .003 .033 .013 .003 .004 .013 .074
Israel .068 .045 .084 .028 .019 .041 .064 .405
Malaysia .043 .000 .001 .000 .000 .004 .018 .094
Colombia .067 .010 .018 .003 .007 .057 .302 .787
Peru .512 .469 .808 .561 .023 .050 .157 .920
Egypt .007 .007 .018 .005 .005 .003 .027 .136
Thailand ,024 .002 .009 .011 .006 .015 .004 .121
Ecuador .019 .002 068 .114 .005 .117 .466 .922

Turkey .017 .011 .475 .251 ,159 .343 .063 .110

Morocco .021 .009 .050 .050 .027 .051 .504 .420
Ivory Coast .009 .001 .010 .003 .013 .016 .236 .554
India .004 .010 .003 .005 .089 .008 .024 .189
Uruguay .013 .003 .017 .000 .005 .039 .363 .816
Costa Rica .065 .014 .014 .008 .036 .407 .823 .956
Sudan .600 .242 .116 .495 .449 .397 .529 .953
Tunisia .003 .004 .043 .005 .005 .007 .007 .137
Cameroon .017 .006 .032 .014 .005 .013 .035 .068
Bolivia .046 .019 .161 .210 .432 .379 .646 .961

cutoff point used by Cline (1983) is to equalize the percentage of errors.

Using a cutoff point of .16, gave 15 percent Type I and Type II errors.
Analyzing where errors occurred yields several important points. First,
several of the errors occurred in the timing of the rescheduling. Using .39
as the cutoff point, the model based on 1980 data predicted that Argentina
should have rescheduled in 1981 (as well as 1982 and 1983). The model
also predicted prematurely that Morocco should have rescheduled in
1982. The second major source of errors centered around three countries
(Turkey, Yugoslavia, and Peru) that had rescheduled several times.9 For
example, based on data from 1977, the model had a probability of .47
that Turkey would reschedule in 1978. However, the probability declined
after that, reaching .06 in the data year 1981. (Turkey rescheduled part of
its debt in 1978, 1979, 1980, and 1982 and its debt service payments
DEBT RESCHEDULING 49

TABLE5

ErrorDistribution,ModelA

Type I Type 11 Overall

Cutoff Point Number Percent Number Percent Accuracy
Percet -Acc--trac
.9 28 70,0 1 0.5 87.9
.8 26 65.0 1 0.5 88,8
.7 25 62.5 3 1.5 88.3
.6 23 57.5 4 2.0 88.8
.5 19 47.5 6 3.0 89.6
.4 11 27.5 10 5.0 91.3
.3 7 17.5 16 8.0 90.4
,2 6 15.0 25 12.5 87.1
.1 2 5.0 46 23.0 80.0
II I * . , - - -
' #I I'i ' :- -'.- -- I' ,t n 1F.. tI-r *-x_ v -

were altered several times.) The model was not sensitive to the debt prob-
lems of Yugoslavia. The highest probability of rescheduling (.11) was in
data year 1982. One reason might be Yugoslavia's relatively low current
debt service ratios, low levels of short-term debt and seemingly adequate
levels of international reserves. In the case of Peru, the errors occurred
mainly in the timing of the reschedulings. Peru rescheduled portions of
the debts in 1976, 1978-79, and 1982-83. The model showed high prob-
abilities of rescheduling from 1976 to 1979 and in 1983, but low prob-
abilities from 1980 to 1982.
One method of reducing some of the errorsin the timing of a rescheduling
is to drop the country from the sample for two years after a rescheduling.
This procedure was followed by Feder and Just (1977) and Cline (1983).
Presumably the reason for dropping a country after a debt rescheduling is
that the rescheduling alters the economic and debt statistics of the coun-
try. For example, principal payments are usually rescheduled for 5 to 12
years. This would effectively lower the current debt service ratio and the
amortization rate for the country. Since the adoption of a stabilization or
austerity program is usually required with a debt rescheduling, changes in
the nation's trade patterns might affect the reserves to imports and ex-
ports to imports ratios. Real GDP growth may also be affected by a stabil-
ization program. Following a procedure of dropping a rescheduled coun-
try for two years, Models A and B were reestimated. The new database
(called the adjusted database) consisted of 211 observations of which 21
observations (10 percent) were of countries rescheduling their debts.
Table 6 shows the estimates and standard errors of Models A and B.
As a result of the reestimation, the relationship between the variables
changed. For example in Model A, the amortization rate lost its signifi-
cance. The t-ratio of the coefficient fell from -2.20 to -0.63. The current
debt service ratio also lost some of its significance. Comparingthe results
of the two methods yields several important observations. The overall
accuracy rates did not vary much between the two sampling methods.
50 JOURNALOF INTERNATIONALBUSINESSSTUDIES,SUMMER1986

TABLE6

Estimatesof Logit ModelsA and B, AdjustedDatabase

Variable Model A Model B

Exports to Imports -4.70

(2.41)
Reserves to Imports -6.52
(2.95)
Total Debt to Exports 1.01
(2.03)
Short-term Debt to Imports 2.86
(2.03)
Amortization Rate -4.32
(6.83)
Current Debt Service Ratio (3.47)
(1.03)
Interest Rate Sensitivity Indicator .0027
(.0027)
Bank Lending -0.074 -0.068
(0.026) (0.026)
Real GDP Growth -0.31 -0.29
(0.095) (0.098)
Constant 4.31 -0.40
(2.37) (1.20)
Log of Likelihood Function -68.37 -68.37

Standard errors are in parentheses.

The cutoff point in Model A, where the errors were equal, dropped from
.39 to .28 with the adjusted database. Likewise, the cutoff point where
the percentage of errors was equal also dropped from .16 to .14 with the
adjusted database. Thus, the model estimated from the adjusted database
appeared to be less sensitive than the original model. Finally, comparing
the errors between the two databases yielded the conclusion that the same
errors were repeated. In sum, the procedure of dropping a country from
the database for two years after a rescheduling does not appear to improve
the efficiency of the model.

A DISCRIMINANTMODEL
Since many of the earlier studies used discriminant analysis [Frank and
Cline (1971), Sargen (1977) and Saini and Bates (1978)], it was useful to
reestimate the model using discriminant analysis. The results of the logit
model can be compared directly with the results of the discriminant model.
The same database from the logit model was used in estimating the dis-
criminant model.10
The discriminant function included the six variablesof Model B, as shown in
Table 7. Two sets of coefficients are given. The unstandardized coefficients
DEBT RESCHEDULING 51

TABLE7

Estimatesof DiscriminantModel B

Standard zed Unstandardized

Variable Canonical Coefficient Canonical Coefficient

Reserves to Imports -.247 -1.42

Total Debt to Exports .559 .73
Short-term Debt to Imports .147 .81
Interest Rate Sensitivity Indicator .159 .00049
Bank Lending -.317 -.03
Real GDP Growth Rate -.448 -.119
Constant .862

were used for computing the Z score. The standardized coefficients show
the relative contribution of a variable to the function. The sign denoted
whether the variable was making a positive or negative contribution. Total
debt to exports and the real GDP growth rate were the most significant
variables, as shown by the large value of the standardized coefficient.
Bank lending was also important. Note that the signs of the coefficients
are the same as the logit model.
The discriminant model had an accuracy of 85.4 percent. As shown in
Table 8, there were 27 Type II errors and 6 Type I errors. The distribution
of errors from the discriminant Model B and the logit Model B was very
similar. For the logit model, a cutoff point of .16 was selected in order to
equalize the percentage of Type I and Type II errors. For the logit model,
there were 6 Type I errors and 26 Type II errors. Both models had the
same six Type I errors. Of the Type II errors, the discriminant model con-
tained 22 of the 26 errors found in the logit model. In the few cases where
the errors were different, the margin of error was small. In sum, the differ-
ences between the discriminant Model B and the logit Model B were slight.

CONCLUDING REMARKS

The logit model presented in this paper is more useful than the earlier
models discussed in the first section for a number of reasons. First, the
models of Frank and Cline (1971) and Feder and Just (1977) were found
to be inefficient in forecasting debt reschedulings during the period from
1975 to 1982. Frank and Cline's model overestimated the number of re-
schedulings, while Feder and Just's model underestimated the number of
reschedulings. Second, the model captures the changes that have occurred
in the world economy since the first oil price change in 1974 and incor-
porates the period of rapid debt accumulation of the developing countries.
Studies by Feder, Just and Ross (1981), Saini and Bates (1978) and Cline
(1983) which covered the late sixties to the late seventies probably would
52 JOURNAL OF INTERNATIONALBUSINESSSTUDIES, SUMMER1986

TABLE8

Comparisonof Errors,Model B

Discriminant Model Logit Model

Error
Type Country Year Country Year

I Argentina 1975 Argentina 1975

Yugoslavia 1979 Yugoslavia 1979
Turkey 1977, 1978, 1981 Turkey 1977, 1978, 1981
Uruguay 1981 Uruguay 1981

Mexico 1976, 1977 Mexico 1976, 1977, 1980

Brazil 1977-1980 Brazil 1980
Venezuela 1980, 1981 Venezuela 1980, 1981
Argentina 1980 Argentina 1980
South Korea 1980, 1982 South Korea 1980, 1982
Philippines 1981 Philippines 1981
Chile 1975 Chile 1975
Portugal 1982 Portugal 1981, 1982
Greece 1981, 1982 Greece 1981,1982
Israel 1982 Peru 1976
Colombia 1982 Egypt 1982
Peru 1976 Turkey 1980, 1982
Egypt 1982 Morocco 1981
Turkey 1980 Ivory Coast 1981
Morocco 1981 Costa Rica 1980
Costa Rica 1980 Sudan 1975-1977
Sudan 1975-1977 Bolivia 1978
Bolivia 1978

have been more accurate if divided into separate sample periods. In other
words, because of the structural changes in the world economy, events
that caused debt reschedulings in the late sixties and early seventies are
likely to be different than events that caused debt reschedulings in the late
seventies and early eighties. Third, the inclusion of short-term debt and
other variables gives a better indication of the indebtedness of the devel-
oping countries. Countries with a high level of short-term debt in relation
to imports are vulnerable to sudden changes in international credit condi-
tions. Finally, because of the large number of countries that have re-
scheduled since 1981, this logit model had the benefit of more observa-
tions of reschedulings. There were 40 observations of debt reschedulings,
or 16.6 percent of the total sample, which was the highest percentage of
any of the studies presented in the second section. Presumably this im-
proved the efficiency of the models.
Three variables always seemed to be significant in distinguishing countries
which reschedule their debts from other countries. Real GDP growth was
negatively related to debt rescheduling. When real GDP growth fell, or be-
came negative, the country was more likely to reschedule. In the Sachs
and Cohen (1982) model, a country was likely to find itself facing the
DEBT RESCHEDULING 53

decision to repudiate or reschedule following a sudden and unexpected

decline in income. The results of the logit model point to this same con-
clusion. The second most important variable was a measure of debt, either
total debt divided by exports or the current debt service ratio. Because of
the-high correlation of the two variables, only one could appear in the
model at a time. Finally, the variable of reserves to imports was also use-
ful in distinguishing countries likely to reschedule. Generally, countries
with low levels of international reserves were more vulnerable to exo-
genous shocks and declines in foreign exchange earnings.
In this paper, several empirical methods of predicting debt rescheduling
have been examined. Both logit and discriminant models were used with
only slight differences in the results. The earlier practice of changing the
sample by dropping a country after rescheduling was shown to have little
effect on reducing the errors of the model. The models presented in this
paper capture the changes that have occurred in the world economy since
the oil price shocks and the period of debt accumulation by the develop-
ing countries. The models, which have proven in actual usage to be effi-
cient in forecasting countries which rescheduled their debts, can be used
to forecast the probability of future debt reschedulings.

NOTES
1. The models presented in this paper were the result of research done by the author while at
Texas Commerce Bank. The models provided the research basis for designing a country risk rating
system. See John B. Morgan, "Assessing Country Risk at Texas Commerce," The Bankers Maga-
zine, May/June 1985.
2. One of the earlier versions of the model contained the ratio of the current account balance
divided by exports. Since the exports to imports ratio was repeatedly found to be more signifi-
cant than the current account balance, the latter was dropped from the list of variables.
3. The World Bank, World Debt Tables, was the data source for all the debt data except short-
term debt in which data were used from the Bank of International Settlements, Maturity Distri-
bution of International Bank Lending. Balance of payments and economic statistics came from
the International Monetary Fund, International Financial Statistics. Estimates of short-term debt
in 1975 and 1976 were based on the relationship of short-term debt to debt from private creditors
in 1977 and 1978. In the estimation process, the logit option of the SHAZAM was used.
4. To determine the significance of the variables, divide the maximum likelihood estimate by its
standard error. The null hypothesis is 3 = 0. Using a 0.95 level of significance, the null hypothesis
is rejected if the sum is greater than 1.96 for a large sample. The test statistic for 0.90 percent level
of significance is 1.645.
5. In the earlier estimations of the model, both the current debt service ratio and the debt service
ratio were tested. Because of the inclusion of short-term debt, the current debt service ratio was
found to be more significant than the debt service ratio.
6. In Cline's study, per capita real GDP growth was used. Feder and Just used per capita real GDP
growth over a 4-year period in their study. Although the variable was somewhat significant, they
preferred to use export growth over an 8-year period.
7. Cline used a similar variable in his study. He defined global credit as the total net external bor-
rowing by all non-oil developing countries divided by their total imports.
8. A Type I error (misclassifying a country that reschedules) is more costly to a commercial bank
than a Type II error (misclassifying a country that did not reschedule) for several reasons. Debt
rescheduling is a costly exercise for a bank. It increases loan monitoring costs and ties up funds for
a much longer than anticipated time. Also there is an opportunity cost, associated with rescheduled
loans. A Type II error means that the bank refrained from lending to a marginal country and lost
some revenue. In short, most banks would prefer to err on the conservative side and would assign a
higher cost to a Type I error than a Type II error.
54 JOURNAL OF INTERNATIONALBUSINESSSTUDIES, SUMMER1986

9. It is interestingto note that Sargen(1977) also had problemsclassifyingthese three countries.

10. A stepwise method from the discriminantanalysisoption of SPSS was used in constructing
the discriminantfunction. At each step the variablewith the highestF-ratiowas selecteduntil the
remainingvariableshad F-ratiosless than 1.0. The cost of errorswas assumedto be equal,and no
priorprobabilitieswere given.All of the variableswere enteredinto the analysis.

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