Early warning system for sovereign debt crisis in developing countries for period 1981-2010

Abstract

This study constructed an Early warning system to explain and predict sovereign debt crisis in 31 developing countries whose data is available through the period 1981-2010 at one year precedence by employing three-stage strategy with multinomial logit regression. While three-stage strategy allowed selecting the best predictors among wide range of explanatory variables, multinomial logit regression solved “post-crisis” bias and thus, improved prediction quality. The main findings are: (i) Solvency, measured by Public debt over GDP ratio, is positively correlated with sovereign debt crisis; (ii) Liquidity measures are highly associated with sovereign debt crisis. When short-term debt to total external debt ratio grows up or reserves to total external debt ratio decrease, the likelihood of both entering into debt crisis and remaining in debt crisis rises; (iii) The macroeconomic fundamentals significantly affect sovereign debt crisis: while GDP per capita growth rate is negatively associated with both entering into and remaining in crisis , inflation only affect positively post-crisis period; (iv) The international liquidity, represented by the three-month the U.S. Treasury bill rate, is highly associated with the first year of crisis and the following years of crisis rather than the initial year of crisis and (v) both external trade link and political institution measurements do not impact on sovereign debt crisis. As a result, the study specified a multinomial logit Early warning model predicting sovereign debt crisis at one year precedence with six determinants namely Public debt over GDP ratio, Short-term debt to total external debt ratio, Reserves to total external debt ratio, GDP per capita growth rate, Inflation rate and Three-month the U.S. Treasury bill rate. In addition, several policy implications are recommended for the countries to avert sovereign debt crisis