An update to the work with @davidmihalyi & @valentin_lang on the effect of the #DSSI on sovereign bond spreads in poor countries. In a nutshell, spreads declined, consistent with the liquidity provision from the suspension of debt service #ResolvingSovereignDebt
A thread 1/8
The Debt Service Suspension Initiative (DSSI) provides debt relief to poor countries by deferring debt service due in 2020 without affecting the NPV of public debt. Liquidity provision under the DSSI accounts for about 20% of the fiscal shortfall due to the Covid-19 shock. 2/8
The DSSI is good for both creditors & debtors, but not all countries have joined. Why? A key motivation behind the reluctance to join are reputational concerns: participation may signal debt sustainability problems and trigger an increase in sovereign bond spreads 3/8
We take the DSSI announcement as a plausible exogenous shock to analyze the reaction of sovereign bond spreads in eligible countries. For identification we construct a counterfactual for each DSSI-eligible country using the synthetic control method (SCM) 4/8
We find that the gap between the actual spread and the one of the synthetic control started declining around the time when the first country decides to join. On average spreads declined by about 200 bps (more in a few countries) and no country experienced an increase 5/8
Results are confirmed in a generalized SCM setting and are robust to in-space and in-time placebos. Treating a sample of non DSSI-eligible countries and shifting the treatment one year back in time show no significant effect on spreads 6/8
To further support the positive effect of debt relief via liquidity provision, we test for heterogeneous effects in a diff-in-diff framework and show that the effect of the DSSI on spreads is larger for countries which received more debt service relief 7/8
Results matter for the ongoing discussions on extending the DSSI to 2021. Postponing debt service in response to a short-term shock could reduce spreads. But if the shock persists a liquidity crisis could evolve in a solvency one, which requires different solutions. End. 8/8
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