^*Junko Koeda is an economist with the IMF's Middle East and Central Asia Department. The author would like to express thanks to Atish Ghosh, Carlos Végh, anonymous referees, Yasuyuki Sawada, Yossi Yakhin, Leah Brooks, Chikako Yamauchi, Jianhai Lin, and Andrew Tweedie for helpful suggestions and comments.

Abstract

This paper presents a theoretical model to explain how debt overhang is generated in low-income countries and discusses its implications for aid design and debt relief. It finds that the extent of debt overhang and the effectiveness of debt relief depend on a recipient country's initial economic conditions and level of total factor productivity.