AN EMPIRICAL STUDY OF THE IMPACT OF DEBT SERVICE RATIO VOLATILITY ON DEBT SERVICE CAPACITY

Financial theoreticians have two diametrically opposed opinions on whether high volatility of indicators of a sovereign's debt service capacity (DSC) will affect its DSC or not. This paper summarizes these opinions into several hypotheses and examines them empirically. Data of debt service ratio and DSC of 105 countries between 1985-1992 were collected and volatility of each country's debt service ratios are computed. Stepwise logistics regression analyses and multivariate Chi-square tests a re conducted to test the relationship between the volatility of a country's DSC indicators and its DSC. Evidence has been found that generally DSC indicators' volatility is not a significant factor affecting a sovereign's DSC. This is probably because the major concern of a sovereign is the reputation of the nation so that the country can maintain a stable source of future international loans. When a borrowing country encounters financial shocks, it often adopts austerity policy and will default its loan only as a last resort. However, among medium-income countries, DSC indicators' volatility does affect a sovereign's DSC. This is probably because the governments in those countries are politically weak and cannot cutback imports to lower the nation's consumption level and make voters unhappy.