Debt valuation

The market value of a country's external debt (valuation of external debt) is a key indicator that summarizes the expectations of current and potential owners of claims. It provides a useful guide for creditors, who can avoid the need to calculate the actual value of external debt.

The contractual value of a debt is defined as the present value of the payments agreed upon in the original contract between the debtor and the creditor, assuming they will be made without risk. In contrast, the market valuation of debt is the present value of the payments that the market expects will actually be made. Usually, the contractual value is higher than the market valuation to cover the risk that the debtor may not meet its obligations in the future. For example, if a country pays a 2% premium on the LIBOR in a floating-rate credit, its contractual debt value will be higher than the market valuation from the start of the contract.

The fact that a country's debt is sold at a discount relative to its contractual value is always a problem, as it limits the country's ability to invest in profitable projects. This condition, which applies to most countries, can become a crisis if most new national investment projects are unprofitable due to factors similar to the discount of existing debt.

Although it is common to focus on external debt, it is argued that all debt of residents (private and official) of the debtor country represents a claim on its future production. Therefore, substantial discounts in the external debt market may be associated with high real interest rates in the national credit markets of the debtor country. If external credits are negotiated with a discount that reflects the expectation that contractual obligations will not be fully met, then all existing credits to residents of the debtor country are likely to be subject to some uncertainty as well. Additionally, all activities and forms of wealth that can be taxed by the debtor country should generate a rate of return that reflects the expected effects of those future taxes. If external debt has a higher market return (a greater discount) than internal debt, residents should try to sell internal debt and buy external debt until their returns equalize. This arbitrage would only be unprofitable if resident and non-resident investors expected equivalent penalties in similar credits.

To understand how the debt market is valued, it is useful to consider the factors that influence its valuation. However, the final valuation depends on the collective wisdom, or ignorance, of those willing to risk their wealth by acquiring claims on debtor countries. This forecast is what determines the economic behavior of debtors and creditors.

Algunos argumentan que el valor de mercado de la deuda externa de los países en desarrollo se ve afectado por el comportamiento de los acreedores existentes, quienes pueden enfrentar restricciones regulatorias en la cantidad de préstamos que pueden hacer a un país. Esto puede generar incertidumbre sobre la futura concesión de préstamos y crear una crisis de liquidez si ningún nuevo acreedor entra en el mercado. Sin embargo, esta idea no tiene en cuenta las oportunidades de arbitraje disponibles. Por ejemplo, si el valor de mercado de la deuda cae al 50% de su valor contractual debido a la falta de nuevos créditos, un nuevo acreedor puede comprar parte de la deuda existente a un precio de mercado reducido y otorgar nuevos créditos, aumentando el valor de mercado de la deuda existente y obteniendo ganancias de capital en el proceso. En consecuencia, si hay una oportunidad de arbitraje disponible, se explotará y los «free riders» serán comprados.

In summary, the market value of external debt is an important indicator that summarizes the expectations of owners of claims on a debtor country. Although the behavior of existing creditors may temporarily affect the market value, arbitrage opportunities are available and can be exploited by new creditors. Therefore, the market value of existing debt is not necessarily a good indicator of the debtor's restoration in credit markets.