willingness to service debt stems from a variety of factors affecting costs and benefitof default. However, while the benefits from default are straigkicforward, the reduced debt service, costs are more difficult to assess and measure and, in any case, governments may not be always careful in evaluating them. It is easier to assess the abilit,' to service public debt, i.e., the perceived solvency of government. A government's ability to service & given stock of debt can be assessed by comparing the present discounted values of future debt service obligations and future primary (non-inter--c) fiscal surpluses.

The risk of explicit debt repudiation, e.g., through an unscheduled tax on debt, may alao be affected by debt management-specific factors such as the level of debt indexation. For a given debt Ltock (of indexed and non-indexed debt) the higher the degree of indexation the less likely that non-indexed (nominal) debt will be implicitly repudiated thrcagh inflation (as the base for implicitly repudiating debt through inflation narrows) and, thus, the more likely that, if the government is to repudiate its debt, it will do it explicitly (Calvo-Guidotti 1990). Thus, the explicit debt repudiation risk premium may increase with the level of inde dtion even if the overall risk of debt rgpudiation is unchanged. Casual evidence supports this hypothesis. In 1988 as the share of dollar-indexed debt rose from almost zero to more than 5% of domestic debt (indexed debt includes dollar-indexed Pagafes and inflation-indexed Ajustabonos in Figure 10), the explicit debt repudiation risk premium, approximated by the Pagafes-US Treasury bill. interest differential, more than doubled (Figure 9). This may explain the subsequent reluctance of the government to keep issuing indexed debt (Figure 10).

Another important factor influencing the risk of domestic debt repudiation, both explicit and implicit, was the foreign debt agreement. In July 1989, when the agreement for restructuring commercial foreign debt was formally announced, both implicit and explicit debt repudiation risk premia dropped sharply (Figures 8 and 9). The debt agreement reduced the net transfer Mexico needs to make to its commercial creditors and brought substantial debt and debt service relief. Lower transfers and debt relief enhanced Mexico's ability to service all public debt, Zoreign and domestic, thus, reduc.ng fears of both domestic and foreign debt repudiation. In turn, debt relief and the significantly lengthened debt maturity helped to dispel fears of new debt renegotiations thus reducing macroeconomic and, in particular, exchange rate uncertainty. 3' To test these hypotheses about the factors that influence the explicit debt repudiation risk premium we run a linear regression with the Pagafes-US Treasury Bill interest differential, the proxy for the debt repudiation risk premium, as dependent variable. Based on the above discussion, the explanatory variables were, apart from the constant term, the primary fiscal surplus lagged up to two months, the degree of debt indexation and a dummy for the foreign debt agreement. A regression wa: run for the March 1987-December 1990 period using monthly data. To calculate the net present value of primary surpluses agents require knowledge 2/ S. van Wijnbergen 1991 a) analyzes the direct and indirect (domestic) effects of the Brady deal: indirect gains (via lower interest rates) were at least as large as the reduction in the external transfer to foreign creditors.