ratios, in order to attain a common set of factors explaining all three classes of default. However, the downside of this is that interpretation becomes less clear, and as transparency is an important consideration in determining risk ratings, this approach may not be suitable. The familiarity of ratios such as debt service to exports, or reserves to imports, means that a model based on such factors is more easily understood by its users.

# 6.5. Modeling IBRD Default as a Two-Step Process

The above analysis models default to each creditor group separately. However, the preferred model for IBRD default contains the extent of arrears to private creditors, and the repayment performance to all creditors as explanatory variables, demonstrating a link between default to other creditors and default to the IBRD. In this section we examine this link more closely, to ascertain whether there is evidence for a creditor hierarchy, whereby countries first default to Commercial Banks and Paris Club creditors, and then subsequently default to the IBRD. One would like to then determine which factors are most important in driving countries to take the additional step of defaulting to the IBRD.

We consider two different approaches to examine this hypothesis. Firstly we use the predicted probability of default to Commercial Banks<sup>2</sup> ' in year t as an explanatory variable in the panel logit analysis of IBRD default in year t. The resulting model then shows the additional factors in year t-l which impact on the probability of default to the IBRD. Models Al and A2 in Table 12 report the results of this analysis. We find a random effects logit model is necessary to account for country heterogeneity, and that once again state dependence is important, resulting in the inclusion of the lagged dependent variable in Model Al. As one would expect, the likelihood of default to the IBRD is strongly positively related to the estimated probability of default to Commercial Banks. Additionally a lower share of official debt service due being paid increases the probability of default, representing the effect of official creditor default in addition to Commercial Bank default. The only other factors to have a significant impact are both political variables, showing that external conflict and a high involvement of military in government have greater effects on IBRD default. In Model A2 we omit the lagged dependent variable, and find that countries in which IBRD debt forms a larger share of the total debt, and countries with more short-term debt, are more likely to default.

The second approach we use to examine the plausibility of a default hierarchy is to restrict our sample to consider only countries which are in default to either Commercial Banks and/or Paris Club creditors in year t-l in modeling default to the IBRD in year t. In model B 1 we see that nations with a high share of IBRD debt in total debt, high short term debt, a low share of official debt service due being paid and high government consumption relative to GDP are more likely to default to the IBRD having already defaulted to other creditors. Once again there is state dependence, so the lagged dependent variable matters, and politics matters. Countries with poor law and order and a large involvement of military in politics are more likely to default to the IBRD. If we omit the lagged dependent variable we see that a higher total arrears to total debt ratio is

> 21 The correlation of 0.64 between the predicted probabilities of default to Commercial Banks and to Paris club creditors meant that both predicted probabilities could not be used as significant regressors in the logit analysis. We used predicted defaults to Commercial Banks as this gave a closer fit.

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