Figure 9 plots the response of the CPIA index which reflects a (subjective) World Bank ranking of the overall quality of economic policy. The response in CPIA is close to mirroring inflation, possibly because it figures prominently in the list of ingredients World Bank economists use to provide an assessment of the quality of overall policy. In three out of four cases, policy deteriorates after the overhang. While these results are less unanimous than those quantifying an investment effect, and also more difficult to interpret, they do provide some support to the hypothesis that overhang episodes coincide with a noticeable deterioration in macroeconomic policies.

## 5.4 The Response of the Terms of Borrowing: Interest Rates and Commitments

Figures 10 plots the dynamic response in the interest rate spread, measured by the (demeaned) difference between local rates as implied by Global Development Finance sources, and the yield on a ten-year Treasury Bill. Interestingly, the onset of debt overhang appears to be characterized by a fall in spreads. What is more, in all cases this easing of borrowing conditions tends to follow a tightening, with interest rates actually increasing prior to the event threshold. This runs exactly contrary to the theoretical prediction that an overhang problem appears because of prohibitive borrowing terms. Here, debt seems to become more concessional as the overhang zone is reached.

A natural explanation for this rests in possible changes in the composition of debt, as if private investors exit the market, and are replaced by an increasing share of multi-lateral agencies lending at concessional rates. But this would suggest debt relief would have hardly any easing impact on the conditions at which highly-indebted countries can borrow, and indeed would if anything worsen the terms of borrowing. Figures 11 and 12 plot the average dynamic path of (the value of) new commitments arising from the private and the official sectors, respectively. Private commitments fall precipitously in all cases for non-negative values of t; what is more, the overhang is preceded by a build-up of private lending, so that our event study is not merely capturing a trend “rush for the exit” amongst private investors. In stark contrast, official commitments increase in value after the threshold.<sup>36</sup> The change in the composition of debt with the onset of overhang is actually not phrased out in any theory that we are aware of, but it is presumably what exonerates highlyindebted countries from having to face exorbitant borrowing conditions. We later present evidence that the servicing of debt actually falls at positive values of t as well, which is also consistent with the terms of borrowing becoming increasingly concessional in the overhang zone. Importantly, this also means that debt relief could actually increase debt service and have the type of crowding out effects on investment that are customarily ascribed to a high debt burden.

# 6 Robustness

We check robustness along two important dimensions. First, we verify whether the dynamics we identify are not caused by global shocks, for instance to interest rates, that would act to

> 36 Changes in private lending are actually close to one order of magnitude larger than official ones.

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