such schemes are ideally based on exogenous factors, such as world interest rates or commodity prices (see Krugman 1988, among others).

In relation to net external liabilities, there has been a major shift away from debt financing towards equity financing for emerging market and developing economies; conversely, many advanced economies have large net foreign debt liability positions that fund positive net foreign equity positions (Lane and Milesi-Ferretti 2007a, Lane and Shambaugh 2010).

In some respects, the debt overhang problem can be interpreted as a liability overhang problem, in the sense that total expected net outward transfers (whether debt payments or equity payments) may influence incentives. Indeed, Lane and Milesi-Ferretti (2007b) emphasize that a high equity component in external liabilities means that more of the upside from future economic growth accrues to foreign investors. Moreover, to the extent that an equity return premium exists, the average level of outward transfers should be higher, the greater is the equity share in external liabilities. However, in the other direction, equity-type liabilities are less risky than debt-type liabilities due to the contingent nature of equity returns. In this way, an adverse macroeconomic shock can amplify the external debt burden but may be hedged in the case of foreign equity liabilities. Accordingly, if tail risk is a major source of debt overhang, this is ameliorated by a greater role for equity-type instruments in external liabilities. Finally, an interesting special case relates to external debt that is intermediated via foreign-owned affiliates in the domestic banking system. In this case, the risk of external debt is attenuated since the equity in the capital base of the foreign-owned domestic banks provides a buffer that can absorb losses in the event of a negative shock.

The accumulated empirical evidence provides some support for the overhang hypothesis in relation to external debt. Cordella et al (2005) study 79 developing countries over 1970-2002 and find external debt above 15%-30% is associated with lower growth performance for those countries with good institutions.<sup>3</sup> Imbs and Ranciere (2008) study 87 developing countries over 1969-2002 and find a negative growth effect if the face value of external debt exceeds 60 percent of GDP (or if the present value of debt exceeds 40 percent of GDP). Moreover, they identify some mechanisms by which debt overhang operates. In particular, they show that investment declines and the conduct of economic policy deteriorates in the debt overhang zone. According to the authors, these results are mostly driven by countries with poor property rights and underdeveloped financial markets, under which external monitoring of borrowers is most difficult.<sup>4</sup> Reinhart and Rogoff (2010) study the relation between external debt and growth performance for a group of twenty emerging market economies over a 200-year period. In bivariate statistical analysis, these authors find a threshold of 60 percent of GDP, with a lower growth rate observed for countries with higher external debt levels.

However, all of these studies focus on developing country studies. One reason is that there are no similar, long datasets on the external debts of advanced economies (partly due to the

> 3 These authors find that is no robust relation between debt and growth for countries with weak institutions. One possibility is that debt rescheduling is fully expected for such countries.

> 4 Arsanalp and Henry (2004) provide related evidence using data on the impact of announcements of debt relief schemes on asset prices.

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