Developing Countries’ Attractiveness for Foreign DirectInvestment – Debt Overhang and Sovereign Risk as MajorImpediments?

With declining debt inflows, foreign direct investment (FDI)has again become one of the major pillars of private financial flows todeveloping countries (Des). This has created some expectation to replaceprivate bank olending by FDI. However, many heavily indebted countriesmay not only be constrained in terms of new private lending, but also interms of FDI inflows. In order to overcome constraints in the supply ofFDI, the determinants of FDI flows have to be identified in the firstplace. This has been done by the Kiel Institute of World Economics in acomprehensive study commissioned by the World Bank. The present papersummarizes some of the major results for details, see Agarwal et aZ.(1991). The focus is on the impact of sovereign risk on FDI and onpossible disincentives for FDI arising from a debt overhang, i.e. onthose aspects that reflect the most important recent changes ininternational capital market conditions. The empirical analysisconcentrates on the 1980s. Regressions are run for an overall sample ofabout 35 host Des and for various subgroups. The paper is organized asfollows. Section II presents the major hypotheses. The empirical resultsare summarized in Sections III and IV. Finally, some policy conclusionsare drawn in Section V.