Working Paper: CEPR ID: DP1608
Authors: Monika Schnitzer
Abstract: In this paper the two standard forms of international investment in developing countries ? debt and foreign direct investment (FDI) ? are compared from a finance perspective. We show that the sovereign risks associated with debt finance are generally less severe than those accompanying FDI. FDI is chosen only if the foreign investor is more efficient in running the project, if the project is risky and if the foreign investor has a good outside option which deters creeping expropriation. The sovereign risk problem of FDI can be alleviated if the host country and the foreign investor form a joint venture.
Keywords: foreign direct investment; sovereign risk; international debt crisis; joint ventures
JEL Codes: F2; F34; L14; O12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sovereign risks associated with debt finance (F34) | Sovereign risks associated with foreign direct investment (FDI) (F23) |
| Efficiency of the foreign investor (F23) | Choice of foreign direct investment (FDI) (F21) |
| Riskiness of the project (D81) | Choice of foreign direct investment (FDI) (F21) |
| Debt finance (G32) | Well-defined right to a fixed monetary payment (J33) |
| Well-defined right to a fixed monetary payment (J33) | Triggering of international sanctions if the host country defaults (F51) |
| Foreign direct investment (FDI) (F21) | Exposure to risks of nationalization and creeping expropriation (H13) |
| Debt finance (G32) | Risk of excessive taxation or temptation to nationalize (H13) |