THE BASIC MACROECONOMICS OF DEBT SWAPS

In any debt swap a country must surrender an asset to extinguish a lia bility. To retire its foreign debt, government must first purchase int ernationally traded assets from the domestic private sector. How this purchase is financed has important macroeconomic implications. Money-f inanced swaps can induce depreciation of the parallel exchange rate, t emporary current-account deficit, and reserve losses. Bond-financed sw aps can increase interest payments, since domestic debt typically carr ies higher real interest than foreign debt. If swaps lead to sustained domestic debt accumulation, which agents perceive will be monetized, the inflation rate will rise as soon as the swap program begins.