Debt Relief and the Current Account: An Analysis of the HIPC Initiative

In this paper I develop a model to investigate the connection between debt relief and current account sustainability. This model can be used as a key input in assessing whether a HIPC country’s real exchange rate is ‘overvalued,’ and will thus need to go through devaluation. The working of the model is illustrated for the case of Nicaragua, a country that in 2002 had one of the highest external debt to GDP ratios: almo t 300 per cent. Nicaragua is the econd poorest country in the Western Hemisphe e (after Haiti), and for the last decade has relied very heavil on foreign as istance and aid. Moreover, in the l st few years Nicaragua has run extremely large current account ficits n excess f 37 per cent of GDP d ring 1997-2001 largely fin nced by grants, donat ons and migrant remittances.