Country risk, incomplete information and taxes on international borrowing

In the 1980s a growing number of countries have found servicing their debt a challenging task. Countries in balance-of-payments crises have tended to impose restrictions on capital mobility, and frequently have adopted various versions of dual exchange rate systems. The growing policy concern with balance-of-payments crises has also been reflected in considerable interest in the factors governing country risk and the role of capital market policies. The purpose of this paper is to integrate these lines of research by analysing the design of optimal policies in the presence of country risk. The characteristics of the supply of credit in a stochastic environment are derived. The analysis identifies the considerations under which country risk introduces a domestic distortion. These considerations facilitate the derivation of the optimal domestic policies. -from Author