World Bank Document

Box 2.3
How inflation affects loan repayments
The last few years have seen substantial fluctuations in produce larger real debt repayments in the near future
inflation and interest rates. Inflation and interest rates and lower real debt repayments near the end of the loan
influence the debt indicators usually relied on to evaluate repayment schedule. This forward tilt in the real amortithe
creditworthiness of borrowers. First, the nominal zation schedule ("front-loading") is more pronounced
value of debt must be deflated by some price indicator to the longer the original maturity of the loan.
obtain a realistic assessment of its real value. Second, to Box table 2.3A shows how the different components of
the extent that inflation either outstrips or lags behind total debt service have moved over time. A variety of
the rise in nominal interest rates, a real transfer of price indexes could be used in these calculations. Here
resources will occur-to the debtor in the former case the developing countries' export prices (merchandise,
and to the creditor in the latter. Finally, the real debt f.o.b., excluding fuel) are used. This implies measuring
burden will not be altered by inflation if nominal interest the value of the debt service in terms of the domestic
rates exactly keep pace with inflation. In that case, never- goods that need to be exported to service the debt. The
theless, the loan will be amortized at a faster real rate debt service ratio shows very little variation from year to
than the original terms might indicate.
year, but total amortization payments fluctuate widely as
When inflation goes up and nominal interest rates rise a result of the inflationary component of interest payin
line, interest payments include a component to com- ments. The share of debt service in export earnings
pensate the lender for the erosion in the real value of declined during the period 1971-73, but the inflationloans.
Although this does not change the real value of all adjusted amortization payments reached their highest
repayments, it does speed up the real amortization: the level in 1973. Similarly, the debt service ratio increased
inflation component of nominal interest rates is added to during the period 1980-82, but in fact the share of inflathe
regularly scheduled nominal amortization payments. tion-adjusted amortization payments showed a sharp
Thus, for a given loan maturity, higher inflation rates decline.
Box table 2.3A
(percent)
Inflationary effects on debt service
Debt _ Inflation-adjusted amortization/exports
Inflation-adjusted
Det + interest
servicelexparts
Inflation-
Scheduled + induced Total payments/exports
Year amortization amortization amortization
1970 14.7 10.6 3.0 13.6 1.2
1971 15.6 11.2 -4.2 7.0 8.6
1972 15.2 10.9 5.9 16.8 -1.6
1973 14.1 9.9 32.4 42.3 -28.1
1974 11.8 7.9 19.1 27.0 -15.1
1975 13.9 9.0 -8.6 0.4 13.5
1976 13.6 8.9 8.2 17.2 -3.5
1977 14.8 9.7 10.0 19.7 -5.0
1978 18.4 12.3 6.0 18.3 0.1
1979 18.4 11.7 13.5 25.2 -6.8
1980 16.0 9.2 12.5 21.7 -5.6
1981 17.6 9.4 -6.8 2.6 15.0
1982 20.5 10.4 -7.4 3.0 17.5
1983 19.0 9.1 0.5 9.6 9.3
1984 19.7 8.2 -0.4 7.8 11.9
Note: The decomposition of the debt service ratio into inflation adjusted interest payments and inflation adjusted amortization is based on the
identities
DS = IN + AM
IN = i - p)D + pD
where DS is debt service; IN is interest payments; AM is amortization; i is the nominal interest rate calculated as the ratio ot interest payments in the
current period (IN) to debt outstanding and disbursed in the previous period (D); p is the annual inflation rate based on the merchandise (F 0. B.)
deflator excluding tueL. Thus,
DS = (i -
p)D + pD + AM
where (i - p)D equals inflation adjusted interest payments, and pD + AM equals inflation adjusted amortization. The various components may not
add up to debt ratio due to rounding.
Source: World Bank data.
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