Sovereign nations financial distress: An early warning system for predicting Paris Club debt re-scheduling events from financial ratios, and neural network indexing model

Government leaders and Bretton Woods institutions managers have called for the development of early warning systems for predicting financial stress of nations. This research addresses that problem by drawing on theories from commercial bankruptcy prediction, and finding a similarity between corporate financial ratios and those of nations, and also finding a similarity between chapter XI corporate restructuring and a Paris Club event, in which multilateral debt is rescheduled to achieve a sustainable debt service status.; Grounded in the literature, four sovereign nation ratios relative to creditworthiness, liquidity, ability to pay, and economic activity were selected. Such ratios include elements of GNP, short-term and total debt, export earnings, internal and external reserves, and debt service requirements. With the exception of the creditworthiness ratio, the study found a significant difference between Paris Club nations and those not defaulting.; A ratio-based neural network was trained on 90 observations from 40 defaulting nations for the period 1989 to 1993, and 45 observations from 45 non-defaulting debtor nations for 1993. The trained neural network was then tested on all 208 nations in the World Bank STAR database for 1994. The neural network was programed to classify 208 nations into probable defaulting and non-defaulting groups, 1994 to 1996.; The neural network correctly classified 77% of defaulting and non-defaulting nations. Its output weights were found to act, look and feel like Zeta-Scores used in corporate bankruptcy classification. On a range of values from 0.0 to 1.0, a nations' neural weight of {dollar}<{dollar}0.73 successfully separated 95% of Paris Club and non-Paris Club nations.; IMF and World Bank policies, and how these changed over recent decades, are discussed, together with social objectives of default prevention, poverty alleviation, and the perspectives of donor nations and debtor nations alike. Future research should address shorter prediction horizons with increased emphasis on commercial debt.