This paper focuses on the significant growth of domestic credit once the debt is restructured and shows that is not correlated with the size of the haircut. Second, it performs an event study around Ecuador’s sovereign default and restructuring of 2008-2009 to study changes in domestic bank lending behavior. After external debt restructuring, private lending increased the most for banks highly exposed to public debt. Finally, it provides a simple model were uncertainty about the return on government external debt during default has spillover effects on the domestic economy by creating dispersion in beliefs across domestic banks, which leads to a misallocation of credit. External debt restructuring eliminates domestic belief heterogeneity by making the return on bonds observable to everyone. This simple framing is not only consistent with the substantial growth in domestic credit upon debt restructuring but also with its independence from the haircut size observed in the data.
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