Sovereign default
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A sovereign default is the failure or refusal of the government of a sovereign state to pay back its debt in full when due. Cessation of due payments (or receivables) may either be accompanied by that government's formal declaration that it will not pay (or only partially pay) its debts (repudiation), or it may be unannounced. A credit rating agency will take into account in its gradings capital, interest, extraneous and procedural defaults, and failures to abide by the terms of bonds or other debt instruments.
Countries have at times escaped some of the real burden of their debt through inflation. This is not "default" in the usual sense because the debt is honored, albeit with currency of lesser real value. Sometimes governments devalue their currency. This can be done by printing more money to apply toward their own debts, or by ending or altering the convertibility of their currencies into precious metals or foreign currency at fixed rates. Harder to quantify than an interest or capital default, this often is defined as an extraneous or procedural default (breach) of terms of the contracts or other instruments.
If potential lenders or bond purchasers begin to suspect that a government may fail to pay back its debt, they may demand a high interest rate in
They may also be vulnerable to a sovereign debt crisis due to
Since a
The
Causes
According to financial historian Edward Chancellor, past instances of sovereign default have tended to occur under some or all of the following circumstances:[8]
- A reversal of global capital flows
- Unwise lending
- Fraudulent lending
- Excessive foreign debts
- A poor credit history
- Unproductive lending
- Rollover risk
- Weak revenues
- Rising interest rates
- Terminal debt
A significant factor in sovereign default is the presence of significant debts owed to foreign investors such as banks who are unable to obtain timely payment via political support from governments, supranational courts or negotiation; the enforcement of
Insolvency/over-indebtedness of the state
If a state, for economic reasons, defaults on its treasury obligations, or is no longer able or willing to handle its debt, liabilities, or to pay the interest on this debt, it faces sovereign default. To declare insolvency, it is sufficient if the state is only able (or willing[9]) to pay part of its due interest or to clear off only part of the debt.
Reasons for this include:[citation needed]
- massive increases in public debt
- declines in employment and therefore tax revenue
- government regulation or perceived threats of regulation of financial markets
- popular unrest at austerity measures to repay debt fully
Sovereign default caused by insolvency historically has always appeared at the end of long years or decades of budget emergency (overspending[12]), in which the state has spent more money than it received. This budget balance/margin was covered through new indebtedness with national and foreign citizens, banks and states.
Illiquidity
There is an important distinction between illiquidity and insolvency.[citation needed] If a country is temporarily unable to meet pending interest or principle payments because it can not liquify sufficient assets, it is "in default because of illiquidity". In this concept the default can be solved as soon as the assets that are "only temporarily illiquid" become liquid (again), which makes illiquidity a temporary state – in contrast to insolvency. The weakness of this concept is that is practically impossible to prove that an asset is only temporarily illiquid.
Change of government
While normally the change of government does not change the responsibility of the state to handle treasury obligations created by earlier governments, nevertheless it can be observed that in revolutionary situations and after a regime change the new government may question the legitimacy of the earlier one, and thus default on those treasury obligations considered odious debt.
Important examples are:
- default of debts of the House of Bourbon after the French Revolution.
- default of bonds through Denmark in 1850, which were issued by the government of Holstein instated by the German Confederation.
- default of debts of the Russian Empire after the Soviet government came to power in 1917.[13]
- repudiation of debts of the Confederate States of America by the United States after the Civil War through the ratification of Section 4 of the Fourteenth Amendment.
Demise of the state
With the demise of a state, its obligations are turned over to one or several successor states. For example, when the Soviet Union dissolved, successor states such as Estonia, Russia, Georgia, Ukraine, etc. came into being. The Soviet state ceased to exist, but its debt could be inherited by successor states.[14]
Lost wars significantly accelerate sovereign default. Nevertheless, especially after World War II the government debt has increased significantly in many countries even during long lasting times of peace. While in the beginning debt was quite small, due to compound interest and continued overspending,[12] it has increased substantially.
Approaches to debt repayment
There are two different theories as to why sovereign countries repay their debt.
Reputation approach
The reputation approach stipulates that countries value the access to international capital markets because it allows them to smooth consumption in the face of volatile output and/or fluctuating investment opportunities. This approach assumes no outside factors such as legal or military action because the debtor is a sovereign country. Debtor countries with poor reputations will lack access to these capital markets.[15]
Punishment approach
The punishment approach stipulates that the debtor will be punished in some form, whether it be by legal action and/or military force. The creditor will use legal and/or military threats to see their investment returned. The punishment may prevent debtors from being able to borrow in their own currency.[15]
Consequences
Creditors of the state as well the economy and the citizens of the state are affected by the sovereign default.
Consequences for creditors
The immediate cost to creditors is the loss of principal and interest owed on their loans to the defaulting country.
In this case very often there are international negotiations that end in a partial
For the purpose of debts regulation debts can be distinguished by nationality of creditor (national or international), or by the currency of the debts (own currency or foreign currency) as well as whether the foreign creditors are private or state owned. States are frequently more willing to cancel debts owed to foreign private creditors, unless those creditors have means of retaliation against the state.[9]
Consequences for the state
When a state defaults on a debt, the state disposes of (or ignores, depending on the viewpoint) its financial obligations/debts towards certain creditors.[
Consequences for the citizens
If the individual citizen or corporate citizen is a creditor of the state (e.g.
In addition, the following scenarios can occur in a debtor state from a sovereign default:
- a write downson credits given to the state.
- an economic crisis, as the interior demandwill fall and investors withdraw their money
- a currency crisis as foreign investors avoid this national economy
Citizens of a debtor state might feel the impact indirectly through high unemployment and the decrease of state services and benefits. However, a monetarily sovereign state can take steps to minimize negative consequences, rebalance the economy and foster social/economic progress, for example Brazil's Plano Real.[16]
Examples of sovereign default
A failure of a nation to meet bond repayments has been seen on many occasions. Medieval England lived through multiple defaults on debt,
In the 1820s, several Latin American countries that had recently entered the bond market in London defaulted. These same countries frequently defaulted during the nineteenth century, but the situation was typically rapidly resolved with a renegotiation of loans, including the writing off of some debts.[18]
A failure to meet payments became common again in the late 1920s and 1930s. As protectionism by wealthy nations rose and international trade fell, especially after the banking crisis of 1929, countries possessing debts denominated in other currencies found it increasingly difficult to meet terms agreed under more favourable economic conditions. For example, in 1932, Chile's scheduled repayments exceeded the nation's total exports; or, at least, its exports under then-current pricing. Whether reductions in prices – forced sales – would have enabled fulfilling
A number of states in the U.S.
More recently Greece became the first developed country to default to the International Monetary Fund. In June 2015 Greece defaulted on a $1.7 billion payment to the IMF.[21]
See also
- Asset–liability mismatch
- Balance of payments
- Debt crisis
- External debt
- Financial crisis
- Sovereign bond
- Vulture fund
References
- D. Andrew Austin (2016), Has the U.S. Government Ever “Defaulted”?
- Guillermo Calvo (2005), Emerging Capital Markets in Turmoil: Bad Luck or Bad Policy?
- Barry Eichengreen (2002), Financial Crises: And What to Do about Them.
- Barry Eichengreen and Ricardo Hausmann, eds., (2005), Other People's Money: Debt Denomination and Financial Instability in Emerging Market Economies.
- Barry Eichengreen and Peter Lindert, eds., (1992), The International Debt Crisis in Historical Perspective.
- M. Nicolas J. Firzli (2010), Greece and the Roots the EU Debt Crisis.
- Charles Calomiris (1998), 'Blueprints for a new global financial architecture'.
- Reinhart, Carmen M.; Rogoff, Kenneth S. (2009). This Time is Different: Eight Centuries of Financial Folly. Princeton University Press. ISBN 978-0-691-14216-6.
- Jean Tirole (2002), Financial Crises, Liquidity, and the International Monetary System.
Citations
- ISBN 0-226-19455-8.
- ^ Borensztein, E.; Panizza, U. (Nov 10, 2010). "The Costs of Sovereign Default: Theory and Reality". VOXLACEA.
- ^ ISBN 978-0-691-14216-6.
- ^ Firzli, M. Nicolas J. (March 2010). "Greece and the Roots the EU Debt Crisis". The Vienna Review.
- ^ Roubini, Nouriel (June 28, 2010). "Greece's best option is an orderly default". Financial Times.
- ^ Louise Armitstead, "EU accused of 'head in sand' attitude to Greek debt crisis" The Telegraph, 23 June 2011
- ISBN 978-9939-76-173-2.
- ^ Reflections on the sovereign debt crisis, Edward Chancellor, GMO White Paper, Juli 2010.
- ^ a b c d Wright, Mark; Tomz, Mike (2010). "Sovereign Theft: Theory and Evidence about Sovereign Default and Expropriation". In Hogan, William; Sturzenegger, Federico (eds.). The Natural Resources Trap: Private Investment without Public Commitment. Cambridge, Massachusetts: MIT Press. pp. 69–110. Archived from the original (PDF) on 15 April 2012. Retrieved 6 November 2011.
- ^ Hagerty, James R. (17 December 2009). "Is Walking Away From Your Mortgage Immoral?". The Wall Street Journal.
- ^ "Sovereign Default: The dark side of globalization and capitalism". AllISayIs.com. August 2015.
- ^ a b Baqir, Reza (30 September 1999). Districts, spillovers, and government overspending (Report). Policy Research Working Paper Series. World Bank. No. 2192.
- ^ Landon-Lane, J., Oosterlinck, K. (2006), "Hope springs eternal: French bondholders and the Soviet Repudiation (1915–1919)", Review of Finance, 10, 4, pp. 507–535.
- ^ "26 years on, Russia set to repay all Soviet Union's foreign debt". The Straits Times. SPH Media Limited. 26 March 2017. Retrieved 8 March 2022.
- ^ JSTOR 2296886.
- ^ Lim, Richard (2011-06-20). "Brazil's Battle Against Inflation". Soundsandcolours.com. Archived from the original on 2013-10-16. Retrieved 2013-10-14.
- ^ Bell, Adrian R.; Brooks, Chris; Moore, Tony (12 June 2019). "England's history of defaulting on European lenders shows repercussions of not paying Brexit bill". The Conversation. Retrieved 2020-07-20.
- ^ a b Erika Jorgensen and Jeffrey Sachs, "Default and Renegotiation of Latin American Foreign Bonds in the Interwar Period" In: Barry J. Eichengreen and Peter H. Lindert, The International Debt Crisis in Historical Perspective
- ^ Frum, David (2020-04-25). "Why Mitch McConnell Wants States to Go Bankrupt". The Atlantic. Retrieved 2020-05-02.
- .
- ^ Liakos, Virginia Harrison and Chris (2015-06-30). "Greece defaults on $1.7 billion IMF payment". CNNMoney. Retrieved 2017-04-26.