Technical Updates

Some Brief Thoughts on Sovereign Defaults

Sovereign default experiences are a staple in international finance. Here are a couple bits of information from a vast literature.

First, from Asonumo (2009):

…we cover stylized facts of serial defaults, especially some features di¤ering by countries’history of defaults. Figure 2 reports external debt-to-GDP ratio, bond spreads and credit ratings. Bond spreads of past defaulters, except Chile and Egypt, are higher than those of non- defaulters given external debt-to-GDP ratio7. Past defaulters tend to su¤er higher spreads on the newly issued bonds in the future after default, even if they have the same level of foreign debt relative to GDP as before. Similarly, past defaulters have lower credit ratings than non-defaulters.

It is apparent that precarious debt intolerance situation of Argentina is more severe than one of Malaysia9. Since Argentina is representative of many countries with a weak credit history and Malaysia is representative of countries with a sound credit history, this result re‡ects that the debt thresholds of countries with a weak credit history are lower than that of countries with a sound credit history. In other words, the default probability of countries with a weak credit history is higher than one of countries with a sound credit history, given the same level of debt-to-GNP.

External debt;GDP, bond spreads abd credit ratings average 2003-2005Figure from Asonuma (2009).

Something to keep in mind, when next you hear someone say with equanimity that a small, or “technical”, default would be no problem. (These are often the same people who say that crowding out — higher interest rates due to accumulating debt — are a problem. This strikes me as an internally inconsistent worldview, but internal consistency I am told is the hobgoblin of small minds.)

More on sovereign debt restructuring/default from Willem Buiter/Citi.

What about orderly restructuring. As many have noted, restructurings are anything but smooth processes. Professor Anne Krueger, who was appointed DMD at the IMF by President G.W. Bush, characterized sovereign debt restructurings as “Messy or Messier”, noted that one could reduce the messy nature of restructurings by either a sovereign debt restructuring mechanism (kind of a chapter 11 for countries), or further use of collective action clauses. I’ll let readers guess if either of these two mechanisms apply to US sovereign debt.

Finally, in my one of my first forays into YouTube land, let me bring people’s attention Douglas Holtz Eakin’s view on the debt ceiling debate.

[Full disclosure: Holtz-Eakin was Chief Economist on CEA staff during the time I served on the staff of the CEA, during the first months of the G.W. Bush administration]


Guest Posted by Menzie Chinn at June 1, 2011 08:56 AM

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