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A sovereign default is the failure or refusal of the
government A government is the system or group of people governing an organized community, generally a state. In the case of its broad associative definition, government normally consists of legislature, executive, and judiciary. Government i ...
of a
sovereign state A sovereign state or sovereign country, is a political entity represented by one central government that has supreme legitimate authority over territory. International law defines sovereign states as having a permanent population, defined ter ...
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 In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
. 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 compensation for the risk of default. A dramatic rise in the interest rate faced by a government due to fear that it will fail to honor its debt is sometimes called a sovereign debt crisis. Governments may be especially vulnerable to a sovereign debt crisis when they rely on financing through short-term bonds, since this creates a
maturity mismatch Maturity or immaturity may refer to: * Adulthood or age of majority * Maturity model ** Capability Maturity Model, in software engineering, a model representing the degree of formality and optimization of processes in an organization * Development ...
between their short-term bond financing and the long-term asset value of their tax base. They may also be vulnerable to a sovereign debt crisis due to
currency mismatch A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general def ...
: if few bonds in their own currency are accepted abroad, and so the country issues mainly foreign currency-denominated bonds, a decrease in the value of their own currency can make it prohibitively expensive to pay back those bonds (see
original sin Original sin is the Christian doctrine that holds that humans, through the fact of birth, inherit a tainted nature in need of regeneration and a proclivity to sinful conduct. The biblical basis for the belief is generally found in Genesis 3 ...
). Since a
sovereign ''Sovereign'' is a title which can be applied to the highest leader in various categories. The word is borrowed from Old French , which is ultimately derived from the Latin , meaning 'above'. The roles of a sovereign vary from monarch, ruler or ...
government, by definition, controls its own affairs, it cannot be obliged to pay back its debt. Nonetheless, governments may face severe pressure from lending countries. In a few extreme cases, a major creditor nation, before the establishment of the UN Charter Article 2 (4) prohibiting
use of force by states Use may refer to: * Use (law), an obligation on a person to whom property has been conveyed * Use (liturgy), a special form of Roman Catholic ritual adopted for use in a particular diocese * Use–mention distinction, the distinction between using ...
, made threats of war or waged war against a debtor nation for failing to pay back debt to seize assets to enforce its creditor's rights. For example, in 1882, the United Kingdom invaded Egypt. Other examples are the United States' "
gunboat diplomacy In international politics, the term gunboat diplomacy refers to the pursuit of foreign policy objectives with the aid of conspicuous displays of naval power, implying or constituting a direct threat of warfare should terms not be agreeable to ...
" in Venezuela in the mid-1890s and the United States occupation of Haiti beginning in 1915. Today, a government that defaults may be widely excluded from further credit; some of its overseas assets may be seized; and it may face political pressure from its own domestic bondholders to pay back its debt. Therefore, governments rarely default on the entire value of their debt. Instead, they often enter into negotiations with their bondholders to agree on a delay (
debt restructuring Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continu ...
) or partial reduction of their debt (a ' haircut or write-off'). Some economists have argued that, in the case of acute
insolvency In accounting, insolvency is the state of being unable to pay the debts, by a person or company ( debtor), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-shee ...
crises, it can be advisable for regulators and supranational lenders to preemptively engineer the orderly restructuring of a nation's public debt – also called "orderly default" or "controlled default". In the case of Greece, these experts generally believe that a delay in organising an orderly default would hurt the rest of Europe even more. The
International Monetary Fund The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster glo ...
often lends for sovereign debt restructuring. To ensure that funds will be available to pay the remaining part of the sovereign debt, it has made such loans
conditional Conditional (if then) may refer to: *Causal conditional, if X then Y, where X is a cause of Y *Conditional probability, the probability of an event A given that another event B has occurred *Conditional proof, in logic: a proof that asserts a co ...
on action such as reducing
corruption Corruption is a form of dishonesty or a criminal offense which is undertaken by a person or an organization which is entrusted in a position of authority, in order to acquire illicit benefits or abuse power for one's personal gain. Corruption m ...
, imposing austerity measures such as reducing non-profitable public sector services, raising the tax take (revenue) or more rarely suggesting other forms of revenue raising such as
nationalization Nationalization (nationalisation in British English) is the process of transforming privately-owned assets into public assets by bringing them under the public ownership of a national government or state. Nationalization usually refers to p ...
of inept or corrupt but lucrative economic sectors. A recent example is the Greek bailout agreement of May 2010. After the
2008 financial crisis 8 (eight) is the natural number following 7 and preceding 9. In mathematics 8 is: * a composite number, its proper divisors being , , and . It is twice 4 or four times 2. * a power of two, being 2 (two cubed), and is the first number of ...
, in order to avoid a sovereign default,
Spain , image_flag = Bandera de España.svg , image_coat = Escudo de España (mazonado).svg , national_motto = '' Plus ultra'' (Latin)(English: "Further Beyond") , national_anthem = (English: "Royal March") , ...
and
Portugal Portugal, officially the Portuguese Republic ( pt, República Portuguesa, links=yes ), is a country whose mainland is located on the Iberian Peninsula of Southwestern Europe, and whose territory also includes the Atlantic archipelagos of th ...
, among other countries, turned their trade and current account deficits into surpluses. Currently, some member countries of the CIS (
Armenia Armenia (), , group=pron officially the Republic of Armenia,, is a landlocked country in the Armenian Highlands of Western Asia.The UNbr>classification of world regions places Armenia in Western Asia; the CIA World Factbook , , and ''O ...
,
Tajikistan Tajikistan (, ; tg, Тоҷикистон, Tojikiston; russian: Таджикистан, Tadzhikistan), officially the Republic of Tajikistan ( tg, Ҷумҳурии Тоҷикистон, Jumhurii Tojikiston), is a landlocked country in Centr ...
,
Kyrgyzstan Kyrgyzstan,, pronounced or the Kyrgyz Republic, is a landlocked country in Central Asia. Kyrgyzstan is bordered by Kazakhstan to the north, Uzbekistan to the west, Tajikistan to the south, and the People's Republic of China to the ea ...
), some African countries (
Cameroon Cameroon (; french: Cameroun, ff, Kamerun), officially the Republic of Cameroon (french: République du Cameroun, links=no), is a country in west-central Africa. It is bordered by Nigeria to the west and north; Chad to the northeast; the ...
,
Egypt Egypt ( ar, مصر , ), officially the Arab Republic of Egypt, is a List of transcontinental countries, transcontinental country spanning the North Africa, northeast corner of Africa and Western Asia, southwest corner of Asia via a land bridg ...
), Pakistan, as well as many other nations, have accumulated central government debt levels surpassing six months of those countries' GDPs.


Causes

According to financial historian
Edward Chancellor John "Edward" Horner Chancellor (born December 1962), is a British financial historian, finance journalist, and former investment strategist. In 2016, the ''Financial Analysts Journal'' called him "one of the great financial writers of our era", a ...
, past instances of sovereign default have tended to occur under some or all of the following circumstances: * 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
creditors' rights A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
against sovereign states is frequently difficult. Such willful defaults (the equivalent of strategic bankruptcy by a company or strategic default by a mortgager, except without the possibility of the exercise of normal creditors' rights such as asset seizure and sale) can be considered a variety of sovereign
theft Theft is the act of taking another person's property or services without that person's permission or consent with the intent to deprive the rightful owner of it. The word ''theft'' is also used as a synonym or informal shorthand term for som ...
; this is similar to
expropriation Nationalization (nationalisation in British English) is the process of transforming privately-owned assets into public assets by bringing them under the public ownership of a national government or state. Nationalization usually refers to p ...
(including inadequate repayment for the exercise of
eminent domain Eminent domain (United States, Philippines), land acquisition (India, Malaysia, Singapore), compulsory purchase/acquisition (Australia, New Zealand, Ireland, United Kingdom), resumption (Hong Kong, Uganda), resumption/compulsory acquisition (Austr ...
). Some also believe that sovereign default is a dark side of globalization and capitalism.


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) to pay part of its due interest or to clear off only part of the debt. Reasons for this include: *massive increases in public debt *declines in employment and therefore
tax revenue Tax revenue is the income that is collected by governments through taxation. Taxation is the primary source of government revenue. Revenue may be extracted from sources such as individuals, public enterprises, trade, royalties on natural resour ...
*government regulation or perceived threats of regulation of financial markets *popular unrest at
austerity Austerity is a set of political-economic policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both. There are three primary types of austerity measures: higher taxes to fund spend ...
measures to repay debt fully Sovereign default caused by insolvency historically has always appeared at the end of long years or decades of
budget A budget is a calculation play, usually but not always financial, for a defined period, often one year or a month. A budget may include anticipated sales volumes and revenues, resource quantities including time, costs and expenses, environme ...
emergency (
overspending Overspending is spending more money than one can afford. It is a common problem when easy credit is available. The term overspending is also used for investment projects when payments exceed actual calculated cost. Causes Some overspending is a ...
), 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

The literature proposes an important distinction between ''illiquidity'' and ''insolvency''. 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 The House of Bourbon (, also ; ) is a European dynasty of French origin, a branch of the Capetian dynasty, the royal House of France. Bourbon kings first ruled France and Navarre in the 16th century. By the 18th century, members of the Spani ...
after the
French Revolution The French Revolution ( ) was a period of radical political and societal change in France that began with the Estates General of 1789 and ended with the formation of the French Consulate in November 1799. Many of its ideas are conside ...
. *default of bonds through
Denmark ) , song = ( en, "King Christian stood by the lofty mast") , song_type = National and royal anthem , image_map = EU-Denmark.svg , map_caption = , subdivision_type = Sovereign state , subdivision_name = Kingdom of Denmark , establish ...
in 1850, which were issued by the government of
Holstein Holstein (; nds, label=Northern Low Saxon, Holsteen; da, Holsten; Latin and historical en, Holsatia, italic=yes) is the region between the rivers Elbe and Eider. It is the southern half of Schleswig-Holstein, the northernmost state of German ...
instated by the
German Confederation The German Confederation (german: Deutscher Bund, ) was an association of 39 predominantly German-speaking sovereign states in Central Europe. It was created by the Congress of Vienna in 1815 as a replacement of the former Holy Roman Empire, w ...
. *default of debts of the
Russian Empire The Russian Empire was an empire and the final period of the Russian monarchy from 1721 to 1917, ruling across large parts of Eurasia. It succeeded the Tsardom of Russia following the Treaty of Nystad, which ended the Great Northern War ...
after the
Soviet The Soviet Union,. officially the Union of Soviet Socialist Republics. (USSR),. was a List of former transcontinental countries#Since 1700, transcontinental country that spanned much of Eurasia from 1922 to 1991. A flagship communist state, ...
government came to power in 1917. *repudiation of debts of the
Confederate States of America The Confederate States of America (CSA), commonly referred to as the Confederate States or the Confederacy was an unrecognized breakaway republic in the Southern United States that existed from February 8, 1861, to May 9, 1865. The Confeder ...
by the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
after the
Civil War A civil war or intrastate war is a war between organized groups within the same state (or country). The aim of one side may be to take control of the country or a region, to achieve independence for a region, or to change government polici ...
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. Lost wars significantly accelerate sovereign default. Nevertheless, especially after
World War II World War II or the Second World War, often abbreviated as WWII or WW2, was a world war that lasted from 1939 to 1945. It involved the World War II by country, vast majority of the world's countries—including all of the great power ...
the
government debt A country's gross government debt (also called public debt, or sovereign debt) is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit oc ...
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 Overspending is spending more money than one can afford. It is a common problem when easy credit is available. The term overspending is also used for investment projects when payments exceed actual calculated cost. Causes Some overspending is a ...
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.


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.


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
debt cancellation Debt relief or debt cancellation is the partial or total forgiveness of debt, or the slowing or stopping of debt growth, owed by individuals, corporations, or nations. From antiquity through the 19th century, it refers to domestic debts, in particu ...
( London Agreement on German External Debts 1953) or
debt restructuring Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continu ...
(e.g. Brady Bonds in the 1980s). This kind of agreement assures the partial repayment when a renunciation / surrender of a big part of the debt is accepted by the creditor. In the case of the Argentine economic crisis (1999–2002) some creditors elected to accept the renunciation (loss, or "haircut") of up to 75% of the outstanding debts, while others ( "holdouts") elected instead to await a change of government (2015) for offers of better compensation. 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.


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. The immediate effect for the state is a reduction in its total debt and a reduction in payments on the interest of that debt. On the other hand, a default can damage the reputation of the state among creditors, which can restrict the ability of the state to obtain credit from the capital market. In some cases foreign lenders may attempt to undermine the monetary sovereignty of the debtor state or even declare war (see above).


Consequences for the citizens

If the individual citizen or corporate citizen is a creditor of the state (e.g.
government bonds A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity dat ...
), then a default by the state can mean a devaluation of their monetary wealth. In addition, the following scenarios can occur in a debtor state from a sovereign default: * a banking crisis, as banks have to make write downs on credits given to the state. * an economic crisis, as the interior demand will 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.


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,
Philip II of Spain Philip II) in Spain, while in Portugal and his Italian kingdoms he ruled as Philip I ( pt, Filipe I). (21 May 152713 September 1598), also known as Philip the Prudent ( es, Felipe el Prudente), was King of Spain from 1556, King of Portugal from ...
defaulted on debt four times – in 1557, 1560, 1575 and 1596. This sovereign default threw the German banking houses into chaos and ended the reign of the Fuggers as Spanish financiers. Genoese bankers provided the unwieldy Habsburg system with fluid credit and a dependably regular income. In return the less dependable shipments of American silver were rapidly transferred from Seville to Genoa, to provide capital for further military ventures. 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.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
'
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
creditors' rights A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
is unknown. A number of states in the U.S. defaulted in the mid-19th century. The most recent U.S. state to default was Arkansas, which defaulted in 1933. 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.


See also

* Asset–liability mismatch *
Balance of payments In international economics, the balance of payments (also known as balance of international payments and abbreviated BOP or BoP) of a country is the difference between all money flowing into the country in a particular period of time (e.g., ...
* Currency crisis * Debt crisis *
External debt A country's gross external debt (or foreign debt) is the liabilities that are owed to nonresidents by residents. The debtors can be governments, corporations or citizens. External debt may be denominated in domestic or foreign currency. It inclu ...
*
Financial crisis A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and man ...
*
Sovereign bond A government bond or sovereign bond is a form of Bond (finance), bond issued by a government to support government spending, public spending. It generally includes a commitment to pay periodic interest, called Coupon (finance), coupon payments' ...
*
Vulture fund A vulture fund is a hedge fund, private-equity fund or distressed debt fund, that invests in debt considered to be very weak or in default, known as distressed securities. Investors in the fund profit by buying debt at a discounted price on a ...


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'
* *Jean Tirole (2002), ''Financial Crises, Liquidity, and the International Monetary System''.


Citations

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