The Economics of Sovereign Debt and Default (2024)

FAQs

What happens when a country defaults on sovereign debt? ›

It has serious economic consequences for the nation, making it expensive or impossible for it to borrow money in the future. It also causes domestic turmoil. Many banks, pension funds, and individual investors keep some of their assets in sovereign bonds. The nation's financial failure ripples through its economy.

The list of sovereign debt crises involves the inability of independent countries to meet its liabilities as they become due. These include: A sovereign default, where a government suspends debt repayments.

The average cumulative five-year default rate between 1995 and 2021 for sovereigns rated 'C' to 'CCC+' by Fitch was 40.6%.

Key Takeaways. Sovereign debt is debt issued by the government of an independent political entity, usually in the form of securities. Several private agencies often rate the creditworthiness of sovereign borrowers and the securities they issue.

Inflation adjusted to the 2023 calendar year. As of April 2024, the five countries owning the most US debt are Japan ($1.1 trillion), China ($749.0 billion), the United Kingdom ($690.2 billion), Luxembourg ($373.5 billion), and Canada ($328.7 billion).

In a default, interest rates on U.S. Treasurys would skyrocket (because investors would demand a higher rate in exchange for taking the risk that they might not be paid back), and Treasurys might no longer be usable as collateral (because their underlying value would not be clear).

1) Switzerland. It is no surprise to see Switzerland on this list. Switzerland is a country that, in practically all economic and social metrics, is an example to follow. With a population of almost 9 million people, Switzerland has no natural resources of its own, no access to the sea, and virtually no public debt.

Measuring by debt to GDP ratio, Lebanon's debt is the highest in the world, and the United States—which has the world's largest economy and highest GDP—drops to spot 12.

Ireland has never defaulted on its obligations and Italy did so only once during a seven-year period during World War II. Portugal has defaulted four times on its external debt obligations with the last occurrence in the early 1890s.

Key Takeaways

Public debt is held by the public: individual investors, institutions, foreign governments. After intragovernmental holdings, the next largest category is national debt held by foreign governments. Of those, Japan has the most, followed by China.

Which country is going to default? ›

Lebanon, Sri Lanka, Russia, Suriname and Zambia are already in default, Belarus is on the brink and at least another dozen are in the danger zone as rising borrowing costs, inflation and debt all stoke fears of economic collapse. Totting up the cost is eyewatering.

Types of Sovereign Debt

Bonds issued by developed economies, such as Germany, Switzerland, or Canada, usually carry very high credit ratings. 12 They are considered extremely safe and offer relatively low yields.

At high debt levels, governments have less capacity to provide support for ailing banks, and if they do, sovereign borrowing costs may rise further. At the same time, the more banks hold of their countries' sovereign debt, the more exposed their balance sheet is to the sovereign's fiscal fragility.

Findings. Private non-bank investors, mainly investment funds, increase their holdings of sovereign debt by more than other investors as the sovereign's total debt expands. They fund nearly 70% of increases in sovereign debt. Further, non-bank investors are the most responsive to changes in sovereign yields.

Asset managers, such as pension funds, typically hold a large amount of government debt. They need relatively safe long-term assets to match their long-term liabilities. Banks also hold large amounts of sovereign debt, especially of governments in the countries where they are based.

Effects of the Crisis

The sovereign debt crisis resulted in economic (GDP) contractions, job destruction, and social turmoil. A part of the austerity measures included cutting down public sector wages and pensions and increasing income taxes – which resulted in backlash from the public.

At high debt levels, governments have less capacity to provide support for ailing banks, and if they do, sovereign borrowing costs may rise further. At the same time, the more banks hold of their countries' sovereign debt, the more exposed their balance sheet is to the sovereign's fiscal fragility.

As of December 2023, total federal debt was $33.1 trillion; $26.5 trillion held by the public and $12.1 trillion in intragovernmental debt.