Sovereigns' Ability to Manage Crises Not Merely Determined by Debt Levels

by: Research Recap

Despite the current focus on high sovereign debt levels, Moody’s says that there are other factors — such as economic resilience, the quality of political institutions and the structure of the debt — that are equally important in determining a country’s ability to manage crises.

“The current sovereign debt crisis is affecting large, wealthy and diversified economies that are well-placed to deal with shocks. By contrast, past defaulters were generally smaller, much less wealthy and non-diversified economies that were much more susceptible to shocks,” explains Daniel McGovern, Managing Director of Moody’s Sovereign Risk Group.

Since 1997, there have been 20 sovereign defaults on government bonds. “Overall, 15% of defaults were due to banking crises, 15% to long-term economic stagnation, 35% to high debt burden, and 35% to political or institutional weaknesses” says Elena Duggar, Group Credit Officer for Sovereign Risk in Moody’s Credit Policy Group.

Specifically, Moody’s new report pinpoints four key findings:

  1. While defaults are correlated with rising debt burdens, a high debt-to-GDP ratio is neither a necessary nor a sufficient condition for sovereign default.
  2. Past defaulters had high foreign currency exposure, an average of 76% of total debt was in foreign currency in the year prior to default, and high debt servicing costs.
  3. Sovereigns with moderately low debt levels have defaulted when their economic prospects were poor, their net foreign currency exposures were large, and their political institutions were weak.
  4. Conversely, countries with high economic resiliency, debt that is predominantly denominated in domestic currency and strong political institutions have historically been successful in managing relatively large debt burdens and eventually reversing increases in debt-to-GDP ratios caused by macroeconomic shocks and banking crises.