Sovereign Environmental Risk

Sovereign Debt at Square One

How to Default on Sovereign Debt

Sovereign debt restructurings with private creditors

A New Approach to Eurozone Sovereign Debt

The Root of All Sovereign Debt Crises

Sixth, rising government debt ratios will eventually lead to increases in real interest rates that may crowd out private spending and even lead to sovereign refinancing risk.

Until the euro crisis, it was generally believed that problems servicing sovereign debt occurred only in emerging markets and the least developed countries. The US Supreme Court s decision on Argentina adds a new wrinkle, and may well further increase the risk attached to holding sovereign debt and this to the cost of issuing it.

One of the key challenges is the negative feedback loop between the weaknesses of many banks and the doubts about the peripheral countries sovereign debt. The sovereign debt and banking crises have become even more closely interlinked as banks bought greater amounts of their home countries sovereign debt.

The European Union s approach to bank regulation encouraged financial institutions to load up on government debt supposedly a risk free asset. Now, given the profound sovereign debt crisis in the eurozone periphery, government defaults threaten to take down the big banks.

Europeans, too, have become dependent on low interest rates, with the European Central Bank as the key stabilizing force. Without the ECB s commitment, in place since 2012, to prevent sovereign debt yields from soaring, there would be a persistent risk to the eurozone and, indeed, to the entire edifice of the European Union of sovereign debt defaults.

Table 3 Recent sovereign debt restructurings with private creditors main features

Clearly, environmental risks are potentially large enough to affect countries economies in ways that could influence their willingness or ability to repay sovereign debt. In addition, these risks vary widely across countries, including countries whose current credit ratings suggest similar levels of sovereign risk.

26 The risk of litigation has increased with the emergence of vulture funds that would buy distressed sovereign debt on the secondary markets and then sue for full repayment once restructuring negotiations commenced.

15. Reiterates the importance of the orderly resolution of sovereign debt crises, notes the increasing voluntary use of collective action clauses in international sovereign bonds, and takes note of the efforts led by sovereign debtors and private creditors to develop a voluntary code of conduct for the resolution of sovereign debt crises

Noted the request of Iraq for the cancellation or reduction of their sovereign debt.

In some countries with high levels of debt and impaired growth, fiscal stimulus could raise the risk premium on sovereign debt and be counterproductive others have more flexibility. Countries vary widely in terms of household balance sheet damage, which clearly affects the propensity to save and hence the multiplier effect.

The solution to breaking the nexus between sovereign debt crises and banking crises is straightforward limit banks to lending where evaluation of borrowers willingness and ability to repay isn t a great leap in the dark. This means no cross border sovereign debt (or esoteric instruments, such as collateralized debt obligations).

Bank lending to sovereign borrowers has been a double disaster, fostering over indebtedness, especially in countries with irresponsible or corrupt governments. And, because much of the risk is borne by banks (rather than by, say, hedge funds), which play a central role in lubricating the payments system, a sovereign debt crisis can cause widespread harm.

But fiscal stimulus is constrained within the eurozone, where member countries no longer issue their own currency and sovereign debt therefore carries a default risk. Aggressive monetary expansion through quantitative easing is also far more complicated and politically contentious in a currency area with no federal debt for the central bank to buy.

It is likely that growing natural resource scarcities are driving a paradigm shift, with potentially profound implications for economies and thus for sovereign debt risk worldwide. Indeed, many countries are already experiencing an increase in import prices for biological resources.

Some might assume that bond markets are shielded from the effects of climate change, ecosystem degradation, and water scarcity. With more than 40 trillion of sovereign debt in global markets at any given time, that is a very high risk game.

When a sovereign decides that its foreign debt is unsustainable, the government and its creditors have had to negotiate among themselves about what to do. For sovereign bonds held by other sovereigns, the Paris Club of creditor countries has developed procedures for handling the debt.

These differences imply that the return to normal market conditions will be slower in the case of the euro crisis. Nevertheless, the crisis should abate somewhat, because the most risk averse institutions have by now sold their holdings of peripheral countries sovereign debt.

When financial markets discovered that supposedly riskless government bonds might be forced into default, they raised risk premiums dramatically. This rendered potentially insolvent commercial banks, whose balance sheets were loaded with such bonds, giving rise to Europe s twin sovereign debt and banking crisis.

Traditionally, sovereign risk has been concentrated in emerging market economies. After all, in the last decade or so, Russia, Argentina, and Ecuador defaulted on their public debts, while Pakistan, Ukraine, and Uruguay coercively restructured their public debt under the threat of default.

Recognizing the current debate on sovereign debt restructuring, especially the efforts led by sovereign debtors and private creditors to develop a voluntary code of conduct, and stressing that modalities for sovereign debt restructuring should be voluntary, market friendly and flexible, with due consideration of the specific circumstances of individual countries, and should result from the participation of all relevant stakeholders,

(f) continue deliberations on the creation of a framework to deal effectively with all sovereign debt of developing countries.

More broadly, the ECB s marginal lending facility is an indirect means of monetizing sovereign debt. It is an even less direct way to address the private, related debt overhang.

The link between sovereign debt and bank debt has to be broken once and for all. We must end the vicious circle whereby the use of taxpayers funds more than 4.5 trillion ( 5.7 trillion) so far to rescue banks weakens governments budgets, while increasingly risk averse banks stop lending to businesses that need funds, undermining the economy further.

Greece has no good options, but a serious contagion risk remains to be contained in order to prevent derailment of the fiscal and growth oriented reforms in Italy and Spain. In the face of high systemic risk, private capital is leaving banks and the sovereign debt markets, causing governments borrowing costs to rise and bank capitalization to fall.

Finally, GDP indexed bonds and other tools for dealing sensibly with unsustainable debt could be applied exclusively to member states debt not covered by the program and in line with international best practices for sovereign debt management.

Nonetheless, Argentina s latest debt trauma shows that the global system for sovereign debt workouts remains badly in need of repair. Deepening domestic debt markets and perhaps change along the lines proposed by the IMF is sorely needed.

Their economies are still tumbling, and the debt continues to grow. The credit ratings agency Standard Poor s has just downgraded the sovereign debt ratings of nine eurozone countries, including France.

The credit ratings agency Standard amp Poor s has just downgraded the sovereign debt ratings of nine eurozone countries, including France.

Schauble advocates a longer term solution a European Monetary Fund (EMF) to provide emergency lending to countries at risk of default on their sovereign debt. Emergency lending would come with a prohibitive price tag, strict conditions, and mandatory penalties in the event of non compliance.

Meanwhile, governments were running large deficits a legacy of the economic downturn which renewed growth was supposed to shrink. In the eurozone, countries like Greece faced sovereign debt crises as bank bailouts turned private debt into public debt.

But the stimulus measures transformed a banking crisis into a fiscal and sovereign debt crisis. From 2010 onwards, governments started to raise taxes and cut spending in response to growing fears of sovereign default.

The international community has, so far, failed to develop effective and equitable arrangements for restructuring sovereign debt, despite the clearly dysfunctional and problematic consequences of past international public debt crises. This prevents timely debt workouts when needed, effectively impeding recovery.

In Europe, the tail risk of a eurozone break up and a loss of market access by Spain and Italy were reduced by last summer s decision by the European Central Bank to backstop sovereign debt. But the monetary union s fundamental problems low potential growth, ongoing recession, loss of competitiveness, and large stocks of private and public debt have not been resolved.

Indeed, increased debt servicing obligations resulting from higher interest rates, along with weakening export prospects, ran the risk of reproducing an unsustainable debt burden.

True, the country s periodic debt crises are often the result of self destructive macroeconomic policies. But, this time, the default has been triggered by a significant shift in the international sovereign debt regime.

Regardless of how the current impasse is resolved, the ruling raises many questions for issuers and holders of sovereign debt. If creditors now believe that holding out makes it more likely that they will receive full value at a later date, restructuring sovereign debt and restoring a debtor economy s normal functioning will be more difficult.

This distinction between foreign and domestic debt is particularly important in the context of the euro crisis, because eurozone countries cannot devalue to increase exports if this is required to service foreign debt. And the evidence confirms that the euro crisis is not really about sovereign debt, but about foreign debt.

We welcome the commitment of the Paris Club to reduce substantially Iraq's sovereign debt and urge the other creditors to take similar decisions.