What happens when a country defaults?

Sri Lanka on 12/4 declared default with $51 billion in foreign debt, as the country faces its worst economic crisis since independence in 1948. Their reserves are now only $2.2 billion, compared to last year. now have to pay $4 billion of debt.

It is not uncommon for a country to default on its debt. Centuries ago, many countries were struggling to pay their debts. King of Spain – Philip II from the 16th century saw his country default on four times during his reign. Greek and Argentina also failed to meet creditors 7 and 9 times respectively in the past 200 years.

Since 1960, 147 governments have defaulted on their debts, the World Economic Forum (WEF) says. This is equivalent to more than half of all governments globally. Recently, Covid-19 has increased pressure on debt repayment, especially in low-income countries and emerging economies, according to the International Monetary Fund (IMF). Argentina, Ecuador, Lebanon and Zambia are the latest countries to restructure their debt.

Strictly speaking, though, countries don’t default, but governments. The IMF defines default as simply breaking a promise or breaking an agreement. When a country borrows money from domestic and foreign creditors, it is obligated to pay interest on those loans. If payment is missed, the country will be considered insolvent. Default occurs when the government is unable, or unwilling, to fulfill some/all of its debt obligations to a lender.

There are many causes of default, such as a weak economy or careless spending. Countries can also get into trouble if they borrow in foreign currencies. In this case, if the budget is in deficit, they will not be able to print more money to fill the gap.

According to Moody’s, slow growth and persistently high unemployment were the main causes of defaults in Russia and Ukraine in 1998, Argentina in 2001 and Venezuela 2017.

Meanwhile, high debt volumes, budget deficits and trade also make debt repayment difficult, as in the case of Greek 2012 and Lebanon 2020.

Another increasingly common cause is political instability and financial mismanagement, such as Argentina in 2014 and 2019, Ukraine in 2015 and Ecuador in 2008, 2020.

Defaults can be very painful times for countries, especially if it is unexpected and out of order. Depositors and investors in the country fearing the depreciation of the local currency will rush to withdraw money from banks and move them abroad. To prevent this and prevent currency devaluation, governments will close banks and impose capital controls.

As in the case of Greece in June 2015, the country had to close its stock market and banking system for a week, and limit daily cash withdrawals and payment transactions with foreign countries. .

Of course, the default of a country is very different from that of a business or an individual. Instead of bankruptcy, countries will have other options. Usually, they restructure debt by negotiating with creditors about extending the repayment period, or depreciating the local currency. A weaker local currency will make their exports cheaper, supporting the manufacturing industry, thereby helping the economy grow stronger and repaying debt easier.

After default, many countries will have to go through a process of harsh austerity. In 2015, Greece became the first developed country to default on IMF loans. A few months later, they received a bailout of up to 86 billion euros over three years from a group of creditors including the European Central Bank (ECB), the International Monetary Fund (IMF), the European Commission (EC). ) and the European Stability Mechanism (ESM), with very draconian reform and spending terms.

The usual consequence of a country defaulting on its debt is that it is difficult to get a loan, or has to borrow at high interest rates. However, many creditors are still willing to lend to countries with very low credit. As long as they get paid later for this risk taking.

Defaults also have a severe economic impact, causing GDP to decline for many years. However, it can also help countries reduce their debt if they run into trouble. This support is usually a reduction in interest after restructuring, rather than a reduction in principal.

A defaulting country also has the potential to affect the world. Last week, Russia was declared insolvent by the credit rating agency S&P debt repayment in ruble instead of US dollars. The IMF assesses this will cause global instability. Banks around the world have $120 billion in outstanding loans in Russia. However, while this number may sound large, it is not enough to cause the global financial system to fail.

It is very difficult to assess the probability of default of a country. Normally, credit rating agencies will assess the borrower’s ability to repay. When a country has a low credit rating, it will be difficult for them to borrow. In the case of Sri Lanka, many credit rating agencies downgraded the country’s rating to near default, leaving them inaccessible to foreign markets and relying on foreign exchange reserves to repay public debt.

However, with Japan, analysts have warned about the country’s public debt for 15 years now. But now, with debt equivalent to more than 200% of GDP, Japan’s borrowing rates are lower than they were in 1998 – when they were downgraded for the first time. Even many defaulting countries have lower debt volumes, equivalent to only 60% of GDP.

Ha Thu