Costs of Sovereign Defaults: Restructuring Strategies and the Credit-Investment Channel

Abstract

Sovereign debt restructurings are associated with declines in GDP, investment, private sector credit and capital flows. The transmission channels and associated output and banking sector costs depend on whether the restructuring takes place preemptively, without missing payments to creditors, or after a default has occurred. Post-default restructurings are associated with larger declines in GDP, investment, private sector credit and capital inflows than preemptive restructurings. The adverse effects from a restructuring are stronger in countries with larger banking sectors, consistent with a “credit-investment channel”.