Abstract
Many sovereigns, including weaker credits, have taken on substantial debt during the COVID-19 pandemic. This raises the prospect of future defaults and sovereign restructurings, which will be informed by debt-sustainability analysis. But when analyzing notable recent sovereign defaults, we find a pattern of serially correlated errors: the analysis at the time of the restructuring is too optimistic about future sovereign debt dynamics. In light of this, I propose that future sustainability analysis should be based on more pessimistic expectations. In turn, this implies that sovereign creditors should face larger losses in future restructurings.
Highlights
With the COVID-19 pandemic still raging in many countries, governments around the world have borrowed significant sums both to respond to the health crisis and to support companies and employees in those parts of the economy most affected by shutdowns in activity and other aspects of the pandemic
From looking at the sovereign defaults outlined above, it is evident that the International Monetary Fund (IMF) has systematically exhibited over-optimism in its assessments of debt dynamics
While the sample size is obviously small, the consistency of the direction of forecast errors represents a clear pattern despite the notable idiosyncrasies of the different sovereign defaults as set out above
Summary
With the COVID-19 pandemic still raging in many countries, governments around the world have borrowed significant sums both to respond to the health crisis and to support companies and employees in those parts of the economy most affected by shutdowns in activity and other aspects of the pandemic. This has resulted in a significant increase in public debt-GDP ratios. Obligations rated at single B are “considered speculative and are subject to high credit risk”, with ratings in the Caa category “judged to be speculative of poor standing and are subject to very high credit risk” (Moodys, 2021)
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