Sovereign Risk

During the 2009 to 2010 European sovereign debt crisis, Greece revealed that its 2009 budget deficit was far larger than first reported. The figure was revised up from about 6 to 8 percent to a final 15.4 percent of GDP, with debt reaching roughly 127 percent of GDP. What happened to its borrowing cost?

Investors repriced Greek default risk sharply. The spread of Greek 10-year bonds over German Bunds blew out from roughly 1 percentage point to above 30 percentage points at the 2011 to 2012 peak, and the agencies cut Greece from A-grade to default-grade, with S&P assigning "Selective Default" in February 2012. Because Greece used the euro it could not print its own money, so the ability-to-pay channel dominated and the March 2012 restructuring forced a 53.5 percent face-value cut on about 197 billion euros of privately held bonds, the largest sovereign restructuring on record.

Argentina has defaulted on its sovereign debt about nine times since independence in 1816. In December 2001 it stopped paying roughly 80 to 100 billion dollars of mostly foreign-currency debt, and in May 2020 it missed a 500 million dollar bond payment. What does this serial record illustrate?

Argentina shows that default is recurrent and tied to foreign-currency exposure. The 2001 collapse, then the largest sovereign default to date, followed a deep recession and a currency peg the country could not defend, so it could not earn or borrow the dollars it owed. The 2020 default repeated the pattern. Because the debt was in dollars rather than pesos, Argentina could not print its way out, and the 2001 episode dragged on for over a decade of litigation with holdout creditors, underlining that there is no court to liquidate a state and recovery comes only through negotiated restructuring.

In August 1998 Russia devalued the ruble and defaulted on its domestic, ruble-denominated GKO and OFZ bonds, alongside a 90-day moratorium on foreign debt. If a government can print its own currency, why would it default on local-currency debt at all?

Russia is the textbook case that "they can always print" is a choice, not a guarantee. It could in principle have printed rubles to redeem the GKOs, but doing so would have meant runaway inflation and an even deeper currency collapse, so it judged outright default the lesser evil. This is a willingness-to-pay decision: the political and economic cost of the inflation needed to honour the debt exceeded the cost of defaulting, exactly the trade-off that makes local-currency debt a choice rather than a certainty.