Sovereign Debt

Sovereign debt is the debt of a nation or its government, often referred to as public debt because it is, in essence, owed by the people. It can be debt that is owed domestically or owed to individuals/parties externally (internationally).

EUROZONE CONTAGION-UPDATE C

External Debt Statistics

This excerpt from pages 11 and 12 of External Debt Statistics of the Euro Area, by Jorge Diz Dias, Directorate General Statistics, European Central Bank, was presented at the IFC Conference on “Initiatives to address data gaps revealed by the financial crisis” for the Bank for International Settlements (BIS), Basel, Switzerland on August 25-26, 2010:

External debt indicators and debt crisis
Debt crises are multifaceted. They can be triggered by diverse factors such as social, political, economic, and financial developments. Reinhart and Rogoff (2008) found that a surge in gross external debt on account of a private borrowing boom, frequently accompanied by a build-up of government debt, usually precedes a banking crisis. The banking crisis precipitates public borrowing, to meet guarantees and to bail-out troubled financial institutions, which often leads to a sovereign debt crisis.

In this respect the composition of external debt in terms of currency and remaining maturity are very important factors for the assessment of the sustainability of that external debt. Similarly, the quality of both the issuer and the debt instrument, as well as the currency denomination of the external debt assets held by investors, are key to reducing risks related to external debt.

Large and increasing gross external debt positions may become a concern for an economy in view of the liquidity risk associated with debt servicing — principal and interest. This is particularly true in periods of financial distress, when prices and interest rates are very volatile. In these circumstances large gross external debt positions may pose a threat to the overall financial stability of an economy, for instance when low interest rate debt needs to be rolled-over into higher interest debt.

In extreme cases these events may lead to a debt crisis followed by a usually long and painful process of debt deleveraging and restructuring. This process, in turn, might have adverse effects on foreign investors’ confidence, reducing the capacity of an economy to access external funding at reasonable prices.

While large and increasing gross external debt positions only provide an indication of accumulating imbalances in, and the potential vulnerabilities of, an economy, significant net external debt levels provide a clearer picture on the existence of such problems. Large imbalances in the net external debt and large net interest payments are a credible early warning signal of rising risks concerning the ability of the economy to successfully meet its external financial obligations, particularly in periods of economic distress or when hit by an external shock.

A closer look is taken here at external debt indicators other than solely gross external debt in an attempt to extract an early-warning “rule of thumb” for possible short to medium-term external debt distress. Is there is a common pattern in the recent national debt crises? Is there any early warning sign in the data for such events?

Statistical analysis of the data suggests a few very striking features:

  • The gross external debt provides a first indication about the probability of future debt distress. After all there is no external debt crisis without external debt. However, there is no single gross external debt-to-GDP threshold that really signals imminent debt problems. The likelihood of such an event occurring varies considerably across countries and depends to a critical extent on, among other things, the stage of development of the country’s financial system as well as on the currency composition and the remaining maturity spectrum of the debt.
  • Large-scale external government debt with respect to GDP increases the country’s dependence on external financing and its risk of an external debt crisis. In the cases of Argentina (2001) and Hungary (2008) the fact that the ratio of such debt to GDP was in excess of 50% clearly contributed to the occurrence of such events.
  • The net external debt provides a more direct causal link to an external debt crisis. The ratio of net external debt to GDP was larger than 50% in the majority of external debt crises.
  • The ratio of net interest payments to GDP points further to countries with financial difficulties related to their external debt. Countries where that ratio is higher than 3% often end up with external debt solvency issues. This was the case in Argentina (2001), Hungary (2008), Ukraine (2008), Iceland (2008), and Greece (2010).

A net external debt ratio above 50% combined with a ratio of net interest payments to GDP larger than 3% seems to be a very powerful indicator for potential external debt difficulties in the short to medium term.

2009-gross-ext-debt

2009 Gross external debt as a percentage of GDP:

  1. Iceland — 1003%
  2. UK — 416%
  3. Switzerland — 250%
  4. Sweden — 221%
  5. Denmark — 198%
  6. Hungary — 182%
  7. Latvia — 173%
  8. New Zealand — 134%
  9. Bulgaria — 123%
  10. Australia — 111%
  11. USA — 96%
  12. Ukraine — 90%

Percentage of GDP to External Debt: Default is Inevitable
A country’s external debt is defined as the part of the total debt of a country owed to foreign creditors. These creditors may include other banks, governments, corporations, and private individuals.

No one is exactly sure how these debts are collateralized. There is a lot of fine print in ultra-small fonts within the billions of pages of these contracts. Some believe that it is based upon the country’s ability to tax its citizens and the good faith of the government to make good on its debts, but it’s always more than that. Argentina learned the hard way when their economy collapsed and foreigners came in to scoop up their resources. In the United States, external federal debt has been collateralized with our national lands, though the vast majority of the population is unaware of this.

Recently I saw a list of the percentage of external debt to GDP on the CNBC website. Sadly, it is in a slide show presentation and a lot of people have missed these important numbers, so I am reproducing the figures here as listed on the CNBC site:

1. Ireland

  • External debt (proportion of GDP): 1,267%
    External debt per capita: $567,805
  • Gross external debt: $2.386 trillion (2009 Q2)
    GDP (2008 est.): $188.4 billion

2. Switzerland

  • External debt (proportion of GDP): 422.7%
    External debt per capita: $176,045
  • Gross external debt: $1.338 trillion (2009 Q2)
    GDP (2008 est.): $316.7 billion

3. United Kingdom

  • External debt (proportion of GDP): 408.3%
    External debt per capita: $148,702
  • Gross external debt: $9.087 trillion (2009 Q2)
    GDP (2008 est.): $2.226 trillion

4. Netherlands

  • External debt (proportion of GDP): 365%
    External debt per capita: $146,703
  • Gross external debt: $2.452 trillion (2009 Q2)
    GDP (2008 est.): $672 billion

5. Belgium

  • External debt (proportion of GDP): 320.2%
    External debt per capita: $119,681
  • Gross external debt: $1.246 trillion (2009 Q1)
    GDP (2008 est.): $389 billion

6. Denmark

  • External debt (proportion of GDP): 298.3%
    External debt per capita: $110,422
  • Gross external debt: $607.38 billion (2009 Q2)
    GDP (2008 est.): $203.6 billion

7. Austria

  • External debt (proportion of GDP): 252.6%
    External debt per capita: $101,387
  • Gross external debt: $832.42 billion (2009 Q2)
    GDP (2008 est.): $329.5 billion

8. France

  • External debt (proportion of GDP): 236%
    External debt per capita: $78,387
  • Gross external debt: $5.021 trillion (2009 Q2)
    GDP (2008 est.): $2.128 trillion

9. Portugal

  • External debt (proportion of GDP): 214.4%
    External debt per capita: $47,348
  • Gross external debt: $507 billion (2009 Q2)
    GDP (2008 est.): $236.5 billion

10. Hong Kong

  • External debt (proportion of GDP): 205.8%
    External debt per capita: $89,457
  • Gross external debt: $631.13 billion (2009 Q2)
    GDP (2008 est.): $306.6 billion

11. Norway

  • External debt (proportion of GDP): 199%
    External debt per capita: $117,604
  • Gross external debt: $548.1 billion (2009 Q2)
    GDP (2008 est.): $275.4 billion

12. Sweden

  • External debt (proportion of GDP): 194.3%
    External debt per capita: $73,854
  • Gross external debt: $669.1 billion (2009 Q2)
    GDP (2008 est.): $344.3 billion

13. Finland

  • External debt (proportion of GDP): 188.5%
    External debt per capita: $69,491
  • Gross external debt: $364.85 billion (2009 Q2)
    GDP (2008 est.): $193.5 billion

14. Germany

  • External debt (proportion of GDP): 178.5%
    External debt per capita: $63,263
  • Gross external debt: $5.208 trillion (2009 Q2)
    GDP (2008 est): $2.918 trillion

15. Spain

  • External debt (proportion of GDP): 171.7%
    External debt per capita: $59,457
  • Gross external debt: $2.409 trillion (2009 Q2)
    GDP (2008 est.): $1.403 trillion

16. Greece

  • External debt (as % of GDP): 161.1%
    External debt per capita: $51,483
  • Gross external debt: $552.8 billion (2009 Q2)
    2008 GDP (est): $343 billion

17. Italy

  • External debt (proportion of GDP): 126.7%
    External debt per capita: $39,741
  • Gross external debt: $2.310 trillion (2009 Q1)
    GDP (2008 est.): $ 1.823 trillion

18. Australia

  • External debt (proportion of GDP): 111.3%
    External debt per capita: $41,916
  • Gross external debt: $891.26 billion (2009 Q2)
    GDP (2008 est.): $800.2 billion

19. Hungary

  • External debt (proportion of GDP): 105.7%
    External debt per capita: $20,990
  • Gross external debt: $207.92 billion (2009 Q1)
    2008 GDP (est): $196.6 billion

20. United States

  • External debt (proportion of GDP): 94.3% External debt per capita: $43,79
  • Gross external debt: $13.454 trillion (2009 Q2) GDP (2008 est.): $14.26 trillion

UPDATE — The Huffington Post:

Iceland, Latvia and Greece are all in a position to call the bluff of the IMF and EU. In an October 1 article called Latvia – the Insanity Continues, Marshall Auerback maintained that Latvia’s debt problem could be fixed over a weekend, by a list of measures including: (1) not answering the phone when foreign creditors call the government; (2) declaring the banks insolvent, converting their external debt to equity, and having them reopen with full deposit insurance guaranteed in local currency; and (3) offering “a local currency minimum wage job that includes healthcare to anyone willing and able to work as was done in Argentina after the Kirchner regime repudiated the IMF’s toxic package of debt repayment.” Evans-Pritchard suggested a similar remedy for Greece, which he said could break out of its death loop by following the lead of Argentina. It could “restore its currency, devalue, pass a law switching internal euro debt into [the local currency], and ‘restructure’ foreign contracts.”

The Road Less Travelled: Saying No to the IMF
Standing up to the IMF is not a well-worn path, but Argentina forged the trail. In the face of dire predictions that the economy would collapse without foreign credit, in 2001 it defied its creditors and simply walked away from its debts. By the fall of 2004, three years after a record default on a debt of more than $100 billion, the country was well on the road to recovery, and it achieved this feat without foreign help. The economy grew by 8 per cent for two consecutive years. Exports increased, the currency was stable, investors were returning, and unemployment had eased. “This is a remarkable historical event, one that challenges 25 years of failed policies,” said economist Mark Weisbrot in a 2004 interview quoted in The New York Times. “While other countries are just limping along, Argentina is experiencing very healthy growth with no sign that it is unsustainable, and they’ve done it without having to make any concessions to get foreign capital inflows.”

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