Why do countries default

Thanks for being here. Engemann: Could you first explain what is sovereign debt, and why do countries borrow or issue debt?

Restrepo-Echavarria: Sovereign debt is those loans that are made by a government. Why do governments borrow? Because they want to smooth consumption. So, countries would like to borrow today to be able to consume a little bit more, and then tomorrow, when they have a larger income, they can repay that debt, in principle.

Engemann: Countries issue bonds of different maturities. Some are shorter term, and some are longer term. Why would they issue those multiple types like that? Engemann: Emerging markets sometimes issue bonds that are denominated in foreign currencies, such as the U. Do you know what percentage of emerging market debt is dollar-denominated, and why is that important? And, how does a country collect dollars? They collect dollars through imports and exports.

So, they need to have kind of the right balance of imports and exports to have all the dollars that they need incoming into their country in order to repay their debt, and the other thing that comes into play is exchange rates because, if you have large swings in your exchange rates and you owe debt in dollars, then this can imply that you owe more or less, in your local currency.

Engemann: Regarding emerging markets that have debt denominated in U. Engemann: How important is the U. Do they pay attention to U.

Restrepo-Echavarria: They pay a lot of attention to the interest rate because they believe that this is actually going to move flows in some sense. So, this is going to kind of cause flights out of their country and this is going to affect the exchange rate, and if the exchange rate is affected, then the amount of the debt they owe is affected as well.

So, they do pay quite a bit of attention, and especially those that do inflation targeting, which means that they have a specific level of inflation that they want to maintain in their country. The amount of currency, both in dollars and in local currency, that they have domestically matters a lot to be able to hit that target. So, they care a lot. Engemann: Can a country have too much debt? When does it become a problem, and how do you determine how much debt is too much?

Is it in absolute terms, or is it relative to GDP, or is it something else perhaps? The U. Then, you have Japan, which is, like, But then, you have countries in Latin America that have only, like, 40 percent. But, everyone is really scared of these countries in Latin America defaulting on their debt, but no one is freaking out every single day because the U.

You can never say that, but there is certainly such thing as too much debt for a country that you know has political risk or issues like that. Venezuela would be a very good example of that. Rolling over debt is like refinancing a mortgage - it's borrowing money to pay off a loan. This typically doesn't "cost" anything, as the new debt should directly replace the old debt.

But if you can't borrow at the same interest rate, your debt then gets more expensive. So if investors decide that they no longer want to be involved with US bonds, they could refuse to buy those bonds. And those that are left could demand higher interest rates - which could cost the US government a significant amount in the long run.

There are three examples in US history that come close to default, with the most recent occurring in The other two instances, in and in , both involve defaults akin to the current situation in Greece, when creditors were forced to take less money than what they were owed. Some economists have defined this as a default, but it's murky territory. IMF warning on US debt ceiling. Bills, bills, bills: how does the US government pay its debt? What is a US debt default? What are the consequences of a US default?

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Table of Contents Expand. Factors Affecting Default Risk. Mitigating Risks. Economic Impact. The Perfect Time to Invest? The Bottom Line. Key Takeaways Sovereign default is a failure of a government to honor some or all of its debt obligations. While uncommon, countries do default when their national economies weaken, when they issue bond denominated in a foreign currency, or a political unwillingness to service debts. Countries are often hesitant to default on their debts, since doing so will make borrowing funds in the future difficult and expensive.

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Partner Links. Related Terms Sovereign Default Sovereign default is a failure by a government in repayment of its country's debts. Sovereign Risk Sovereign risk is the risk that a foreign government will default on their bonds or impose foreign exchange regulations that harm FX contracts' value.

Sovereign Bond Yield Definition Sovereign bond yield is the interest rate paid to the buyer of the bond by the government, or sovereign entity, issuing that debt instrument. Find out what the U. Full Faith and Credit Full faith and credit describes one entity's unconditional guarantee or commitment to back the interest and principal of another entity's debt.

What Is a Sovereign Bond?