Structural reform lowers country risk
Christopher Findlay, Silvia Sorescu, Camilo Umana Dajud 29 August 2014
Countries facing rising risk premiums on their debt have recognised the need for structural reform, but some politicians have argued that austerity is necessary in the short run because structural reform takes too long. This column argues that financial markets can bring forward the benefits of structural reform, and therefore that such reforms should be given greater weight in the package of crisis responses.
In late 2008, financial stress became widespread and perceptions of risk hit new highs. Concerns related to contagion among countries also had an increasing effect on premiums and increased the financing cost for many economies. The response to this problem was austerity – to stress the importance of getting the fiscal situation, and thereby the levels of debt of those countries with this problem, under control.
structural reforms, risk premiums, Credit Default Swaps, sovereign debt
It takes more than two to tango: Cry, but not for Argentina, nor for the holdouts
Jeffrey Frankel 22 July 2014
The US court ruling forcing Argentina to pay its hold-out creditors has big implications. This column argues that some of them are particularly worrying. The court ruling undermines the possibility of negotiated re-structuring of unsustainable debt burdens in future crises. In the future, it will not be not enough for the debtor and 92% of creditors to reach an agreement, if holdouts and a New York judge can block it. This will make both debtors and creditors worse-off.
US federal courts have ruled that Argentina is prohibited from making payments to fulfil 2005 and 2010 agreements with its creditors to restructure its debt, so long as it is not also paying the few creditors that have all along been holdouts from those agreements. The judgment is likely to stick because the judge (Thomas Griesa, in New York) told American banks on 27 June that it would be illegal for them to transfer Argentina’s payments to the 92% of creditors who agreed to be restructured, and because the US Supreme Court in June declined to review the lower court rulings.
Development Global governance
US, sovereign debt, Argentina
Banks, government bonds, and default: What do the data say?
Nicola Gennaioli, Alberto Martin, Stefano Rossi 19 July 2014
There is growing concern – but little systematic evidence – about the relationship between sovereign default and banking crises. This column documents the link between public default, bank bondholdings, and bank loans. Banks hold many public bonds in normal times (on average 9% of their assets), particularly in less financially developed countries. During sovereign defaults, banks increase their exposure to public bonds – especially large banks, and when expected bond returns are high. At the bank level, bondholdings correlate negatively with subsequent lending during sovereign defaults.
Recent events in Europe have illustrated how government defaults can jeopardise domestic bank stability. Growing concerns of public insolvency since 2010 caused great stress in the European banking sector, which was loaded with Euro-area debt (Andritzky 2012). Problems were particularly severe for banks in troubled countries, which entered the crisis holding a sizeable share of their assets in their governments’ bonds – roughly 5% in Portugal and Spain, 7% in Italy, and 16% in Greece (2010 EU Stress Test).
sovereign debt, financial crises, banking, banks, bonds, sovereign default, credit, bank lending, risk-weighting
Saving the euro: self-fulfilling crisis and the ‘Draghi put’
Marcus Miller, Lei Zhang 26 June 2014
Like banks, indebted governments can be vulnerable to self-fulfilling financial crises. This column applies this insight to the Eurozone sovereign debt crisis, and explains why the ECB’s Outright Monetary Transactions policy reduced sovereign bond spreads in the Eurozone.
In surveying eight centuries of financial folly, Reinhart and Rogoff (2009) observed that:
International finance Monetary policy
ECB, eurozone, sovereign debt, financial crises, sovereign debt crisis, Outright Monetary Transactions, European sovereign debt crisis, self-fulfilling crises
Privatisation and debt: Lessons from Greece’s fiasco
Paolo Manasse 31 January 2014
Sales of state-owned assets have been proposed as a way for highly-indebted countries to ease the pain of fiscal consolidation. This column argues that, despite the potential merits of privatisation in terms of long-run efficiency, in practice it is unlikely to improve short-run fiscal solvency. Since governments rarely alienate control rights, the efficiency gains from privatisations are often small. Moreover, financial markets may not fully reflect these gains – particularly during a financial crisis. The implication is that the Troika policy of linking financial assistance to privatisations is inappropriate and self-defeating.
In the midst of the European debt crisis, it is tempting to think that high-debt countries could alleviate the recessionary impact of the budget-consolidation process by selling (poorly managed) assets and stakes in their state-owned enterprises (SOEs), and by using the proceeds to buy back their debts (Hope 2011). In addition to providing a cushion for ongoing adjustment programmes and improving solvency, privatisations are deemed to entail long-term efficiency and welfare gains by attracting foreign direct investment and managerial expertise, thus spurring competition and growth.
Financial markets International finance
sovereign debt, privatisation, debt, Greece, European sovereign debt crisis
Why hasn’t Japan’s massive government debt wreaked havoc (yet)?
Charles Yuji Horioka, Takaaki Nomoto, Akiko Terada-Hagiwara 21 January 2014
Japan’s sovereign debt-to-GDP ratio is higher than any country in Europe and more than twice the OECD average. This column explains why Japan’s massive government debt did not wreak havoc in the past. Robust domestic saving and a temporary inflow of foreign capital caused by the Global Crisis have prevented a crisis thus far. As both of these factors become less applicable the government faces pressure to reduce debt-to-GDP ratio can be brought under control quickly.
The potential sovereign debt crisis in Japan looks even grimmer than those in the Eurozone economies if one looks only at the gross general government debt-to-GDP ratio. According to the OECD, this ratio ranged from 90 to 166% in some developed economies in 2012 (“only” 166% in Greece, 140% in Italy, 139% in Portugal, 123% in Ireland, and 91% in Spain—collectively referred to as the PIIGS economies) but was a full 219% in Japan in the same year.
Financial markets International finance
sovereign debt, fiscal sustainability
Why fiscal sustainability matters
Willem Buiter 10 January 2014
Fiscal sustainability has become a hot topic as a result of the European sovereign debt crisis, but it matters in normal times, too. This column argues that financial sector reforms are essential to ensure fiscal sustainability in the future. Although emerging market reforms undertaken in the aftermath of the financial crises of the 1990s were beneficial, complacency is not warranted. In the US, political gridlock must be overcome to reform entitlements and the tax system. In the Eurozone, creating a sovereign debt restructuring mechanism should be a priority.
Does fiscal sustainability matter only when there is a fiscal house on fire, as was the case with the Greek sovereign insolvency in 2011–12? Far from it.
Financial markets Global crisis International finance Macroeconomic policy
eurozone, sovereign debt, capital flows, financial crisis, credit booms, fiscal policy, emerging markets, global financial crisis, banking, banks, Eurozone crisis, Currency wars, fiscal sustainability, banking union, sovereign debt restructuring, balance-sheet recession
The ghost of Deauville
Ashoka Mody 07 January 2014
On 19 October 2010, Angela Merkel and Nicolas Sarkozy agreed that in future, sovereign bailouts from the European Stability Mechanism would require that losses be imposed on private creditors. This agreement was blamed for the increase in sovereign spreads in late 2010 and early 2011. This column discusses recent research on the market reaction to the surprise announcement at Deauville. With the exception of Greece, the rise in spreads was within the range of variability established in the previous 20 days.
The aversion to debt restructuring in the Eurozone has been remarkable, even though public debt ratios in several countries are well above the IMF-identified critical debt overhang threshold of 100% of GDP (IMF 2012). By early 2010, some recognised the urgency of restructuring Greek public debt (Calomiris 2010). But the official position between late 2009 and early 2011 deemed even Greek debt to be sustainable. Beyond the particularities of Greece, general principles were invoked. In the words of Cottarelli et al.
Financial markets International finance
eurozone, sovereign debt, Eurozone crisis, sovereign debt restructuring, financial contagion, Deauville
Joint liability in international lending: A proposal for amending the Treaty of Lisbon
Kaushik Basu, Joseph Stiglitz 02 January 2014
The Eurozone crisis exposed weaknesses in the Eurozone’s design. This column – by Nobelist Joe Stiglitz and World Bank Chief Economist Kaushik Basu – argues that the Eurozone’s financial architecture can be improved by amending the Treaty of Lisbon to permit appropriately structured cross-country liability for sovereign debt incurred by EZ members.
The sovereign debt crisis exposed weaknesses in the Eurozone’s financial architecture that may not have been fully anticipated when the founding treaties of the Eurozone were drafted. Key among these weak spots are the provisions of the Treaty of Lisbon which regulate intergovernmental debt obligations and preclude direct financing of sovereigns by the ECB.
EU institutions International finance
eurozone, Maastricht Treaty, sovereign debt, moral hazard, Lisbon Treaty, Eurozone crisis, no-bailout clause