Sovereign defaults on domestic law debt: a new database

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As part of the process of financial deepening, governments in emerging economies are increasingly relying on domestic sources of finance (IMF 2020). Brazil and Mexico are two prime examples of this trend.1 What is less known is that nearly 80% of all African sovereign bonds are issued domestically.2 Since national public debt markets form the backbone of national financial systems (CGFS 2007), sustainable public debt is paramount for national financial stability (Acemoğlu et al. 2022, Boone et al. 2022).

In this context and despite the risk that the pandemic will end in a wave of sovereign defaults in international and domestic sovereign debt markets (Kose et al. 2021), there is no systematic work focused on the description of sovereign defaults involving debt under national governance (IMF 2021). Since debt jurisdiction (i) affects the ability of governments to restructure their debt (Gelpern and Panizza 2021), (ii) is critical in shaping the restructuring process (Gulati and Weidemaier 2015), and (iii) affects timing and market conditions (Chamon et al. 2018), this lack of data hampers policy work on preventing and resolving sovereign debt crises (IMF 2021).3

In a pair of papers (Erce et al. 2021a, 2021b), we fill this gap by introducing a new database that identifies sovereign defaults on domestic law debt instruments held by private creditors.4 The database systematically records domestic sovereign defaults that are identified on the basis of whether the law governing the debt instruments was local or not.5

The database

It was difficult to document breaches of national legislation, their timing, scale and details of restructuring conditions. We reviewed several diverse sources, ranging from official IMF documents to local press reports. Our efforts have identified 76 episodes of sovereign default and restructuring in 52 countries. We built the database using a bottom-up approach, collecting information at the instrument level (default events) and aggregating it to obtain episode-level variables. These 76 default episodes are composed of 134 default events on different instruments (bonds, bank loans or deposits). The sample spans four decades, from 1980 to 2018, and covers events on five continents.

The database collects finer details about each default event, such as its timing, the instrument and volume involved, and the restructuring terms and methods adopted. When available, the database also reports net present value losses to creditors. Using our database, we learn various lessons.

Breaches of national laws are a growing global phenomenon. America and Africa are the continents where most restructuring has taken place. While breaches of national laws are more common in poor and middle-income countries, they also occur in advanced economies. Figure 1 combines our data with the Foreign Defaults Database maintained by Tamon Asonuma and Christoph Trebesch. Since the end of the 1990s, domestic defaults have been more frequent than foreign defaults. Whereas in the 1980s, around 10% of default episodes concerned debts under domestic law, in the 2000s, 70% of default episodes were. In addition, governments operate selective defaults. In contrast, in the theoretical literature, defaults are often modeled as affecting all creditors equally (Thaler 2021) or discriminating in favor of domestic debt (Broner et al. 2010).

Figure 1 Overtime by default under national and foreign law

Defaults on bond debt, which are the most common form of default in domestic law, are increasingly important. While, as shown in Table 1, they are smaller than external bonds, the median volume of domestic bonds involved in recent restructuring episodes has reached 14% of GDP. On the contrary, defaults on bank loans and deposits are rare these days, likely reflecting the change in sources of government funding.

Table 1 Volume of debt in default, by instrument (% of GDP)

Domestic debt restructurings are often quick, but can take a long time. Table 2 shows that, in contrast to longer external defaults, around 40% of domestic defaults were resolved within six months (this group includes events in which the obligations included collective action clauses). Yet a sizeable fraction of episodes took a very long time to resolve – a third of them lasted over three years and 6% over 12 years.6

Table 2 Duration of failures of domestic law (months)

Maturity extension is the most common form of restructuring. Prolongations of maturity are present in 75% of episodes, but vary considerably from case to case, ranging from a few months to 50 years. Changes in the coupon structure are also common, often involving a reduction in coupons and the exchange of floating rate coupons for fixed rate coupons. Face value reductions are rare.

The median losses in NPV are higher than those of external defaults. Table 3 presents summary NPV loss statistics for different categories of domestic debt and for external defaults (as reported by Asonuma and Trebesch). Median NPV losses are higher due to shortcomings in national legislation. Losses are greatest when the government defaults on bank loans, but also significant when CACs are used to restructure bonds.

Table 3 Losses to creditors, by instrument in default

Unilateral post-default restructurings were the norm, but a preference for a negotiated pre-default approach is emerging. Since the 2000s, most domestic debt restructuring has taken place before default, with debtor governments taking a cooperative approach to creditors (see Figure 2). Governments were more aggressive in the 1980s and 1990s.

Figure 2 Events before and after default and position of debtors

conclusion

In a world where public debt is growing at an alarming rate (Acemoğlu et al. 2022, Boone et al. 2022), the stylized facts drawn from our dataset convey important insights and analytical material to policy makers who need to find policies to combat over-indebtedness. These same stylized facts can also inform quantitative work. Existing quantitative work, including domestic debt markets, has struggled to calibrate the models.7 Our database documents multiple aspects of the restructuring process and provides a comprehensive set of statistics for the correct calibration of quantitative sovereign default models featuring domestic debt.

Our data could be useful not only for lawyers and economists interested in the prevention and resolution of debt crises, but also for political scientists and sociologists interested in the interplay between national failures and political cycles, stability institutional, social cohesion or economic inequalities, among others. other subjects.

Authors’ note: The database described in this column can be accessed here. The opinions expressed in this column are those of the authors and not those of the Federal Reserve Board or the European Stability Mechanism.

The references

Acemoğlu, D, T Beck, M Obstfeld and Y Chui Park (2022), “Prospects of the global economy after Covid-19”, VoxEU.org, 28 February.

Asonuma, T and C Trebesch (2016), “Sovereign debt restructurings: pre-emptive or post-default”, Journal of the European Economic Association 14(1).

Beers, D and P de Leon-Manlagnit (2019), “The BoC-BoE Sovereign Default Database: What’s New In 2019?”, Bank of England Working Paper No. 829.

Boone, L, J Fels, O Jordà, M Schularick and AM Taylor (2022), Debt: the eye of the stormGeneva report on the world economy 24.

Broner, F, A Martin and J Ventura (2010), “Sovereign Risk and Secondary Markets”, American Economic Review 100(4).

Bulow, J and K. S. Rogoff (1989), “A Constant Recontracting Model of Sovereign Debt”, Journal of Political Economy 97(1).

CGFS – Committee on the Global Financial System Papers (2007), “Financial Stability and Local Currency Bond Markets”, Committee on the Global Financial System Papers 28.

Chamon, MJ Schumacher and C Trebesch (2018), “Foreign Law Bonds: Can They Reduce Sovereign Borrowing Costs?” », Journal of International Economics 114(C).

Erce, A, E Mallucci and M Picarelli (2021a), “A Journey in the History of Sovereign Defaults on Domestic Law Public Debt”, European Stability Mechanism Working Paper No. 51.

Erce, A, E Mallucci and M Picarelli (2021b), “A Journey in the History of Sovereign Defaults on Domestic Law Public Debt – Sovereign Histories”, Departamento de Economía, Universidad Pública de Navarra, Working Paper No. 2108.

Gabor, D (2021), “The Liquidity and Sustainability Facility for African Bonds: Who Benefits? », Eurodad Policy paper.

Graf von Luckner, C, J Meyer, C Reinhart and C Trebesch (2021), “External Sovereign Debt Restructurings: Delay and Replay”, VoxEU.org, 30 March.

Gulati, M and M Weidemaier (2015), “The Relevance of Law to Sovereign Debt”, Annual review of law and social sciences 11.

Gelpern, A and U Panizza (2021), “Emerging Market Debt Crises Economic and Legal Aspects”, mimeo.

IMF (2020), “The International Architecture for Sovereign Debt Resolution Involving Private Sector Creditors – Recent Developments, Challenges and Options for Reform”, IMF Policy Paper 2020/043.

IMF (2021), “Issues in Restructuring of Sovereign Domestic Debt”, IMF Policy Paper 2021/071.

Kose, MA, F Franziska Ohnsorge, C Carmen Reinhart and K Rogoff (2021), “Debt in the post-pandemic developing economy”, VoxEU.org, 3 November.

Reinhart, C and K Rogoff (2011), “The Forgotten History of Domestic Debt”, Economic review 121(552).

Thaler, D (2021), “Sovereign Default, National Banks and Exclusion from International Capital Markets”, The Economic Review 131(635).

Endnotes

1 Domestic debt accounted for 22% of Mexico’s public debt in 1995, and more than 80% in 2010. In Brazil, it rose from 54% to 90%.

2 In 2020, national bonds of African sovereigns reached US$500 billion and Eurobonds reached US$150 billion (Gabor 2021).

3 The importance of legal competence for the timing and form of sovereign default resolution has already been noted by Kenneth Rogoff and Jeremy Bulow in their seminal 1989 article in the Journal of Political Economy (Bulow and Rogoff 1989).

4 In Erce et al. (2021b), we present a collection of histories describing the finer details of each default episode.

5 Our work extends and complements existing databases, such as Reinhart and Rogoff (2011), which also considers domestic debt, and Asonuma and Trebesch (2016), which focuses on external debt.

6 von Luckner et al. (2021) discuss the length of default periods when restructuring foreign law debt.

7 Hatchondo et al. (2016) discuss the difficulties of calibrating quantitative sovereign default models on domestic debt.

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