IMF Note on Sovereign Default

Économiste Monétaire

For those interested: Default in Today's Advanced Economies: Unnecessary, Undesirable, and Unlikely (pdf).

From the introduction,

The state of the public finances has worsened substantially in the main advanced economies as a result of the 2008–09 global financial and economic crisis. For some “peripheral” European countries, market participants and some commentators occasionally seem to believe that default (here intended as some form of debt restructuring) will sooner or later inevitably occur. Concerns about fiscal solvency in those countries have been reflected in financial market pressures, large default risk premiums on sovereign bonds, and downgrades by rating agencies. At the time of writing (late August 2010), credit default swap spreads are about 900 basis points in Greece and 300 basis points in Ireland and Portugal. In general, volatility remains high and every auction of government paper—especially in Europe, including in the largest countries—is closely monitored to discern possible triggers of abrupt market reactions.

In our view, the risk of debt restructuring is currently significantly overestimated. Although it is generally wise to assume that market developments reflect economic fundamentals, market overreaction does occur from time to time, with adverse implications for countries’ borrowing costs and debt dynamics. For example, considering data on sovereign bond spreads over the past decades, markets sounded false alarms in the vast majority of episodes—see Appendix 1. To place recent sovereign bond market developments in context, the present note reviews macro-fiscal factors underlying government debt dynamics in the top ten advanced economies ranked by needed fiscal adjustment in the illustrative scenario presented in the May 2010 Fiscal Monitor (IMF, 2010): France, Greece, Ireland, Italy, Japan, Netherlands, Portugal, Spain, United Kingdom, and United States.

This note summarizes the main arguments put forward by some market commentators who argue that default is inevitable, and presents a rebuttal for each argument in turn. Their main arguments focus on the size of the adjustment and continued market concerns reflected in government bond spreads. The essence of our reasoning is that the challenge stems mainly from the advanced economies’ large primary deficits, not from a high average interest rate on debt. Thus, default would not significantly reduce the need for major fiscal adjustment. In contrast, the economies that defaulted in recent decades did so primarily as a result of high debt servicing costs, often in the context of major external shocks. We conclude that default would not be in the interest of the citizens of the countries in question. Fiscal adjustment supported by reforms that enhance economic growth is a more effective response.

Two other papers linked here by Philip Lane.

Justin Collery

I'm not saying they are outright wrong, but you have to evaluate the messenger as well as the message. Some of the said countries who defaulted as a result of debt servicing costs thought it best to tell the IMF where to go to resolve their issues.

You have to look at what the remit of the IMF is, to promote stability. Even if the IMF believed that default was the best option, they would never say it publicly as to suggest that the US, UK, Japan, Italy, France and the rest should even consider defaulting would have a destabilising effect.

I am also amused by the IMF saying "default would not be in the interest of the citizens". Given a situation where you have citizens on one side, and large governments / banks / companies (i.e. lenders) on the other I believe the IMF will work to the benefit of the lenders, not the citizens.

I guess what is significant here is what is not said. What is not said is "the IMF is ready to stand in" etc etc.

"The first rule of politics: never believe anything until it's been officially denied." - John Hackett, PM

whatawaster

"In contrast, the economies that defaulted in recent decades did so primarily as a result of high debt servicing costs, often in the context of major external shocks. We conclude that default would not be in the interest of the citizens of the countries in question."


I'm no expert, but don't we pretty much fit this description perfectly?

noodler

whatawaster wrote: »

"In contrast, the economies that defaulted in recent decades did so primarily as a result of high debt servicing costs, often in the context of major external shocks. We conclude that default would not be in the interest of the citizens of the countries in question."


I'm no expert, but don't we pretty much fit this description perfectly?

Absolutely.

Our national debt repayments are going to be reasonably high for years to come.

In the sort term I just hope the bond market calms down a little - at this rate I couldn't blame the NTMA for sitting out this month's bond auction.

Slippers 2

noodler wrote: »

In the sort term I just hope the bond market calms down a little - at this rate I couldn't blame the NTMA for sitting out this month's bond auction.

ba-dum tish