Government Default

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A Government Default is a financial default by a sovereign government (in which it cannot meet its government debt-repayment obligations).

References

2014

  • (Wikipedia, 2014) ⇒ http://en.wikipedia.org/wiki/sovereign_default Retrieved:2014-1-22.
    • A sovereign default is the failure or refusal of the government of a sovereign state to pay back its debt in full. It may be accompanied by a formal declaration of a government not to pay (repudiation) or only partially pay its debts (due receivables), or the de facto cessation of due payments. (Another name is national insolvency if default is not willful, for instance when total debts are more than total assets.) Most authorities will limit the use of "default" to mean failure to abide by the terms of bonds or other debt instruments. Countries have at times escaped the real burden of some of their debt through inflation. This is not "default" in the usual sense because the debt is honored, albeit with currency of lesser real value. Sometimes countries devalue their currency by ending or altering the convertibility of their currency into precious metals or foreign currency at fixed rates. This is also not "default" in the usual sense of the word, but the remainder of this article will treat it as a default and in the list below of instances of sovereign default will include the US actions to diminish and then end the link between the dollar and gold. Calling this "default" is controversial, however, since all dollars owed were repaid with dollars as required by the terms of the bonds.

      If potential lenders or bond purchasers begin to suspect that a government may fail to pay back its debt, they may demand a high interest rate in compensation for the risk of default. A dramatic rise in the interest rate faced by a government due to fear that it will fail to honor its debt is sometimes called a sovereign debt crisis. Governments may be especially vulnerable to a sovereign debt crisis when they rely on financing through short-term bonds, since this creates a situation of maturity mismatch between their short-term bond financing and the long-term asset value of their tax base.

      They may also be vulnerable to a sovereign debt crisis due to currency mismatch if they are unable to issue bonds in their own currency, as a decrease in the value of their own currency may then make it prohibitively expensive to pay back their foreign-denominated bonds (see original sin). Since a sovereign government, by definition, controls its own affairs, it cannot be obliged to pay back its debt. Nonetheless, governments may face severe pressure from lending countries. In the most extreme cases, a creditor nation may declare war on a debtor nation for failing to pay back debt, in order to enforce creditor's rights. For example, Britain routinely invaded countries that failed to repay foreign debts, invading Egypt in 1882[citation needed]. Other examples include the United States' “gunboat diplomacy” in Venezuela in the mid-1890s and the United States occupation of Haiti beginning in 1915.[1] A government which defaults may also be excluded from further credit and some of its overseas assets may be seized; and it may face political pressure from its own domestic bondholders to pay back its debt. Therefore governments rarely default on the entire value of their debt. Instead, they often enter into negotiations with their bondholders to agree on a delay or partial reduction of their debt payments, which is often called a debt restructuring or 'haircut'. Some economists have argued that, in the case of acute insolvency crises, it can be advisable for regulators and supranational lenders to preemptively engineer the orderly restructuring of a nation’s public debt- also called “orderly default” or “controlled default”. In the case of Greece, these experts generally believe that a delay in organising an orderly default would hurt the rest of Europe even more. [2]

      The International Monetary Fund often assists in sovereign debt restructurings. To ensure that funds will be available to pay the remaining part of the sovereign debt, it often makes its loans conditional on austerity measures within the country, such as tax increases or reductions in public sector jobs and services. A recent example is the Greek bailout agreement of May 2010.

  1. ↑ Reinhart, Carmen M.; Rogoff, Kenneth S. (2009). This time is different: Eight Centuries of Financial Folly (p. 54ff). Princeton University Press. ISBN 0-691-14216-5. 
  2. ↑ Louise Armitstead, "EU accused of 'head in sand' attitude to Greek debt crisis" The Telegraph, 23 June 2011


  • World Economic Forum. (2014). “Global Risks 2014." Insight Report, Ninth Edition.
    • The risk of fiscal crises features as the top risk in this year’s Global Risks report. Governments often run deficits, spending more than they raise in taxes. They make up the shortfall by selling bonds – borrowing money from private investors with the promise of repaying it, with interest, at a specified future date. A fiscal crisis occurs when investors begin to doubt the government’s future ability to repay; the government then has to offer higher interest on its bonds to compensate investors for the increased risk. A vicious cycle starts: ballooning interest payments add to government debt, increasing the doubts of investors and forcing interest rates up still further. This can rapidly turn into a fatal spiral, in which fears that a country will default on its debt become a self-fulfilling prophecy.

      As government bonds tend to be held in substantial part by domestic banks, when the government defaults, the resulting losses on these bonds endanger banks’ solvency. In this way, a fiscal crisis can lead to financial crisis. The causation can also run the other way: the government may be forced to bail out large banks at risk of default to avoid a systemic financial crisis. However, the additional debt taken on can plunge the government from an already-precarious fiscal position into a full-blown fiscal crisis.

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