According to World Economic Forum, a record number of countries are piling up on sovereign debt amid the COVID-19 pandemic. The rating firm S&P Global has reiterated its concern for several sovereign defaults.
Earlier in 2012 after the Financial Crisis of 2008, there were 5 sovereign defaults. Greece defaulted twice in 2012.
However, in 2020, there were seven sovereign defaults in total. They involved Argentina, Ecuador, Lebanon, Zambia, Belize, and Suriname (twice).
What is sovereign debt?
The declaration of default comes when a country fails to repay part of its sovereign debts and requests the suspension or postponement of the standing payment.
Once in default, the country starts negotiations with creditors to review the terms of the loans and reach an agreement that is called debt restructuring. For example, creditors will waive part of the interest or the reduction of the loan, to obtain at least part of what belongs to them.
Countries that borrow in their local currency can print more money to pay the debt and thus, initiating high inflation.
Sovereign debt defaults of 2020
The only one of the seven defaults unrelated to the pandemic is Lebanon’s default. It declared its inability to pay its debt on March 7, 2020, when the government failed to pay a $ 1.2 billion worth of foreign currency bond.
At the base of the Lebanon default, there is a situation of an economic crisis that has been going on for years, and an excessive debt that is no longer sustainable.
Ecuador defaulted its payment to International Monetary Fund (IMF) due plummeting oil prices at the onset of the pandemic. It asked in August for an $800 million installment for maturing bonds to be postponed.
The Republic of Suriname, a small South American country and former Dutch colony defaulted on sovereign debt twice, in April and November of 2020. It has a standing sovereign debt of $4 billion as of March 2021.
The economy of Suriname relies heavily on the export of aluminium oxide, oil, and natural gas. It saw a lack of resources deriving from oil and exports of precious materials. The travel and hospitality industry contributes to 3.7% of the GDP of Suriname. The COVID-19 pandemic had a significant effect on the hospitality sector of the country.
Zambia is one of the most indebted economies in Africa. It defaulted payment of $40 million in November 2020 to IMF.
Zambia is a leading exporter of copper and other metals. However, the copper exports declined due to the COVID-19 pandemic. Moreover, the pandemic induced further pressure on the already struggling Zambian economy due to extra spending on healthcare. Zambia lacked the revenue streams to pay its debt to IMF.
In the past few years, the Zambian leaders have been accused of corruption and poor economic management. Zambia doesn’t just owe IMF. It has also taken $3 billion loans from China. According to the critics, the terms and conditions of the Chinese loans aren’t clear.
In the last 20 years, South American countries have defaulted their sovereign debts time and again. Be it Argentina in 2001 or Venezuela in 2018.
Belize is a South American country that is heavily reliant on the tourism and hospitality sector. For the small Caribbean country, the main cause of insolvency was the collapse of tourism, its main source of income.
Speaking of Latin America, Argentina could not be missing. It’s a country that for almost a century has been experiencing cyclical difficulties in managing its debt, aggravated in this case by the outbreak of the health crisis.
According to S&P Global Ratings for Argentina this is the fifth default only since 2001, triggered by non-payment of bonds in April and June 2020.
Consequences of sovereign debt default
Countries default primarily because they have high levels of public debt relative to their GDP. Debt to GDP ratio gives an insight into the financial health of a country. Debt to GDP ratio is the highest for Japan at 235%, followed by Greece at 181%, Italy at 135%, United States at 131% and Portugal at 118%.
Although countries like Japan and the US have high debt to GDP ratio, the interest rate on them is very low or even negative for Japan.
On the other hand, countries like Suriname, Zambia and Argentina have very high inflation rate and because of the poor credit ratings on the loans, the interest charged on them is very high.
The COVID-19 pandemic has forced several countries to borrow more money or just print them causing inflation.
A sovereign debt default significantly affects the country’s reputation towards the creditors. In fact, after the default, the country will be perceived as riskier, and in order to issue new debt, it will be forced to pay higher interest to new creditors. This may even spark a debt spiral, just like in the case of Greece.