Sovereign default
Topic: Balance of Payments and Exchange Rates · NCERT: Beyond NCERT
Meaning
A sovereign default happens when a government fails to pay principal or interest on its debt on time. After a default, the country loses access to fresh loans, its credit rating is cut and its currency usually falls sharply. The usual next step is sovereign debt restructuring, meaning renegotiated terms. This can involve haircuts that cut the principal, lower interest (coupon) rates or longer repayment periods.
Example
Sri Lanka defaulted in 2022. It then received an IMF Extended Fund Facility in March 2023 and restructured its debts with its creditors. India came close to default in 1991, when it could not pay interest and no one would lend to it.
Don't confuse with
- Rating downgrade: this is a rating agency's worse judgement of a government's ability to repay. It raises borrowing costs, but the government is still paying. In a default, payments are actually missed.
Related concepts
- External debt
- Debt service ratio
- Sovereign credit rating
- Sovereign debt restructuring
- Official Creditor Committee
- Comparability of treatment
- Debt-for-nature swap
- Blended finance