Sunday, 19 June 2011

A focused look on some cases of sovereign default

For a while now I wanted to take a look at recent sovereign default/restructuring episodes. Here's a first take on this based on the so-called misery index which is computed by adding up  the unemployment rate and the inflation rate. 

Here are the misery index readings for the most prominent cases of sovereign default/restructuring (or the ones I could find if you prefer).

source: IMF

Argentina is maybe the better known case of default for most people. Argentina defaulted in December 2001. As you can see following the default misery index readings exploded upwards due to the surge in both unemployment and inflation.

source: IMF

Ecuador defaulted in September 1999. Here too after the event the misery index surged.

source: IMF

Moldova started restructuring proceedings in June 2002. After the event the misery index rose but not significantly.

source: IMF

Pakistan implemented an exchange offer in November 1999. After the event the misery index actually dipped.

source: IMF

Russia defaulted on its debt in December 1998. The index more than doubled during the year after the event but fell significantly the following years.

source: IMF

Ukraine after earlier efforts to restructure launched an exchange offer in February 2000. During 1999-2000 the misery index readings doubled cumulatively but quickly fell significantly afterwards.

source: IMF

Uruguay launched an exchange offer on its sovereign debt in April 2003. The year that the exchange offer was implemented as well as the previous year the index rose significantly to fall rather fast the next few years.
Some of the default/restructuring events were accompanied by large spikes in the readings of the misery index while others did not, what is the differentiating factor?

In my humble opinion the gamechanger is whether we are talking about a liquidity crisis of a solvency crisis. Liquidity crises' negative effects should be rather more contained while solvency crises in most cases should prove to be more painful.

To differentiate between the two I look at debt reduction following the event and the real GDP growth rate during the year of the event as well as the ones right before and after.

By these simple (and maybe not foolproof) criteria, the case of Moldova seems to be the less painful. I think that this was definitely a liquidity crisis. I think that the exact same goes for  the case of Pakistan.

Argentina's case seems to be rather painful, it definitely falls under the umbrella of a solveny crisis and it appears to be the most painful of the cases I mention in this post.

Uruguay's case was quite harsh too and I think that it was a solvency crisis too. It also appears that there was some kind of contagion from Argentina's earlier default.

Ukraine's case is a weird one. There is some significant debt reduction in the years prior to the event mentioned here at the same time that the misery index spiked. The event mentioned here is maybe the exhaust fumes of the whole situation. All in all I think that there was a solveny crisis in Ukraine prior to this particular event. Of course it is more than likely that I've got this wrong so please if that's the case and you know what actually went on please say so in the comments section.

Finally Russia's case is well known so I don't have to say much here. It was a victim of contagion from the SE Asia crisis of 1997-1998, the fall in crude prices as well as the fiscal knock-on effects of the Chechen war and other chronic weaknesses of the Russian economy. I think that we are talking about a solvency crisis here that escalated rather abruptly and is a case-study in what contagion actually means.

Sovereign defaults/restructuring events seem to be associated with a lot of pain and are not to be taken lightly, since this amount of pain being inflicted on people abruptly can have some rather adverse effects. Readings of the misery index do deescalate fast but some social scars may linger.

To wrap this up, the Greek crisis is a rather severe solvency crisis that could make all the ones mentioned above seem like small beer...

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