Sovereign default/Addendum

Sovereign Spreads

Senior 5-year credit default swap premia, in basis points

	Jan 08	Oct 08	Feb 09	Jun 09	Dec 09
USA	8	28	94	45	32
UK	9	43	175	87	70
Germany	7	22	78	34	23
Greece	22	87	285	155	182
Ireland	13	67	170	98	86
Spain	18	66	170	98	86
Japan	9	33	121	44	67
Dubai		470	977	505	486

(Source: IMF[1])

Defaults and downgrades

Russia, 1998

By 1997 Russia's central bank had achieved a major improvement in the country's financial stability, having reduced its inflation rate to 11 percent from its 1994 rate of 224 percent, and the depreciation of its exchange rate to 7 percent from its 1995 30 per cent rate. The budget deficit had been rising rapidly, however, and debt repayments were absorbing a substantial proportion of tax revenue. There were fears that further use of high discount rates to control inflation and maintain its exchange rate within its announced ("crawling peg") limits would hamper economic growth and further increase debt repayments . To make matters worse, a fall in the world price of oil caused a nearly 18 per cent year-on-year deterioration in Russia's terms of trade and the Asian banking crisis had drastically reduced investors' confidence in emerging market economies. There were two speculative attacks on the Rouble in the course of 1998 and an unsuccessful negotiation for support from the International Monetary Fund; and in September the government announced a suspension of debt repayments and the adoption of a floating exchange rate policy.

The magnitude of the default broke previous records and created a further loss of investor confidence with internal repercussions that may even have contributed to a subsequent default by Brazil .

Argentina, 2001

Argentina also used exchange rate regulation in a successful attempt to reduce its inflation rate, but in Argentina's case the most damaging reaction came from of own citizens rather than overseas investors - although there was also a succession of credit rating downgrades by the credit rating agencies. The attempt to maintain a fixed rate of exchange with the US dollar added to the depth of a persistent recession, causing hardship that provoked a series of general strikes that led finally to the collapse of the government. Unlike the Russian crisis, the problem did not arise suddenly but had been the subject of long-standing policy advice and financial support from the International Monetary Fund (whose policy toward Argentina was later judged to have been mistaken) .

Greece, 2009

Greece had been in default for more than half of its history since 1832, running an average fiscal deficit of 7.8 per cent of gross domestic product since 1988. The CDS spread on its 5-year bonds reached 285 points in February 2010.

Sovereign default credit rating criteria

Standard and Poor's Sovereign Categories

1. Political risk
Stability, predictability and transparency of political institutions. Public and national security. Responsiveness to change.
2. Income and Economic Structure
Degree economy is market-oriented. Extent of property rights. Per-Capita GDP.
3. Economic Growth Prospects
Changes in standard of living. Income distribution.
4. Fiscal Flexibility
Tax revenues, expenditures and past performance in balancing budgets. Methods of deficit financing and their inflationary impact. Growth friendly tax system and the ease of which it can be changed, Efficiency of expenditures
5. Government Debt Burden
Extent to which government can pay and manage its debt
6. Off-Budget and Contingent Liabilities
Size and health of non-financial public sector enterprises. Health of financial and banking system.
7. Monetary Stability
Credit trends. Price behavior in past economic cycles. Level, currency and maturity of public sector debt, Money and credit expansion. Independence of central bank. Compatibility of exchange rate regime with monetary policy. The range and efficiency of monetary policy tools. Depth and breadth of capital markets.
8. External Liquidity
Structure of merchandise trade, service, income and transfers. Vulnerability to changes in investor sentiment. Gross external financing as a percentage of official foreign exchange reserves.
9. Private Sector Debt Burdens
Residents assets and liabilities.
10. Public Sector Debt Burdens
Trends in public sector debt. Contingent liabilities. Foreign exchange reserves.

Moody’s Sovereign Categories

1. Economic Structure and Performance
GDP, inflation, population, GNP per capita, unemployment, imports and exports.
2. Fiscal Indicators
Government revenues, expenditures, balance, debt all as percentage of GDP
3. External Payments and Debt
Exchange rate, labor costs, current account, foreign currency debt and debt service ratio.
4. Monetary and Liquidity Factors
Short-term interest rates, domestic credit, M2/foreign exchange reserves, maturing debt/foreign exchange reserves, liabilities of banks/assets of banks.

(Source: Gautam Setty and Randall Dodd: Credit Rating Agencies: Their Impact on Capital Flows to Developing Countries, Financial Policy Forum,April 14, 2003[2])