Enough Potential Repudiation: Economic and Legal Aspects of Sovereign Debt in the Pandemic Era

Abstract

This article reviews recent economic and legal literature on sovereign debt in light of the COVID-19 shock. Most of the core theoretical contributions across the two disciplines hinge on immunity, and the sovereign borrower's consequent inability to commit to repay foreign creditors, as the distinguishing attribute of sovereignty. We highlight a persistent gap between sovereign debt theories grounded in immunity and empirical evidence that the governments of low- and middle-income countries borrow far more than theory would predict. On the other hand, the governments of advanced economies, generally viewed as outside the scope of this literature before the euro area debt crisis, have shown themselves to be far more commitment challenged than previously supposed. We conclude that the traditional split between a literature concerned with developing economy sovereigns that repudiate debt and one concerned with advanced economies that do not is no longer appropriate (if ever it was). We argue that shifting some attention away from immunity to a different attribute of sovereignty—authority—could help bridge the gap between the two literatures. Expected final online publication date for the Annual Review of Economics, Volume 14 is August 2022. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.

Sovereign Debt Puzzles

“…Multiple puzzles emerge when one looks at sovereign debt markets through the lens of the canonical sovereign debt framework. We are not the first to point out that a mismatch exists between the predictions of the canonical model of sovereign debt and the reality of sovereign debt markets [for more on discrepancies between theory and practice see, e.g., Rogoff (2022), Mitchener & Trebesch (2023), Gelpern & Panizza (2022)]. 1 Our contribution here is to identify and classify the main sovereign debt puzzles and to suggest alternative explanations.…”

“…There are two issues with this assumption in reflecting reality. First, the evidence suggests that reputational costs tend to be short-lived (Panizza, Sturzenegger & Zettelmeyer 2009;Gelpern & Panizza 2022;and Mitchener & Trebesch 2023). Second, quantitative models of sovereign debt predict that reputation alone would imply debt limits close to zero [for a textbook treatment, see Uribe & Schmitt-Grohé (2017)].…”