Resolving sovereign debt crises: the role of political risk

Abstract

Sovereign defaults are bad news for investors and debtor countries, in particular if a default becomes messy and protracted. Why are some debt crises resolved quickly, in a matter of months, while others take many years to settle? This paper studies the duration of sovereign debt crises based on a new dataset and case study archive on debt renegotiations between governments and foreign banks and bondholders. Using Cox proportional hazard models, I find that domestic political instability ('political risk') is a significant predictor of negotiation delays, after controlling for macroeconomic conditions. Government crises, resignations, and street protests are particularly disruptive for a quick settlement process. Overall, the evidence suggests that debtor countries often lack the political ability to resolve a debt crisis. Governments in turmoil are unlikely to exit a default quickly.

Introduction to the special issue on sovereign debt restructuring

“…In his contribution to this volume, 'Resolving debt crises: the role of political risk', Christoph Trebesch finds a positive correlation between delay and domestic political risk in the debtor country -for both of which a rich set of data is compiled. Whether this finding -that 'politics matters' -can be reconciled with the delay-in-bargaining perspectives just discussed is an interesting issue (Trebesch, 2019). Could the political risk be part of the cost that makes delay a credible signal in bargaining?…”

From Health Crisis to Financial Distress

“…28 In addition, shifts in debtor bargaining power can lead to longer default spells, as can business cycle conditions in the creditor country (Benjamin and Wright 2009;Asonuma and Joo 2020). Trebesch (2019) focuses on political instability in the debtor country as a factor that can delay and derail an effective debt restructuring. This problem can be self-reinforcing, as economic crises often undermine the political situation, which in turn, increases uncertainty about the current government's ability to deliver the future reforms needed to restore solvency.…”

Can this Time be Different? Policy Options in Times of Rising Debt

“…Political instability and unrest often precede debt crises, particularly when a rapid buildup of government debt necessitates policy adjustments that have important distributional consequences (Andreasen, Sandleris, and Van der Ghote 2019). Conversely, political stability tends to be associated with a lower likelihood of sovereign default and quicker resolution of debt crises (Trebesch 2019;Van Rijckeghem and Weder 2009). 4…”