Sovereign Default Forecasting in the Era of the COVID-19 Crisis

The COVID-19 crisis has revealed the economic vulnerability of various countries and, thus, has instigated the systematic exploration and forecasting of sovereign default risks. Multivariate statistical and stochastic process-based sovereign default risk forecasting has a 50-year developmental history. This article describes a continuous, non-homogeneous Markov chain method as the basis for a COVID-19-related sovereign default risk forecast model. It demonstrates the estimation of sovereign probabilities of default (PDs) over a five-year horizon period with the developed model reflecting the impact of the COVID-19 crisis. The COVID-19-adopted Markov model estimates PDs for most countries, including those that are advanced with AAA and AA ratings, to suggest that no sovereign nation’s economy is secure from the financial impact of the COVID-19 pandemic. The dynamics of the estimated PDs are indicative of contemporary evidence as experienced in the recent financial crisis. The empirical results of this article have policy implications for foreign investors, sovereign lenders, export finance institutions, foreign trade experts, risk management professionals, and policymakers in the field of finance. The developed model can be used to timely recognize potential problems with sovereign entities in the current COVID-19 crisis and to take appropriate mitigating actions.

Fewer but Better: Sudden Stops, Firm Entry, and Financial Selection

We develop a tractable quantitative framework to study the productivity effects of financial crises. The model features endogenous productivity, heterogeneous firm dynamics, and aggregate risk. Selection of the most promising ideas gives rise to a trade-off between mass (quantity) and composition (quality) in the entrant cohort. Chilean plant-level data from the sudden stop triggered by the Russian sovereign default in 1998 confirm the model’s main mechanism, as firms born during the credit shortage are fewer but better in terms of idiosyncratic productivity. The quantitative analysis shows that at the end of the crisis, total output is permanently 0.9 percent lower. (JEL D22, E32, F41, G01, O11, O14, O33)

Analysis of Australia’s Fiscal Vulnerability to Crisis

Fiscal vulnerability, like a contagion, poses a threat to financial sector stability, which can lead towards sovereign default. This study aimed to assess fiscal vulnerability to crisis by investigating the Australian economy’s gross public debt, net public debt, and net financial liabilities. We used a threshold regression model and compared results with the baseline deficit–debt framework of analysis. The results of the base model suggested that the economy is fiscally sustainable, and that the primary surplus remains unaffected by increasing levels of public debt. In contrast, the threshold regression model indicated that the increasing level of debt has eroded primary surplus below the threshold level of 30.89% of public debt to GDP. These results need further investigation. Therefore, we modified our basic threshold model to capture budget deficit and surplus as a threshold in response to changes in public debt. The results from the sequential threshold regression model using the debt to GDP ratio and primary budget surplus identifying the periods of 1991, 1992, 2008, 2009, 2011 and 2019 as times of likely vulnerability to fiscal crisis. The overall results confirmed that the primary surplus remained sustainable over the estimated threshold level of public debt in all other sample periods and these findings persisted across alternative measures of public debt.

Some aspects concerning the economics of sovereign debt and possible influences of the COVID-19 pandemic

In the last 10 years, the sovereign debt crisis and its effects have made certain concepts, reserved until then only to specialists, to become elements of current language – public debt, sovereign debt, default, over-indebtedness, structural deficit, monetary policy, indebtedness ratios, sovereign debt effects, IMF intervention, willingness to pay… The indebtedness and over-indebtedness generated negative effects that affected not only the public finances, but also the economic agents (businesses) and the population, fueled by the lack of vision and responsibility of some governors. After the global economic crisis of 2008 and that of sovereign debt after 2010, a better control of indebtedness was tried, a more rigorous approach was implemented, but the Coronavirus pandemic that manifested itself in 2020 (and continues to do so) brought back to the forefront the problem of sovereign indebtedness and sovereign default.

Banks’ international assets and sovereign default risk

Purpose This paper aims to investigate the nexus between banks’ foreign assets and sovereign default risk in a panel of 15 developed economies. The empirical evidence suggests that banks’ foreign exposure is an important determinant of sovereign default probability. Design/methodology/approach Using data from the consolidated banking statistics (total foreign claims on ultimate risk basis) by the Bank of International Settlements, the author constructs a measure of bank international exposure to peer countries. This measure is then used as the target variable in a panel regression for sovereign credit default swaps. The model includes 15 European and non-European developed economies. Identification is discussed extensively in the paper. Findings Quantitatively, a 1% increase in banks’ cross-border claims increases sovereign default risk by about 0.19%. The relationship is weaker when banks are more capitalised. On the other hand, governments are more vulnerable to credit risk spillovers from banks’ international portfolios when having higher debt to GDP ratios. Originality/value To the best of the author’s knowledge, this is the first paper that attempts explicitly to establish an empirical connection between banks’ international assets and sovereign default risk. To the author’s opinion, this paper represents a contribution to our understanding of how sovereign credit risk spills over across countries. It also extends significantly the existing literature on the determinants of sovereign risk (that primarily focused on fundamentals, market characteristics – such as liquidity – and global factors). This paper ultimately sheds some new light on the role of intermediaries in the international transmission of credit risk, also adding to today’s discussion about the linkages between banks and sovereigns.

Sudden Stops, Sovereign Risk, and Fiscal Rules

This paper studies the effect of implementing fiscal rules on sovereign default risk and on the probability of large capital ow reversals for a large sample of countries including both developed and emerging market economies. Results indicate that fiscal rules are beneficial for macroeconomic stability, as they significantly reduce both sovereign risk perception and the probability of a sudden stop in countries that implement them. These results, which are robust to various empirical specifications, have important policy implications specially for countries that have relaxed their fiscal rules in response to the Covid-19 pandemic.