Throughout global history, we have seen and experienced the rise and fall of economies with more recent examples such as the COVID-19 Pandemic causing significant levels of economic distress globally and regionally.

As increased interest rates began to rise, many countries were struggling even to fulfill basic needs of its people, leading to borrowed funds or debts to stay afloat.

These issues then re-surface after a certain period of time which if not addressed properly may lead to countries threatened to fall into default due to debt in various scenarios, often driven by the aftermath of these events whether that be the economic, political, or financial instability.

When a country defaults on its debt, studies have shown that the severe decline can generally lead to long-lasting damage with a few examples, such as increased interest rates, inflation, recession, lowered credit ratings, and many more impacts in the economic, financial, social, and political aspect.

In today’s interconnected world, the effects of a sovereign default are not only confined to a single nation where there are even potential ripple effects across the global economy, influencing international trade and financial markets.

What is a Sovereign Debt Default?

A sovereign debt default can be understood as the failure of a nation’s government of a sovereign entity to repay its debt whether they are unable or unwilling to do so.

This failure is usually formally declared as it shows how the government can no longer continue repayment towards their creditor, other countries, and/or investors. However, global pandemics or international events may not always be the cause for a country’s default as it may be due to other factors such as external economic shocks, poor investments, mismanagement of funds, banking crisis, economic stagnation, political instability, etc.

Countries that have defaulted is usually limited in their options to remedy it where some have suggested towards the printing of more money, increase its taxes, or obtaining loans although usually with higher expense.

Sovereign countries unlike companies or individuals are not subjected to bankruptcy laws, therefore the borrowed party usually investors may seek a review of the interest rates to compensate for the increased risk of default.

Other companies or multinational lenders (the International Monetary Fund (IMF)) and the World Bank usually is needed to be repaid however as it usually lends towards accomplishing a certain policy goal or promotion of exports. Therefore a default in a nation’s own currency is easier to manage in comparison to foreign debt as it impacts relationships politically in the international sphere.

Main Factors Contributing Towards Sovereign Default

There are several factors that may increase the likelihood of sovereign default, below are some of the main causes that are usually present in past cases, which includes:

• Excessive Debt Levels: When a country accumulates high levels of debt compared to its GDP, it becomes quite difficult to manage and can be unsustainable leading towards default.
• Economic Recession or Decline: Economic declines may reduce government revenues from taxes and other sources, making it harder to meet debt obligations. If there are prolonged recessions, can severely weaken a country’s ability leaving it susceptible to economic shocks or external factors.
• Political Instability: Political turmoil, frequent changes in government, or internal conflicts within a country is one of the more common catalysts of sovereign default as it can disrupt economic policies.
• Financial Instability: Rising interest rates, a decline in the value of a country’s currency, a drop in export earnings or other significant revenue sources, ineffective budgeting, uncontrolled spending, and a lack of financial management are also frequently one of the main causes towards sovereign default.
• External Shocks: Unexpected events such as natural disasters, global financial crises, or sharp declines in commodity prices can put significant pressure on a country’s economy. This is one of the factors that are uncontrollable towards prevention of a default.
• Dependence on External Borrowing: Countries that are heavily reliant on external borrowings are usually vulnerable towards the shifts in the global market therefore more susceptible towards default.

The Effects of Sovereign Default

A nation that has been driven towards a sovereign default can experience widespread and long-term effects as it impacts various aspects in its economic and political aspects. Generally, the main effects caused by a sovereign default can be broken down into:

• Economic Impacts: As a country experiences a decline, it usually is susceptible of recession leading to lower economic activity and higher unemployment, inflation from currency devaluation following a default can lead to higher import costs and increasing exportations, eroding purchasing power, and heightened interest rates.
• Financial Impacts: Sovereign Default may lead to banking crisis which can lead to severe instability in the financial sector. A nation experiencing default may also be affected by its credit rating which increases borrowing costs and create difficulties towards accessing global markets.
• Social Impacts: With the decline of revenue and financial gain, countries that have default will cut public services, social programs, and welfare benefits reducing its citizens’ quality of life. The economic instability also leads to increased unemployment rates as businesses cut back on employees which in turn increases poverty, and decreases overall national GDP.
• Political Impacts: Distress whether economically or financially may cause internal instability caused by protests.
• International Impacts: Default may damage a country’s reputation, making it harder to build relationships towards other nations and secure future investors. An uncontrollable default may also lead to global market volatility or may spread economic distress to other nations.