Loading the player...

WHAT IS 'Sovereign Default'

Sovereign default is a failure in the repayment of a county's government debts. Countries are often hesitant to default on their debts, since doing so will make borrowing funds in the future difficult and expensive. However, sovereign countries are not subject to normal bankruptcy laws and have the potential to escape responsibility for debts without legal consequences.

BREAKING DOWN 'Sovereign Default'

Sovereign defaults are relatively rare, and are often precipitated by an economic crisis affecting the defaulting nation. Investors in sovereign debt closely study the financial status and political temperament of sovereign borrowers in order to determine the risk of sovereign default.

In the event of a country’s default, a credit rating agency will take into account the country’s interest, extraneous and procedural defaults and failures to abide by the terms of bonds or other debt instruments. Inflation has sometimes helped countries to escape the true burden of their debt. Other times when faced with extreme debt, some governments have devalued their currency, which they do by printing more money to apply toward their own debts, or by ending or altering the convertibility of their currencies into precious metals or foreign currency at fixed rates.

Sovereign Debt Crisis

When the United States needs more money, it relies on two primary options. One is to raise taxes and the other is to issue debt. Because raising taxes can be a lengthy and unpopular option, the U.S. Department of Treasury will instead often choose to issue debt in the form of selling U.S. securities. These Treasury securities and bonds act as loans in which the purchaser gets to collect interest until the bond matures and the government pays back the original amount.

If potential lenders or bond purchasers begin to suspect that a government may fail to pay back its debt, they will sometimes demand a high interest rate as compensation for the risk of default. This is sometimes referred to as a sovereign debt crisis, which is a dramatic rise in the interest rate faced by a government due to fear that it will fail to honor its debt. Governments that rely on financing through short-term bonds may be especially vulnerable to a sovereign debt crisis since short-term bonds create a situation of maturity mismatch between short-term bond financing and the long-term asset value of a country’s tax base.

A number of countries have excellent records of paying on sovereign debt obligations and have never defaulted. These nations include Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, Switzerland and England.

RELATED TERMS
  1. Sovereign Debt

    Sovereign debt is issued by the national government in a foreign ...
  2. Sovereign Bond

    A sovereign bond is a debt security issued by a national government ...
  3. Debt Restructuring

    Debt restructuring is a method used by companies with outstanding ...
  4. Default Probability

    Default probability is the likelihood over a specified period, ...
  5. Fitch Ratings

    An international credit rating agency based out of New York City ...
  6. Credit Default Contract

    Credit default contracts are products that shift risks between ...
Related Articles
  1. Investing

    The Risks Of Sovereign Bonds

    Sovereign debt can play an important role in providing international diversification to individual investors.
  2. Investing

    7 Things You Didn’t Know About Sovereign Debt Defaults

    Sovereign debt defaults are scary, but should they be? They are actually more common than you think.
  3. Insights

    Why and When Do Countries Default?

    Countries can default on their debt. This happens when the government is either unable or unwilling to make good on its fiscal promises.
  4. Insights

    The History Of Greek Sovereign Debt Defaults

    This isn't the first time Greece has been in financial trouble. Here's a brief history of the country's money woes.
  5. Investing

    Explaining Government Bonds

    A government bond is a debt security a government issues.
  6. Financial Advisor

    Emerging Market Defaults: Beware of Second Wave

    Emerging market corporate defaults have the potential to be the biggest risk to global markets.
  7. Investing

    How PIIGS Defaults Could Affect The Markets

    What would a default by Europe's PIIGS do to the European and world financial markets, and how would the eurozone cope?
  8. Insights

    How Debt Limits A Country's Options

    While debt is fundamentally necessary to the operation of a national government, it can also be limiting and dangerous.
  9. Investing

    Investing In Emerging Market Debt

    This asset class has left much of its unstable past behind. Find out how to invest in it.
  10. Insights

    Moody's Sovereign Debt Outlook Worst Since 2012

    More sovereign debt issuers have negative outlooks than at any time since the European sovereign debt crisis.
RELATED FAQS
  1. In what types of financial situations would credit spread risk be applied instead ...

    Find out when credit risk is realized as spread risk and when it is realized as default risk, and learn why market participants ... Read Answer >>
Trading Center