Ian Bremmer on Sovereign Defaults
Ian Bremmer and Preston Keat, of Eurasia Group, have a new book out — which means that in the process of plugging it, they’re happy to give detailed answers to bloggers on matters geopolitical. I decided to ask Ian about sovereign defaults; he gave a broad answer to begin with, but then I pushed him on specifics, and he came up with some very interesting analysis. Here’s the full exchange; you’ll have to scroll quite far down before Bremmer says that Ecuador’s default "was probably a rational decision", but there’s a fair amount of juicy stuff before that.
Felix Salmon: How many sovereigns are going to default in the coming year?
Ian Bremmer: The question has really two answers to it. First how many governments are really not going to be able to, economically-speaking, continue to honor their debt obligations. We are not macroeconomists, but certainly some states in Eastern Europe and Club Med states are going to face structural difficulties, especially if the economic conditions continue to worsen. However this is simply a matter of structural economicdifficulties and not of choice to default.
The second answer which is however often ignored, involves asking which countries will choose to default for political reasons? When economists assess sovereign credit defaults, they often overlook that states choose not to honor their debt obligations, in order to favor specific political players. Narrow political and economic interests often trump broad the broad public good, when it comes to default decisions. Economic analysis cannot capture these political choices, as economics assumes that most debt decisions are made with the broader public good in mind. But that is not always the case, we saw this with Russia in 1998, when the government chose to default in large part because that favored specific domestic industries and political interest groups. Ecuador in late 2008 reached a similar decision – there, a populist President repudiated part of the national debt for lagely because the decision plays well with populist left-wing elements of the electorate in advance of the April 2009 election.
In the next year, we do not foresee any states that defaulting for political reasons at this point. But it will be important to monitor two issues: countries that have populist or nationalist leaderships and second, whether multilateral organizations will be politically able/willing to bail out smaller states that are significantly impacted by the crisis.
States with authoritarian and populist government, such as Algeria, Lybia, Russia and Venezuela, have a natural propensity to default, as their elites and governments often politically benefit from such actions. However, the first three don’t really have high levels of debt. Russia of course has significant corporate debt where there could be significant defaults, especially if the Kremlin decides to stop bailing out oligarchs. Venezuela could be in the middle of a full-fledged fiscal and balance of payments crisis by the middle of 2010 if oil prices remain depressed and they maintain their current policy mix. Venezuela’s risk spreads, which have climbed to 1800bps in the last few months, reflect market concerns over their ability to pay. However, bear in mind that Chavez has stayed current on Venezuela’s sovereign external debt obligations even at the worst of times (2002/2003 PDVSA strike). History is no predictor of the future, but PDVSA has substantial overseas refining assets that could potentially be at risk of attachment in the case of default, which should temper the government’s propensity to default.
This raises an important question, namely which other states could get populist leaderships that will have incentives to default? This is something that we’ll be watching very carefully as the social effects of the economic crisis are increasingly felt around the world. Current governments could either be voted out of office or forced to resign because of the crisis, as it has already happened in Iceland and Latvia. It will be key to watch who are the replacement governments? Will these come to office on a wave of anger directed at foreign interests? Will governments see defaults as politically profitable? Much of this will be a matter of timing, and again it is too early to tell…governments often make the decisions to default or continue to pay at the last minute, these things are not always planned in advance. So we will continue to monitor that.
The second political risk here is the inability of multilateral organizations to get their act together. The IMF will likely need more funding, especially if the crisis worsens, and more states need aid. With the G20-level negotiations facing a high likelihood of deadlock, what are the chances that more money will be pumped into the IMF? Capital-rich states such as China, the GCC states or Japan will inevitably ask for an increased voice within the IMF, but readjusting voting rights within the organization will be subject to lengthy negotiations. Similarly, while the EU provides support to countries within the EU, the question of capacity is critical. The EU is obviously less likely to support non-EU states, especially if the crisis worsens. So monitoring the capacity of multilaterals for concerted actions is essential. While we expect that in emergency cases, these organizations will function, their capacity, especially under worse economic conditions, cannot be taken for granted.
With this in mind, the set of countries to watch are the smaller states in regions that are historically default-prone or have been hard hit by the crisis, such as in Central America or Eastern Europe. These states are generally extremely dependent on global markets and securing international financing, especially from the multilateral institutions, so they are reluctant to default. These are the states that in a worst case scenario (such as is the case currently with Hungary or Ukraine or Romania), they will turn to the IMF/WB/IDB or the EU before defaulting to private creditors.
FS: Ian, you start off by drawing the distinction, which is very common in the world of sovereign credit analysis, between ability to pay and willingness to pay. On the subject of ability to pay, you start off by mentioning "Eastern Europe and Club Med states": are those the credits which you think are most likely to face the kind of real fiscal crunch which makes debt repayments essentially impossible? Can you be a bit more specific about which countries you have in mind? Would they include Greece? Italy?
IB: There are still multiple variables affecting default risk that are not yet known. In addition, we expect ad hoc support would be provided from other eurozone members to avert default, though this depends on the extent of the needs. Clearly Greece and Italy are causes for concern as are a number of Eastern European countries outside the Euro zone, such as the Baltic states, especially Latvia, Hungary, Romania and Bulgaria. There is however still a high degree of "solidarity" among EU states even as each concentrates primarily on its domestic economic problems. There is a very high treshhold of tolerance to do what is necessary to keep the overall EU project on track. This includes, within reason, providing whatever budgetary support an EU member state might need in the short time to ride out the worst aspects of the financial crisis.
FS: You then, rightly, spend quite a lot of time on the states which might default simply through a lack of willingness to pay — as Ecuador has already done. You say that this factor is "often ignored" — do you mean by the IMF? By sovereign credit analysts? By the market? How do you think that the world and the markets might change if the people ignoring willingness-to-pay issues stopped ignoring them?
IB: The problem is that it is more difficult for everyone to price in willingness to pay than ability to pay. When markets do not have adequate information to price things, often they don’t. Capability to pay can be measured in multiple ways (capital and investment inflows, cash in hand and foreign exchange reserves, budget deficit levels, export values etc) whereas willingness is a more subjective issue and can turn on a political whim. If the IMF has a decent relationship with a country’s political and economic leadership, they should be able to spot willingness problems earlier than markets. But markets can indicate an unease about a country’s willingness to pay, for example by allowing spreads to widen: this usually indicates grave doubts that a country can or wants to service its debts in the long term.
FS: You say that "Venezuela could be in the middle of a full-fledged fiscal and balance of payments crisis by the middle of 2010 if oil prices remain depressed and they maintain their current policy mix." Given that the current policy mix is very much a consequence of high oil prices, how likely do you think it is that Chavez will continue his current rates of spending even in the face of severely reduced revenues? And when making those decisions, how cognisant will he be of the fact that PDVSA’s overseas assets risk being attached if the sovereign defaults? Do you think that Venezuela has a significantly higher degree of economic and legal sophistication than Ecuador, which seemingly defaulted without really going through the consequences of that decision?
IB: In Venezuela there will be some fiscal adjustment, as well as the ongoing currency devaluation, but nothing major that will generate significant political pain for the rest of 2009. In other words, Chavez’s government will continue to muddle along as long as it can during 2009, dipping into its oil funds to finance current expenditure rates. The likelihood of a significant fiscal adjustment is low. But things do get much more serious if the oil price remains this low through 2010. There are other strains meantime though: PdVSA has billions of dollars of unpaid receipts from oil service companies on its hands.
It’s not at all clear that Ecuador paid a high and immediate cost for defaulting. That might embolden others. In Venezuela there has been an issue over whether assets could be sequestered due to the policies of nationalization, but the legal case remains unclear. In the meantime PdVSA is divesting itself of some assets abroad (including gas stations in the US) to limit their liabilities. Not sure there is a high likelihood is of PdVSA’s assest being sequestered. But clearly, this would be a last recourse.
FS: Can you be a bit more specific about the Central American and Eastern European countries which are "extremely dependent on global markets and securing international financing, especially from the multilateral institutions"? In Eastern Europe are you saying that absent multilateral intervention, Hungary, Ukraine, and Romania would already have defaulted on their private-sector debts? And which Central American countries did you have in mind?
IB: In EU eastern Europe, there are mechanisms available to avert sovereign default, and this makes it very unlikely. But there are fewer tools to avert private debt defaults, and the severe credit and liquidity constraints in the region make refinancing more difficult. So we can see significant defaults, even if not at the sovereign level. Ukraine is riskier, as it is not eligible for the EU facilities that provide support to EU members. Likewise, western Balkans countries have no formal recourse to the EU, though they can benefit from IFI support, and potentially bi-lateral EU support. So they are riskier than EU members, but not as risky as Ukraine. In addition, the key Balkan governments — Serbia and Croatia — are averse to default, and display more effective macroeconomic policy management than does Ukraine.
Countries such as El Salvador, Costa Rica, Panama, and Jamaica have already turned to the WB and the IDB and contracted loans to pay off soverign debt or to contract contingency funds in the event that support is needed for their domestic banks and financial institutions.
FS: What do you foresee happening on the external-debt front with the largest sovereign defaulter of all time, Argentina? Will it default again? Will it attempt some kind of swap with the holders of its defaulted debt?
IB: Argentina faces a tough financing picture in 2009, 2010 and 2011, which could become even more complicated as revenues fall (due to an economic slowdown and falling export prices) . Exports are likely to fall even quicker if Argentina remains isolated from international capital markets. The government, however, has been trying to dispel doubts about its willingness and capacity to pay, and last year nationalized the local pension funds so as to have enough cash to meet its (more than $18 billion) debt obligations. The government probably has enough to make it through this year, but 2010 will be challenging.
Still, a default will probably be politically costly, as it will bring back memories of the 2001 crisis. As a result, the government will probably try to avoid one, and even some sort of agreement with the IMF is more likely than a default at this point. In spite of its heterodox orientation, Kirchner has made a point of honoring all its debt obligations.
FS: Finally, with dozens of sovereigns trading at distressed levels, the debate over "vulture funds" is heating up again. Do you think that the current crisis has changed the balance of power between sovereigns, multilaterals, and private-sector creditors? Is there a chance that the IMF might attempt to resuscitate the kind of sovereign bankruptcy proceedings (SDRM) which failed to get traction a few years ago? Given that the funding window is now closed for these countries, would it be fair to say that the opportunity cost of default — and the cost of default more generally — has never been lower? How much damage has Ecuador, say, really done to itself by defaulting on its global bonds? And what are the chances of the IMF revisiting its lending-into-arrears policy in the event that a few more countries default?
IB: This is outside the pool we usually swim in but let me take a macro-level stab at unpacking the issue. The real issue is how quickly international institutions will be reoriented toward keeping as many countries as possible in the system. The repricing of risk brought on by the bursting of the global credit bubble has doubtless limited the availability of credit to more distressed sovereigns and, in turn, their ability to turn to private markets for money. But the G20 will take up the effort to make emergency financing more available through the IMF, though the way that institution is managed going forward remains very unclear. My sense is they will have larger fish to fry – i.e. they will focus assets and rescources on being able to bail out more mature markets. The IMF may come out of next month’s G20 a more important and better capitalized institution. That strengthening of the multilateral institution doesn’t imply weakening sovereigns and may in fact produce more efficient outcomes as the availability of such funding creates opportunites for sovereign borrowers and eventually, one hopes, even with private-sector creditors.
For these reasons, it is hard to say whether Ecuador’s default represents a harbinger. It clearly made the calculus that with access to markets dried up, the up-sides of defaulting now were larger than the costs. And it was probably a rational decsion. The problem is that the costs will be felt more in the medium term, placing stresses on dollarization etc. In other words, the government opted for some short term econmic gain but generated conditions for larger dislocation down the road.
Reprinted from Portfolio.com