Sovereign Debt Standstills
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Summary:
As a response to economic crises triggered by COVID-19, sovereign debt standstill proposals emphasize debt payment suspensions without haircuts on the face value of debt obligations. We quantify the effects of standstills using a standard default model. We find that a one-year standstill generates welfare gains for the sovereign equivalent to a permanent consumption increase of between 0.1% and 0.3%, depending on the initial shock. However, except when it avoids a default, the standstill also implies capital losses for creditors of between 9% and 27%, which is consistent with their reluctance to participate in these operations and indicates that this reluctance would persist even without a free-riding or holdout problem. Standstills also generate a form of “debt overhang” and thus the opportunity for a “voluntary debt exchange”: complementing the standstill with haircuts could reduce creditors’ losses and simultaneously increase welfare gains. Our results cast doubts on the emphasis on standstills without haircuts.
Series:
Working Paper No. 2020/290
Subject:
Asset prices Debt burden Debt relief Personal income Securities markets
Frequency:
regular
English
Publication Date:
December 18, 2020
ISBN/ISSN:
9781513564531/1018-5941
Stock No:
WPIEA2020290
Pages:
27
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