Finance: Research, Policy and Anecdotes

Sovereign debt and financial stability

We had two events at the Florence School of Banking and Finance over the past two weeks on financial and sovereign debt stability. Joint with Georgetown University, Graduate Institute of Geneva and the Sovereign Debt Fund, we held the 5th edition of DebtCon last week in Florence, a fascinating interdisciplinary event with economists, lawyers, historians and political scientists, academics, practitioners and policymakers.  As the world has been emerging from the pandemic, corporate and sovereign overindebtedness as consequence of the pandemic, lockdowns and government support measures has been of increasing concerns. With monetary policy in the US tightening (and at least a normalisation on the horizon in the euro area) and thus the global financial cycle tightening even more rapidly after the Russian invasion of the Ukraine, the threat of sovereign distress becomes more acute and is already happening in some countries, such as Sri Lanka.  However, we were reminded that the current (corporate and sovereign) debt wave actually started in 2010, with global sovereign debt/GDP now higher than global corporate debt/GDP.  If the fear of a global recession materialises, there might be further sovereign distress such as in some countries of the former Soviet Union and Central America and Caribbean.

 

Certainly a scary backdrop for the academic and policy discussions at the conference, but also an important impetus for research in this area, including studies of historical sovereign distress situations (or situations where default was prevented, such as Colombia in the 1980s), studies of the domestic and international politics of sovereign debt restructuring and attempts to improve data availability on sovereign debt and increasing transparency.

 

There are also new issues arising; most importantly, as my new colleague Sony Kapoor pointed out, the moral debt of advanced countries not only vis-à-vis their own future generations but also vis-à-vis developing countries having used up environmental space. At the same time, developed countries are encouraging their developing peers to go for high-initial-cost investment in green energy, which might not be feasible given limited access to international capital market. Given the nature of a stable climate as global public good, there is certainly a global deal to be made; given the current geopolitical situation, however, the likelihood of such a deal seems depressingly low.    

 

Similar themes last Thursday, when we had an exciting online roundtable (jointly organised with the Center for Global Development) on Sovereign Debt and Financial Stability in Europe and Latin America. Several important messages came out of the discussion: first, there has been an increasing divergence in access to financing markets by sovereigns; the ability of countries to respond to the pandemic differed dramatically by their access to international capital markets. This, in turn, will also affect post-pandemic growth paths  and whether or not countries can go back to pre-covid growth paths. This divergence might be further exacerbated with the current geopolitical disruption and the monetary tightening in the US. Interestingly, this can also be seen in Europe, where countries outside the euro area (but within the EU) have seen a faster increase in sovereign bond yields than countries inside the euro area. Second, there was a general agreement that price stability is a necessary (though not sufficient) condition for returning to a sustainable growth path. And even though supply-side induced inflation (as it might be primarily the case in the euro area) might not be influenced by monetary policy, inflation expectations will, which reinforces the argument for normalisation if not tightening of monetary policy in the euro area. Third, there is a clear difference between commodity exporters and importers in the economic effects from the dramatic recent increase in commodity prices; not surprising but important to keep in mind! Fourth, as interest rates increase, bank-sovereign fragility links will again gain prominence, including in emerging markets.