Debt crisis macro_ Daniel COHENPresentation Transcript
Sovereign debt crises
the lost decade: 1980s
Asia, 1982, 1997
Two lost decades, culminating in HIPC initiative
40 years of sovereign debt crises
A country is said to experience a debt crisis in a year if one of the following conditions holds:
The sum of its interest and principal arrears on long-term debt outstanding to all creditors is larger than 5% of the total debt outstanding.
The country receives debt relief from the Paris Club (w/o HIPC initiative exits)
The country receives substantial balance-of-payment support from the IMF in the form of StandBy Arrangements and Extended Fund Facility. We define exceptional support by the IMF the event where a country actually uses more than 50% of its quota in one year (KN just looked at events where the IMF extended resources to the country in excess of 50% of its quota, regardless of the fact that it actually used it).
Data on 126 countries from 1970 to 2007.
Debt crises: a simple but misleading statistic
Unconditional probability for a country to experience a debt crisis in any given year : 37%
Very high number!
How can we explain such a high default probability?
The serial defaulters hypothesis (1)
The serial defaulters hypothesis (2)
On average a given country in our sample is considered to be in debt distress one third of the time (11,6 years out of 38 years).
When we exclude the countries which spend more than 20 years out of 38 in a debt crisis, i.e. the “serial defaulters”, the mean annual probability of a debt crisis only goes to 24%.
The global crisis hypothesis (1)
The global crisis hypothesis (2)
On a given year, one third of the countries (38,5 out of 126) are in debt distress on average.
When we exclude the years where more than 52 countries are in debt crisis (the 4th quartile), the mean annual probability of a debt crisis does not change that much: 32%.
Market access? default probability market access countries 27% non-market access countries 43%
US business cycle? default probability years where there is a recession in the US (NBER) 33% years where there is no recession in the US (NBER) 38%
A new definition of a debt crisis
Debt distress episodes: years where a country experiences a debt crisis as previously defined, iif this crisis is preceded by three years without crisis.
Similarly, normal times: years without any crisis preceded by three years without any crisis.
Avoids counting several consecutive years of crisis as different debt distress events.
What we thought was a high unconditional default probability is in fact the sign that debt crises are protracted in most countries. New unconditional default probability: 7%.
Serial Defaulters revisited Outliers: The Gambia (3 times), Ghana (3), Grenada (3), Kenya (4), Turkey (3) and Uruguay (3).
Global crisis revisited
Non-Market Access Countries experience longer crises
Debt crises, Currency crises and Banking crises
Definitions of Laeven and Valencia (2008) to identify both currency crises and banking crises
36 simultaneous sovereign and currency crises, 19 simultaneous sovereign and banking crises, 40 simultaneous currency and banking crises and 10 triple crises.
This tends to show that debt crises are not so often correlated with other kinds of crises but are rather crises of their own.
The macroeconomic determinants of debt crises
Consider the following model: P (y ct =1) = G (β’X ct )
where y ct is a dummy variable equal to 1 when country c experienced a debt crisis at time t and 0 otherwise. X ct is a vector of explanatory variables, β is the vector of estimated coefficients and G is the cumulative distribution function of the logistic distribution (logit estimation).
Independent variables: log(real GDP per capita), log(debt/GDP), total debt service/exports, CPIA all lagged for two years and the spread between the yield of corporate bonds in the US rated Baa by Moody’s and the yield of 10-year US Treasury bonds (proxy for world financial shock).
Results *** denotes 1% significance, ** denotes 5% significance, * denotes 10% significance debt distress=1 log (debt/GDP) t-2 0,523*** total debt service/exports t-2 3,943*** real gdp per capita t-2 -0,379*** cpia t-2 -0,577*** Baa US corporates spread 0,611*** intercept 0,718 N 1159 Pseudo R² 0,0987 Prob>Chi2 0,0000
Quintiles of risk (1) default probability A p < 2,5% B 2,5%< p <4,4% C 4,4%< p <7,1% D 7,1%< p <11,3% E 11,3%< p
Quintiles of risk (2)
Dynamics in risk classification
The sources of risk (1)
We want to focus on the respective weight carried by each factor identified by our baseline regression in the total default probability. Four factors stood out in our estimation of the likelihood of a debt distress episode:
Debt and Debt service
GDP per capita
Governance quality (CPIA)
World shock (Baa-Treasury Bonds spread)
Let’s call z the risk index corresponding to the linear combination of these risk factors weighted by the coefficients of the baseline regression. The default probabilities we estimate are simply G ( z ) where G is the cumulative distribution function of the logistic distribution.
The z factor is additive: we can directly weight the influence of such or such terms on the probability of default.
The sources of risk (2) In order to measure the influence of each variable on the default probability, we computed the average value of each variable (weighted by its coefficient in the regression) for each risk category A, B, C, D and E.
Risk Probabilities (1)
We take the average values of each variable for class E countries as a numeraire and we compute the role of each factor in explaining the overall risk.
We measure by how much the risk in decreased when switching the average of each of the five variables in E to the average in A, B, C and D respectively. Compared to the global effect z, we can measure the contribution of each factor to total risk.
In the following table we compute for each cell P(x i +v E ) where x i +v i =z i . All x, v and z are averaged over i=A, B...E
Risk Probabilities (2)
In the last crisis, 2008-2010, sovereign debt crises was much less severe than one could have expected
Most vulnerable countries were either non market countries, or already in crisis…
The big surprise was the sovereign debt crisis in EUROPE
On the 3 september 2009, PM Costas Caramanlis calls new elections
4 october 2009, elections won by George Papandreou
21 october 2009, budget shoot from 3.7% expected to 12.5%
The spiral BPs October 4 - Papandreou's Panhellenic Socialist Movement (PASOK) party wins power. At this stage, the government expects the 2009 deficit to reach 6% of GDP December 16 - S&P cuts Greece’s rating to BBB+ from A- December 22 - Moody’s cuts Greek debt to A2 from A1 January 14 - Greece unveils a stability program w/ budget gap cut to 2.8% of GDP in 2012 from 12.7 in 2009 February 3 - The EU Commission says it backs Greece’s plan to reduce its budget deficit below 3% of GDP by 2012 March 5 - New package of public sector pay cuts and tax increases March 25 - Euro zone leaders agree to create a joint financial safety net for Greece with the IMF April 11 - Euro zone finance ministers approve a €30 bn emergency aid mechanism for Greece April 27 - S&P downgrades Greece’s credit rating to junk status May 2 - Greece seals deal with EU and IMF opening door to 110 bn euro bailout in exchange for extra budget cuts of €30 bn over 3 years May 18 - Greece receives a € 14.5 bn loan from the EU and can now repay its immediate debt December 8 - Fitch Ratings cuts Greek debt to BBB+ w/ a negative outlook November 5 – The new government pledges to save Greece from banruptcy by cutting the budget deficit June 14 - Moody’s cuts Greece’s credit rating 4 notches to Ba1 (or junk status) over risks to an EU / IMF package February 2 - Government extends a public sector wage freeze to those making below €2,000 a month for 2010
The European response
30 bls euros on 11 april 2010
110 bls euros on May, along with a program aiming at a 2.6% deficit in 2014
On July 21st, 2011, another 109 bl package is voted, cum a market participation of 106 bn, involving a 21% haircut.
Former European episodes
Debt to GDP from de 107% à 92.5%
Structural deficit from –7% to –2.2%
Former European episodes (2)
Budget went from a structural deficit of –11.8% in 1994 to a surplus of 0.9% in 1998
Devaluation preceded the crisis
Former European episodes (3) IRELAND SUÈDE
Previous Greek adjustment 1992-2002
What is the nature of Greek crisis?
Self-fulfilling debt crisis?
Debt service jumps from i*D/Q to (i+p)D/Q
What should Europe do? Set up a lender of first resort facility?
Thoughts on ratings agencies
They play a critical role, explaining government fears
What is their role?
Do they follow or anticipate market sentiments?
Two conflicting views
Procyclical: Kaminsky et Schmukler (2001); Ferri et Stiglitz (1999), Reisen et Malzan (1998)
‘ Neutral’, often late: Reinhart (2002), Gaillard (2009)
Spreads et notations: l’Uruguay 2002
Spreads and ratings: Brazil, 1998-99
Spreads and ratings: Greece
Spreads before and after « watch negative »
Spreads before and after a positive outlook annoucement