Debt crisis

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Debt crisis is a situation in which a government (nation, state/province, county, or city etc.) loses the ability of paying back its governmental debt. When the expenditures of a government are more than its tax revenues for a prolonged period, the government may enter into a debt crisis. Various forms of governments finance their expenditures primarily by raising money through taxation. When tax revenues are insufficient, the government can make up the difference by issuing debt. [1]

Contents

Public debt as a percent of GDP, evolution for USA, Japan and the main EU economies. Dept.svg
Public debt as a percent of GDP, evolution for USA, Japan and the main EU economies.
Public debt as a percent of GDP by CIA (2012) Public debt percent gdp world map.PNG
Public debt as a percent of GDP by CIA (2012)

A debt crisis can also refer to a general term for a proliferation of massive public debt relative to tax revenues, especially in reference to Latin American countries during the 1980s, the United States and the European Union since the mid-2000s, and the Chinese debt crises of 2015. [2] [3] [4] [5] [6]

Debt wall

Hitting the debt wall is a dire financial situation that can occur when a nation depends on foreign debt and/or investment to subsidize their budget and then commercial deficits stop being the recipient of foreign capital flows. The lack of foreign capital flows reduces the demand for the local currency. The increased supply of currency coupled with an decreased demand then causes a significant devaluation of the currency. This hurts the industrial base of the country since it can no longer afford to buy those imported supplies needed for production. Further, any obligations in foreign currency are now significantly more expensive to service both for the government and businesses.

Current and recent debt crises

Europe

European debt crisis

The European debt crisis is a crisis affecting several eurozone countries since the end of 2009. [7] [8] Member states affected by this crisis were unable to repay their government debt or to bail out indebted financial institutions without the assistance of third-parties (namely the International Monetary Fund, European Commission, and the European Central Bank).[ citation needed ] The causes of the crisis included high-risk lending and borrowing practices, burst real estate bubbles, and hefty deficit spending. [9] As a result, investors have reduced their exposure to European investment products, and the value of the Euro has decreased. [10]

Sovereign CDS showing a temporary loss of confidence in creditworthiness of certain EU countries. The left axis is in basis points; a level of 1,000 means it costs $1 million to protect $10 million of debt for five years. Sovereign credit default swaps.png
Sovereign CDS showing a temporary loss of confidence in creditworthiness of certain EU countries. The left axis is in basis points; a level of 1,000 means it costs $1 million to protect $10 million of debt for five years.

In 2007 the global financial crisis began with a crisis in the subprime mortgage market in the United States, and developed into a full-blown international banking crisis with the collapse of the investment bank Lehman Brothers on 15 September 2008. [11] The crisis was nonetheless followed by a global economic downturn, the Great Recession. The European debt crisis, a crisis in the banking system of the European countries using the euro, followed later.

In sovereign debt markets of PIIGS (Portugal, Ireland, Italy, Greece, Spain) created unprecedented funding pressure that spread to the national banks of the euro-zone countries and the European Central Bank (ECB) in 2010. The PIIGS announced strong fiscal reforms and austerity measures, but toward the end of the year, the euro once again suffered from stress. [12]

Causes

The eurozone crisis resulted from the structural problem of the eurozone and a combination of complex factors, including the globalisation of finance, easy credit conditions during the 2002–2008 period that encouraged high-risk lending and borrowing practices, the financial crisis of 2007–08, international trade imbalances, real estate bubbles that have since burst; the Great Recession of 2008–2012, fiscal policy choices related to government revenues and expenses, and approaches used by states to bail out troubled banking industries and private bondholders, assuming private debt burdens or socializing losses.

In 1992, members of the European Union signed the Maastricht Treaty, under which they pledged to limit their deficit spending and debt levels. However, in the early 2000s, some EU member states were failing to stay within the confines of the Maastricht criteria and turned to securitising future government revenues to reduce their debts and/or deficits, sidestepping best practice and ignoring international standards. [13] This allowed the sovereigns to mask their deficit and debt levels through a combination of techniques, including inconsistent accounting, off-balance-sheet transactions, and the use of complex currency and credit derivatives structures. [13]

From late 2009 on, after Greece's newly elected, PASOK government stopped masking its true indebtedness and budget deficit, fears of sovereign defaults in certain European states developed in the public, and the government debt of several states was downgraded. The crisis subsequently spread to Ireland and Portugal, while raising concerns about Italy, Spain, and the European banking system, and more fundamental imbalances within the eurozone. [14]

Other European debt crises

Greek debt crisis

Timeline of Greek debt crisis

2009 December - One of the world's three leading rating agencies downgrades Greece's credit rating amid fears the government could default on its ballooning debt. PM Papandrou announces programme of tough public spending cuts.

2010 January–March - Two more rounds of tough austerity measures are announced by government, and government faces mass protests and strikes. [15]

2010 April–May - The deficit was estimated that up to 70% of Greek government bonds were held by foreign investors, primarily banks. [16] After publication of GDP data which showed an intermittent period of recession starting in 2007, [17] credit rating agencies then downgraded Greek bonds to junk status in late April 2010. On 1 May 2010, the Greek government announced a series of austerity measures. [18]

100,000 people protest against the austerity measures in front of parliament building in Athens (29 May 2011). 2011 Greece Uprising.jpg
100,000 people protest against the austerity measures in front of parliament building in Athens (29 May 2011).

2011 July – November - The debt crisis deepens. All three main credit ratings agencies cut Greece's to a level associated with substantial risk of default. In November 2011, Greece faced with a storm of criticism over his referendum plan, Mr Papandreou withdraws it and then announces his resignation. [15]

Protests in Athens on 25 May 2011 Syntagma Square 'indignados'.png
Protests in Athens on 25 May 2011

2012 February - December - The second bailout programme was ratified in February 2012. A total of €240 billion was to be transferred in regular tranches through December 2014. The recession worsened and the government continued to dither over bailout program implementation. In December 2012 the Troika provided Greece with more debt relief, while the IMF extended an extra €8.2bn of loans to be transferred from January 2015 to March 2016.

2014 - In 2014 the outlook for the Greek economy was optimistic. The government predicted a structural surplus in 2014, [19] opening access to the private lending market to the extent that its entire financing gap for 2014 was covered via private bond sales. [20]

2015 June – July - The Greek parliament approved the referendum with no interim bailout agreement. Many Greeks continued to withdraw cash from their accounts fearing that capital controls would soon be invoked. On 13 July, after 17 hours of negotiations, Eurozone leaders reached a provisional agreement on a third bailout programme, substantially the same as their June proposal. Many financial analysts, including the largest private holder of Greek debt, private equity firm manager, Paul Kazarian, found issue with its findings, citing it as a distortion of net debt position. [21] [22]

2017 - The Greek finance ministry reported that the government's debt load is now €226.36 billion after increasing by €2.65 billion in the previous quarter. [23] In June 2017, news reports indicated that the "crushing debt burden" had not been alleviated and that Greece was at the risk of defaulting on some payments. [24]

2018 - Greek successfully exited (as declared) the bailouts on 20 August 2018. [25]

Greek debt restructuring

It stands out in the history of sovereign defaults. Greek debt restructuring of 2012 achieved very large debt relief – with minimal financial disruption, using a combination of new legal techniques, exceptionally large cash incentives, and official sector pressure on key creditors. But it did so at a cost. The timing and design of the restructuring left money on the table from the perspective of Greece, set precedents and created a large risk for taxpayer – particularly in its very generous treatment of holdout creditors – that are likely to make future debt restructurings in Europe more difficult. [26]

Effects

To take considerations that the most characteristic feature of the Greek social landscape in the current crisis is the steep rise in joblessness. The unemployment rate had fluctuated around the 10 per cent mark in the first half of the previous decade. It then began to fall until May 2008, when unemployment figures reached their lowest level for over a decade (325,000 workers or 6.6 per cent of the labour force). While job losses involved an unusually high number of workers, loss of earnings for those still in employment was also significant. Average real gross earnings for employees have lost more ground since the onset of the crisis than they gained in the nine years before that. [27]

In February 2012, it was reported that 20,000 Greeks had been made homeless during the preceding year, and that 20 per cent of shops in the historic city centre of Athens were empty. [28]

Latin America

Argentine debt crisis

Background

Argentina's turbulent economic history: Argentina has a history of chronic economic, monetary and political problems. Economic reforms of the 1990s. In 1989, Carlos Menem became president. After some fumbling, he adopted a free-market approach that reduced the burden of government by privatizing, deregulating, cutting some tax rates, and reforming the state. The centerpiece of Menem's policies was the Convertibility Law, which took effect on 1 April 1991. Argentina's reforms were faster and deeper than any country of the time outside the former communist bloc. Real GDP grew more than 10 percent a year in 1991 and 1992, before slowing to a more normal rate of slightly below 6 percent in 1993 and 1994. [29]

The 1998–2002 Argentine great depression was an economic depression in Argentina, which began in the third quarter of 1998 and lasted until the second quarter of 2002. [29] [30] [31] [32] [33] [34] It almost immediately followed the 1974–1990 Great Depression after a brief period of rapid economic growth. [33]

Effects

Depositors protest the freezing of their accounts, mostly in dollars. They were converted to pesos at less than half their new value. Buenos Aires - Manifestacion contra el Corralito - 20020206-17.JPG
Depositors protest the freezing of their accounts, mostly in dollars. They were converted to pesos at less than half their new value.

Several thousand homeless and jobless Argentines found work as cartoneros , cardboard collectors. An estimate in 2003 had 30,000 to 40,000 people scavenging the streets for cardboard to sell to recycling plants. Such desperate measures were common because of the unemployment rate, nearly 25%. [35]

Argentine agricultural products were rejected in some international markets for fear that they might have been damaged by the chaos. The US Department of Agriculture put restrictions on Argentine food and drug exports. [33]

Debt restructuring history

President Nestor Kirchner and Economy Minister Roberto Lavagna, who presented the first debt restructuring offer in 2005 Nestor Kirchner y Roberto Lavagna-Buenos Aires-23 de agosto de 2004.jpg
President Néstor Kirchner and Economy Minister Roberto Lavagna, who presented the first debt restructuring offer in 2005

2005 Venezuela was one of the largest single investors in Argentine bonds following these developments, which bought a total of more than $5 billion in restructured Argentine bonds from 2005 to 2007. [36] Between 2001 and 2006, Venezuela was the largest single buyer of Argentina's debt. In 2005 and 2006, Banco Occidental de Descuento and Fondo Común, owned by Venezuelan bankers Victor Vargas Irausquin and Victor Gill Ramirez respectively, bought most of Argentina's outstanding bonds and resold them on to the market. [37] The banks bought $100 million worth of Argentine bonds and resold the bonds for a profit of approximately $17 million. [38] People who criticize Vargas have said that he made a $1 billion "backroom deal" with swaps of Argentine bonds as a sign of his friendship with Chavez. [39] The Financial Times interviewed financial analysts in the United States who said that the banks profited from the resale of the bonds; the Venezuelan government did not profit. [38]

Bondholders who had accepted the 2005 swap (three out of four did so) saw the value of their bonds rise 90% by 2012, and these continued to rise strongly during 2013. [40]

2010 On 15 April 2010, the debt exchange was re-opened to bondholders who rejected the 2005 swap; 67% of these latter accepted the swap, leaving 7% as holdouts. [41] Holdouts continued to put pressure on the government by attempting to seize Argentine assets abroad, [42] and by suing to attach future Argentine payments on restructured debt to receive better treatment than cooperating creditors. [43] [44] [45]

The government reached an agreement in 2005 by which 76% of the defaulted bonds were exchanged for other bonds at a nominal value of 25 to 35% of the original and at longer terms. A second debt restructuring in 2010 brought the percentage of bonds out of default to 93%, but some creditors have still not been paid. [46] [47] Foreign currency denominated debt thus fell as a percentage of GDP from 150% in 2003 to 8.3% in 2013. [48]

U.S. interventions

The U.S. foreign policy known as the Roosevelt Corollary asserted that the United States would intervene on behalf of European countries to avoid those countries intervening militarily to press their interests, including repayment of debts. This policy was used to justify interventions in the early 1900s in Venezuela, Cuba, Nicaragua, Haiti, and the Dominican Republic (1916–1924).

North America

Public debt as a percent of GDP by IMF (2024) .mw-parser-output .legend{page-break-inside:avoid;break-inside:avoid-column}.mw-parser-output .legend-color{display:inline-block;min-width:1.25em;height:1.25em;line-height:1.25;margin:1px 0;text-align:center;border:1px solid black;background-color:transparent;color:black}.mw-parser-output .legend-text{} >100% >75-100% >50-75% >25-50% 0-25% no data Government debt in percent of GDP IMF.svg
Public debt as a percent of GDP by IMF (2024)
  >100%
  >75–100%
  >50–75%
  >25–50%
  0–25%
  no data

On 19 January 2023, the United States again reached the debt ceiling. [49] In February 2024, the total federal government debt grew to $34.4 trillion after having grown by approximately $1 trillion in both of two separate 100-day periods since the previous June. [50]

Sub-Saharan Africa

Sub-Saharan Africa has a long history of external debt, beginning in the 1980s when the public finances of many countries sharply declined following several external shocks. This led to a “lost decade” of low economic growth, increased poverty, food insecurity and socio-political instability. However, the implementation of debt relief under the Heavily Indebted Poor Countries (HIPC) initiative [51] and the supplementary Multilateral Debt Relief Initiative (MDRI) [52] wiped out most of Sub-Saharan Africa’s external debts. These debt relief initiatives substantially reduced nominal public debt to sustainable levels, bringing it from a GDP-weighted average of 104 percent before their implementation to nearly 30 percent during the period from 2006 to 2011. [53] According to World Bank data, the Sub-Saharan African governments' foreign debt tripled between 2009 and 2022. [54] According to IMF (2024), 7 African countries are in debt distress (Republic of the Congo, Ghana, Malawi, Sudan, São Tomé & Príncipe, Zambia and Zimbabwe), and 13 more are at risk of becoming debt distressed. [55] Unlike previous debt crises, the current one is characterised by a shift from multilateral to commercial and bilateral creditors, notably China, and the proliferation of Eurobonds, aggravating debt conditions. Pressured by heavy debt burdens, there is a risk that African governments divert funds from essential sectors such as education, health care and agriculture, causing a vicious cycle of stalled development, food insecurity and an elevated risk of socio-political instability. [53]

See also

Further reading

Related Research Articles

<span class="mw-page-title-main">Holdout problem</span> Economic issue of securities

In finance, a holdout problem occurs when a bond issuer is in default or nears default, and launches an exchange offer in an attempt to restructure debt held by existing bond holders. Such exchange offers typically require the consent of holders of some minimum portion of the total outstanding debt, often in excess of 90%, because, unless the terms of the bond provide otherwise, non-consenting bondholders will retain their legal right to demand repayment of their bonds at par. Bondholders who withhold their consent and retain their right to seek the full repayment of original bonds, may disrupt the restructuring process, creating a situation known as the holdout problem.

<span class="mw-page-title-main">Government debt</span> Total amount of debt owed to lenders by a government/state

A country's gross government debt is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit occurs when a government's expenditures exceed revenues. Government debt may be owed to domestic residents, as well as to foreign residents. If owed to foreign residents, that quantity is included in the country's external debt.

<span class="mw-page-title-main">Argentine debt restructuring</span> Process following Argentinas Great Depression

The Argentine debt restructuring is a process of debt restructuring by Argentina that began on January 14, 2005, and allowed it to resume payment on 76% of the US$82 billion in sovereign bonds that defaulted in 2001 at the depth of the worst economic crisis in the nation's history. A second debt restructuring in 2010 brought the percentage of bonds under some form of repayment to 93%, though ongoing disputes with holdouts remained. Bondholders who participated in the restructuring settled for repayments of around 30% of face value and deferred payment terms, as well as warrants that paid investors based on annual economic growth as part of the same offer, and began to be paid punctually; the value of their nearly worthless bonds also began to rise. The remaining 7% of bondholders were later repaid 25% less than they were demanding, after centre-right and US-aligned leader Mauricio Macri came to power in 2015.

A sovereign default is the failure or refusal of the government of a sovereign state to pay back its debt in full when due. Cessation of due payments may either be accompanied by that government's formal declaration that it will not pay its debts (repudiation), or it may be unannounced. A credit rating agency will take into account in its gradings capital, interest, extraneous and procedural defaults, and failures to abide by the terms of bonds or other debt instruments.

<span class="mw-page-title-main">European debt crisis</span> Multi-year debt crisis in multiple EU countries since late 2009

The European debt crisis, often also referred to as the eurozone crisis or the European sovereign debt crisis, was a multi-year debt crisis that took place in the European Union (EU) from 2009 until the mid to late 2010s. Several eurozone member states were unable to repay or refinance their government debt or to bail out over-indebted banks under their national supervision without the assistance of other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).

<span class="mw-page-title-main">Greek government-debt crisis</span> Sovereign debt crisis faced by Greece (2009–2018)

Greece faced a sovereign debt crisis in the aftermath of the 2007–2008 financial crisis. Widely known in the country as The Crisis, it reached the populace as a series of sudden reforms and austerity measures that led to impoverishment and loss of income and property, as well as a humanitarian crisis. In all, the Greek economy suffered the longest recession of any advanced mixed economy to date and became the first developed country whose stock market was downgraded to that of an emerging market in 2013. As a result, the Greek political system was upended, social exclusion increased, and hundreds of thousands of well-educated Greeks left the country.

<span class="mw-page-title-main">European Financial Stability Facility</span>

The European Financial Stability Facility (EFSF) is a special purpose vehicle financed by members of the eurozone to address the European sovereign-debt crisis. It was agreed by the Council of the European Union on 9 May 2010, with the objective of preserving financial stability in Europe by providing financial assistance to eurozone states in economic difficulty. The Facility's headquarters are in Luxembourg City, as are those of the European Stability Mechanism. Treasury management services and administrative support are provided to the Facility by the European Investment Bank through a service level contract. Since the establishment of the European Stability Mechanism, the activities of the EFSF are carried out by the ESM.

<span class="mw-page-title-main">2000s European sovereign debt crisis timeline</span>

From late 2009, fears of a sovereign debt crisis in some European states developed, with the situation becoming particularly tense in early 2010. Greece was most acutely affected, but fellow Eurozone members Cyprus, Ireland, Italy, Portugal, and Spain were also significantly affected. In the EU, especially in countries where sovereign debt has increased sharply due to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany.

<span class="mw-page-title-main">Private sector involvement</span> Cut in the value of private sectors holdings of debt

In the context of sovereign debt crisis, private sector involvement (PSI) refers, broadly speaking, to the forced contribution of private sector creditors to a financial crisis resolution process, and, specifically, to the private sector incurring outright reductions ("haircuts") on the value of its debt holdings.

The 2010–2014 Portuguese financial crisis was part of the wider downturn of the Portuguese economy that started in 2001 and possibly ended between 2016 and 2017. The period from 2010 to 2014 was probably the hardest and more challenging part of the entire economic crisis; this period includes the 2011–14 international bailout to Portugal and was marked by intense austerity policies, more intense than the wider 2001-2017 crisis. Economic growth stalled in Portugal between 2001 and 2002, and following years of internal economic crisis, the worldwide Great Recession started to hit Portugal in 2008 and eventually led to the country being unable to repay or refinance its government debt without the assistance of third parties. To prevent an insolvency situation in the debt crisis, Portugal applied in April 2011 for bail-out programs and drew a cumulated €78 billion from the IMF, the EFSM, and the EFSF. Portugal exited the bailout in May 2014, the same year that positive economic growth re-appeared following three years of recession. The government achieved a 2.1% budget deficit in 2016 and in 2017 the economy grew 2.7%.

<span class="mw-page-title-main">Causes of the European debt crisis</span>

The European debt crisis, often also referred to as the eurozone crisis or the European sovereign debt crisis, was a multi-year debt crisis that took place in the European Union (EU) from 2009 until the mid to late 2010s that made it difficult or impossible for some countries in the euro area to repay or refinance their government debt without the assistance of third parties.

<span class="mw-page-title-main">Policy reactions to the eurozone crisis</span> Political response to an economic event

The European debt crisis, often also referred to as the eurozone crisis or the European sovereign debt crisis, was a multi-year debt crisis that took place in the European Union (EU) from 2009 until the mid to late 2010s. Several eurozone member states were unable to repay or refinance their government debt or to bail out over-indebted banks under their national supervision without the assistance of other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).

<span class="mw-page-title-main">Economic reforms and recovery proposals regarding the eurozone crisis</span>

The eurozone crisis, also known as the European sovereign-debt crisis, was a financial crisis that made it difficult or impossible for some countries in the euro area to repay or re-finance their government debt.

<span class="mw-page-title-main">Greek government-debt crisis timeline</span>

The Greek government-debt crisis began in 2009 and, as of November 2017, was still ongoing. During this period, many changes had occurred in Greece. The income of many Greeks has declined, levels of unemployment have increased, elections and resignations of politicians have altered the country's political landscape radically, the Greek parliament has passed many austerity bills, and protests have become common sights throughout the country.

The Second Economic Adjustment Programme for Greece, usually referred to as the second bailout package or the second memorandum, is a memorandum of understanding on financial assistance to the Hellenic Republic in order to cope with the Greek government-debt crisis.

The Third Economic Adjustment Programme for Greece, usually referred to as the third bailout package or the third memorandum, is a memorandum of understanding on financial assistance to the Hellenic Republic in order to cope with the Greek government-debt crisis.

The Economic Adjustment Programme for Cyprus, usually referred to as the Bailout programme, is a memorandum of understanding on financial assistance to the Republic of Cyprus in order to cope with the 2012–13 Cypriot financial crisis.

<span class="mw-page-title-main">Greylock Capital Management</span>

Greylock Capital Management, LLC is a U.S. Securities and Exchange Commission registered alternative investment adviser that invests globally in high yield, undervalued, and distressed assets worldwide, particularly in emerging and frontier markets. The firm was founded in 2004 by Hans Humes from a portfolio of emerging market assets managed by Humes while at Van Eck Global. AJ Mediratta joined the firm in 2008 from Bear Stearns and serves as its president.

The Intervention of ECB in the Eurozone Crisis were the interventions made between 2009 and 2010 by the European Central Bank (ECB) during the European debt crisis. In 2009–2010, due to substantial public and private sector debt, and "the intimate sovereign-bank linkages" the eurozone crisis impacted the periphery countries in Europe. This resulted in significant financial sector instability in Europe; banks' solvency risks grew, which had direct implications for their funding liquidity.

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  50. ↑ Fox, Michelle (1 March 2024). "The U.S. national debt is rising by $1 trillion about every 100 days". CNBC.
  51. ↑ "Debt Relief Under the Heavily Indebted Poor Countries Initiative". IMF. Retrieved 28 June 2024.
  52. ↑ "Multilateral Debt Relief Initiative - Questions and Answers". www.imf.org. Retrieved 28 June 2024.
  53. 1 2 "The debt trap dilemma of African governments - The Nordic Africa Institute". nai.uu.se. Retrieved 28 June 2024.
  54. ↑ "IDS Online Tables_Standard_Region". datatopics.worldbank.org. Retrieved 28 June 2024.
  55. ↑ "List of LIC DSAs for PRGT-Eligible Countries - As of October 31, 2024" (PDF). imf.org.
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