Dallas Fed: Sovereign debt default is politically strategic
The ability to pay off sovereign debt levels has more to do with political will than financial constraints, according to a study by the Federal Reserve Bank of Dallas. The Dallas Fed looked at debt levels in Ireland, Italy, Portugal, Spain and the much-publicized struggles of Greece. In these five countries, debt levels have risen for several years, to about 115% of the gross domestic product (GDP) for Greece and Italy at the end of 2009. Portugal saw an increase to 77%, Ireland to 64%, and Spain saw its debt increase to 54% of GDP. Budget deficits have created widened shortfalls as well. Greece's deficit was 13.6% of GDP at the end of 2009, 14.3% in Ireland, 11.2% in Spain, 9.4% in Portugal, and 5.3% in Italy. "Looking at the excessive debt levels and budget deficits, it seems intuitive to link debt size to the likelihood that a government will be able to repay: At some point, increasing debt must exceed the resources available for repayment. However, the link isn’t entirely clear," according to Ananth Ramanarayanan, senior research economist at the Dallas Fed and author of the report. Ramanarayanan wrote that sovereign debt bankruptcy is very different from an individual's or even company's. In those cases, the ability to pay a debt is based on weighing debts against assets. But there is no framework on the international level that governs such debt. "Therefore, a government will repay its debt only if it faces negative consequences for defaulting. Those costs include the possibility that a government will be unable to borrow in the future. Argentina, for example, defaulted in 2001 and still hasn’t fully regained access to international financial markets," according to the report. Ramanarayanan suggests the proper response then in cases of debt crisis, such as the Greece situation, policies such as subsidized loans will make governments feel richer and more willing to pay debt service than face the costs of default. "More generally, policy measures aimed at preventing sovereign default ultimately need to raise incentives to repay debt, either by making the payment of debt less costly or by raising default costs," according to the report. Write to Jon Prior.