HOLA!

Sovereign Debt Crisis

 Sovereignty

• It is the quality of having supreme,

independent authority over a territory.

• It can be found in a power to rule and make

law that rests on a political fact for which no
purely legal explanation can be provided.
 Government Debt
• Government debt (also known as public debt, national debt)is money (or
credit) owed by any level of government; either central government, federal
government, municipal government or local government.

• Debt of a sovereign government is called sovereign debt.

• Government debt can be categorized as

Internal debt (owed to lenders within the country)

External debt (owed to foreign lenders)

• Governments usually borrow by issuing securities, government bonds and bills.

• Less creditworthy countries sometimes borrow directly from supranational

institutions.
 Risk free

• Government bonds are theoretically risk-free

bonds

• Governments can, up to a point, raise taxes,

reduce spending, or simply print more money
to redeem the bond at maturity.
 Really?
• Sovereign Risk

• It is the probability that the government of a country

(or an agency backed by the government) will refuse to
comply with the terms of a loan agreement during
economically difficult or politically volatile times.

• Although sovereign nations don't "go broke," they can

assert their independence in any manner they choose,
and cannot be sued without their assent.
 Risk
• In practice, the market interest rate tends to be
different for debts of different countries.
Example: Borrowing by different Eurozone countries

• A politically unstable state is anything but risk-free as it

may, being sovereign, cease its payments

Spain in the 16th and 17th centuries nullified its

government debt 7 times during a century

Revolutionary Russia of 1917 refused to accept the

responsibility for Imperial Russia's foreign debt
 Sovereign Debt Rating
• Assessment of the international rating
agencies on the likelihood that a particular
country will default on its loans.
 Forms it can take
• Outright default – domestic or external debt
Eg: Russia, Spain, Ecuador

• Unable to rollover debt (investor’s unwillingness)

• Debt Restructuring
Eg: Pakistan (1999), Ukraine (2000), Uruguay (2003)

• Bailout (solvent but illiquid)

Eg: Mexico (1994-95), Korea/Thailand (1997-1998)
Peru Debt Crisis
 Peru Debt Crisis
• In 1980’s the living standard of Peruvian
people was unbearable due to TWO reasons -

• ??
• ??
 Reasons
1. Unmanageable Debts
2. Hyper inflation
 Administration of PERU before the
80’s Crisis

In 1960’s there exist two GOVERNMENTS –

• One was of General Alvarado

• Other was of Belaunde – he implements a

Liberal Model of Economy.
Phases that led to Crisis
Export led economy of Belaunde

Administration took over by

Alvarado

De – privatized many IMPORT SUBSITUTE

aspects of economy INDUSTRALIZATION

Led to heavy More DEBT than

BORROWING before
 Phases that led to Crisis : continued
Oil Crisis of 1973 Topped
Inflation began in Peru Agricultural
the economic problem
industry Failed

In 1980 , Increased
Privatize 2/3 th
Belaunde took government
of the economy
over Alvarado spending has led
to more Debts

Money comes to Suddenly Peru

Belaunde policies suffered with the
the Elite People
were on the edge NATURAL
not to the poor
to work BUT ???? DISASTERS LIKE
people
earthquakes in
1983
Phases that led to Crisis : continued

Major exports, Per capita GDP

was reduced When Peru took
potatoes &
from $2,569 the money from
sugar got
to$2.443 IMF ?
devastated

In 1985, Peru
Popularity of inflation become
GUERILLA group and increased RISKEST for
weak economy further further investors
led to inflation
In 1991, after the
FUGIMORI government,
the condition become
little stable
Argentine Debt Crisis
 Argentina Debt Crisis

• Argentina's current economic crisis coming for a

long time, with economy worsened during current
government's two years in power.

• The country has been in recession for four years .

• Situation is deteriorating fearing, it could default on its

£90bn public debt and the currency may need to be
devalued.
 Timeline
• 1916 - Hipolito Yrigoyen of the Radical party is
elected president. He introduces a minimum wage to
counter the effects of inflation

• 1939 - Outbreak of World War II. Argentina proclaims

its neutrality.

• From 1939 to 1998 ,there exist a lot of political

instability in Argentina (change in power)
 Recession Bites . .
• 1999 - Fernando de la Rua of the centre-left Alianza
opposition coalition wins the presidency, inherits 114
billion-dollar public debt.

• 2000 - Strikes and fuel tax protests

• Beef exports slump after an outbreak of foot-

and-mouth disease

• The IMF grants Argentina an aid package of

nearly 40 billion dollars.
• 2001 July - Much of the country is brought to a
standstill by a general strike in protest against
proposed government spending cuts

• Return of the Peronists

• 2001 October - The opposition Peronists take

control of both houses of parliament in
Congressional elections.
• Within days the government devalues the peso, ending
10 years of parity with the US dollar

• Banking and foreign exchange activity suspended

• 2002 November - Argentina defaults on an $800m

debt repayment to the World Bank, having failed to re-
secure IMF aid. The World Bank says it will not consider
new loans for the country

• 2003 September - After weeks of negotiations Argentina

and IMF agree on debt-refinancing deal
• 2003 September - After weeks of negotiations
Argentina and IMF agree on debt-refinancing
deal under which Argentina will only pay interest
on its loans.

• 2005 March - President Kirchner declares the

restructuring of the country's debt to be a
success

• 2006 January - Argentina repays its multi-billion-

dollar debt to the IMF.
Dubai Debt Crisis
 The Country

• UAE consists of seven states (emirates)

• Abu Dhabi, Dubai, Sharajah, Ajman, Ummal -

Quwain, Rasal – Khaimah and Fujairah
 Dubai World
• Vice President and Prime Minister of UAE and ruler of
Dubai - Sheikh Md bin Rashid Al Maktoum, holds the
majority stake in the company

• An investment company that manages and supervises a

portfolio of businesses for the Dubai government

• Promotes Dubai as a hub for commerce and trading

• It is Emirate’s flag bearer in global investment

• Plays a central role in the direction of Dubai economy.

 Assets of Dubai World
• Dubai Ports World • Tejari
• Jafza • Limitless
• Nakheel • Leisurecorp
• Dubai Drydox • Istihmar
• Maritime City • Island Global Yachting
• Dubai Multi • Inchcape Shipping
Commodities Services
• Centre
 What Happened . .
• Dubai let its whole economy to rest on a single
sector i.e. real estate sector.

• The property bubble which was created during

2005-2007, went bust because of the financial
crisis that engulfed almost the entire world.

• Dubai fell victim even with massive levels of

government involvement in its real estate sector.
 What Happened . .

• By 2009, Dubai had debts amounting to $80 bn of which

Dubai World’s share was a staggering $59 bn.
 What Happened . .

• The Dubai Government announced that the company

would delay all maturing payments to May 2010.

• This raised risk of the largest government default since the

Argentine debt restructuring of 2001.

• Moody’s and S&P immediately heavily downgraded the

debt of various government related entities.

• Major stock exchange reacted immediately. Banking stocks

led the tumble.
 What Happened . .
• On Dec 1, officials in UAE intervened by bringing
to notice that Dubai World was seeking to
negotiate only the$26 bn in obligations held by
Nakheel (its troubled real estate developer)

• On Dec 14, Islamic bonds of Nakheel amounting

to $4.1 bn were maturing

• On the same day Dubai Govt received $10 bn in

surprise aid from Abu Dhabi for debt laden Dubai
World.
 What Happened . .

• On May 2010, Dubai World had drawn an agreement

with most of its lender banks to restructure debts
worth $23.5 bn.
European Financial Crisis
 Story begins
EUROPEAN UNIFICATION -

January 1,1999 - Introduction of the euro as the

official currency in eleven countries.
 Conditions for entering into Eurozone
• Euro convergence criteria (also known as the
Maastricht treaty)

• Main criteria to enter the Eurozone (European

community treaty)

Inflation rates

Government finance

Exchange rate

Long term interest rates

• The purpose of setting the criteria is to maintain the

price stability within the Eurozone even with the
inclusion of new member states.
 Maastricht Treaty
• Inflation rates: No more than 1.5% higher than the
average of the three best performing (lowest inflation)
member states of the EU.

• Government finance:

Annual government deficit: Annual government deficit to

GDP must be less than 3% at the end of the preceding
fiscal year.

Government debt: Gross government debt to GDP must

be less than 60% at the end of the preceding fiscal year.
 Maastricht Treaty
• Exchange rate: should have joined ERM and
should not have devalued its currency for 2
consecutive years.

• Long-term interest rates: Long-term interest

rate must not be more than 2% higher than in
the three lowest inflation member states.
 Regulators of Eurozone

• European Central Bank (ECB)

• European commission
 ECB Powers
• The definition and implementation of monetary policy for
the euro area.

• The conduct of foreign exchange operations.

• The holding and management of the official foreign

reserves of the euro area countries (portfolio
management).

• The promotion of the smooth operation of payment

systems.

• The ECB has the exclusive right to authorise the issuance of

banknotes within the euro area.
 As of Jan 1999
1. Austria 7. Italy

2. Finland 8. LUXEMBOURG

3. Belgium 9. NETHERLAND

4. France 10. PORTUGAL

5. Germany 11. SPAIN

6. Ireland
 By 2008
12. Greece -2000

13. Slovenia-2006

14. Cyprus-2007

15. Malta-2007

16. Slovekia - 2008

 Countries affected:
• PORTUGAL

• IRELAND

• ITALY

• GREECE

• SPAIN
 Default by stealth
• If a country has its own currency, it can print it
according to its gold deposits and as per the
prevailing needs of the economy.

• But as Greece was a part of the European Union,

it could not print current as per its whims.

• This led to cascading of its debts as it could never

print enough currency to meet its obligations.
WHY GREECE?
The Miniscule Greece...
 So what if Greece defaults…?
• Bank Runs
• ‘Sudden-stop’ to capital Inflows
• Firms and Banks in ‘sibling’ countries- Capital
market access.
• The Europe Inter – Bank Market
• The rest is history…
Even Spiderman won’t find the way out …
 The current (unsustainable) debt
levels!
• So, when did it start?
• Before joining Eurozone.
• Post joining Eurozone.
• Impact of Global Recession.
 New government, New Deficits…
• Change of government : George Papandreou

• New deficit figures, from 6 % to 12.7 % to GDP.

• Accumulated government debt is forecasted

at 120 % by 2010.
 The ratings fell! ! !
• Who are Rating agencies?

• Why do we need them?

• How do they measure sovereign risk?

 Determinants of Sovereign rating

• Per capita income : GNP per capita

• GDP growth : Average annual real GDP growth
on a year-over-year basis
• Inflation: Average annual consumer price
inflation rate
• Fiscal balance : Average annual central
government budget surplus relative to GDP
 Determinants of Sovereign rating

• External balance: Average annual current

account surplus relative to GDP
• Indicator for economic development: IMF
classification as an industrialized
• Indicator for default history : Default on
foreign currency debt
Judging the Judges…
 Total Debt Levels

466 %
71 %
259 % 286 %
322 %
158 %
296 %
471 %
366 % 315 %

129 %

144 %
 Goldman Sachs
• How does it makes money ?

• The CEO says that they are ‘Doing God’s

Work’

• Is it really only an Investment Bank?

 Role of Goldman Sachs!
• Facilitating Currency swaps

• Arranging ‘emergency’ credit

• And (of course) betting against Greece.

Role of Speculators
 Role of Speculators

• Betting against the

Euro.

• Credit default swaps

on Greek debt
The timeline of Greek Crisis
 IMF and EU Rescue package
• European Financial Stability Facility
• Euro 440 billion from 27 Euro area member
states
• Additional Euro 60 billion by EC.
• And Up to Euro 250 billion by the IMF.
 IMF: an unwarranted favor
• IMF resources raised for low and middle
income countries
• Greece’s problem is European
• The IMF was created to deal only with balance
of payments problems.
• Disciplining Greece
• Interest subsidy
 Greek Domestic policy Response
• Stability and Growth Programme

• Fiscal Austerity:
• Target to cut deficit from an estimated 13.6% of GDP
in 2009 to below 3% by 2012.
• Hiked taxes on fuel, tobacco and alcohol, raised the
retirement age by two years, imposed public sector
pay cuts and applied tough new tax evasion
regulations.
 Greek Domestic policy Response
• Structural Reforms
• Wide-ranging reforms to the pension and health care
systems and to Greece’s public administration.
• Announced measures to boost Greek economic
competitiveness by enhancing employment and
economic growth, fostering increased private sector
development, and supporting research, technology,
and innovation.
 Broader Implications of Greece’s
Crisis
• Contagion

• Complex Financial Instruments and Financial

Regulation

• European Integration

• The impact on Euro.

 What is the way out?
• Stagflation

• Default

• Inflation

• OR GROWTH
THANK YOU ! ! !