Convergence in Sovereign Debt Defaults: Quantifying the Roles of Institutions
| Published date | 01 June 2021 |
| Author | Mita Bhattacharya,John Inekwe |
| Date | 01 June 2021 |
| DOI | http://doi.org/10.1111/obes.12411 |
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©2021 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 83, 3 (2021) 0305–9049
doi: 10.1111/obes.12411
Convergence in Sovereign Debt Defaults:Quantifying
the Roles of Institutions
Mita Bhattacharya† and John Inekwe‡
†Department of Economics, Monash University, Clayton, VIC 3145,Australia (e-mail:
Mita.Bhattacharya@monash.edu)
‡Centre for Financial Risk, Macquarie University, Macquarie Park, NSW 2109,Australia
(e-mail: nkwnischa@yahoo.com)
Abstract
In this study, using an ex ante measure, we examine the convergence patterns in sovereign
defaults among 101 developing countries for the period from 1990 to 2015. We employ the
club convergence algorithm to determine convergence paths across countries and examine
the role of institutions in shaping the observed convergence patterns. The merging of
clubs reveals three distinct convergentsub-clubs. Countries in each of these sub-clubs tend
to exhibit a similar pattern of long-run convergence in cases of sovereign debt default.
Countries with better institutions are less likely to belong to a club with greater risks of
sovereign defaults by 7% points. Unlike trade openness, levels of external debt, inflation
and current account balance increase the probability of default in these economies.
Highlight
•We explore the determinants of the observed patterns in sovereign debt defaults.
•We use a test for convergence to select heterogeneous countries for club membership.
•We identify factors that define the observed convergent groups.
•Under better institutions, the probability of belonging to a club of defaulters is reduced.
I. Introduction
Identifying the causes of sovereign debt defaults is a growing area of research in the
empirical and theoretical finance.1Studies predicting the probability of default in the debt
obligations of a sovereign state are voluminous. In most cases, the literature relates to
periods of financial crisis, with studies covering a wide range of countries. In analysing the
global financial crisis in the US context, Reinhart and Rogoff (2008) conclude that, ‘while
each financial crisis no doubt is distinct, they also share striking similarities in the run-up
of asset prices, in debt accumulation, in growth patterns, and in current account deficits’
JEL Classification numbers: E02; E32; F02.
1Sovereign default denotes the inability of the government of a sovereign state to fulfil its debt obligations.
Developing countries and Sovereign debts793
(p. 342). Kalemli- ¨
Ozcan, Reinhart and Rogoff (2016) provide a comprehensive review of
the literature. Along with macro-economic variables,the authors consider the role of public
and private sector debt, as well as the political processes involved in balancing fiscal and
financial distress.
Recent research on sovereign defaults has been drivenby the phenomenal accumulation
of external debt by sovereign states – a paramount issue in the international financial arena
because of an increasing likelihood of default in debt repayment obligations, including in-
flating accumulated arrears. The relevance of this issue can be seen in the recent concerns
of policy advisers, and it is becoming more and more relevantnot only for developing coun-
tries but also for developed countries. Many countries engage in public spending in order
to stimulate economic recovery. The concern here is the risk involved in over-borrowing,
which can be mitigated by incorporating responsible debt management mechanisms. In
these situations, as argued by the International Monetary Fund (IMF), transparency and
responsive lending are critical.
Taking into account the impact of sovereign defaults on efforts to foster economic
stability and strong international relations, this study contributes to current knowledge by
examining the convergencepatterns in sovereign defaults among developing countries. The
choice of developing countries is relevant, since most of these countries find it difficult to
service their debt. Also, the dependence of this cohort of countries on similar sources of
sovereign debt relief means that the debt motion law of one country may directly affect or
have implications for other similar countries. Uncertainty in lender countries may affect
economic outcomes in these developing economies. Thus, global financial interdepen-
dence necessitates the examination of debt behaviour among these developing economies.
Understanding the long-term evolution of debt in these economies becomes essential for
designing appropriate debt management strategies.
Wecontribute to the existing literature in four ways. First, we focus on developingcoun-
tries specifically.While some studies on sovereign default convergence do exist (see, e.g.
Ehrmann et al., 2011; Apergis and Cooray, 2014;Antonakakis et al., 2017), the literature
on analysing the convergence path for developing countries remains limited. This research
gap is partly due to the absence of appropriate debt data, given that information about
default swaps and sovereignbond yields is almost non-existent for pur poses of meaningful
economic analysis.2We focus on the convergence of sovereign default risk because of the
relevance of contagion in this domain, due to financial integration and liberalization. As
defined in the literature, contagion depicts a significant increase in co-movements across
countries (conditional on a crisis in one of them) that cannot be explained by the countries’
economic fundamentals taken alone (Masson, 1998).
Second, we contribute to the literature by employing an ex ante measure of sovereign
default. More specifically, we employ the ratio of accumulated arrears to external debt as
the proxy for sovereign default.This technique has been used in Chakrabarti and Zeaiter
(2014) to capture an ex ante measure of default on external debt, given that the occurrence
of IMF upper credit-tranche drawings or debt payment rescheduling is a consequence of
2Although not directly related to sovereigndebt in par ticular, a fewstudies do consider the convergence of capital
flows and equity markets within the EU region resulting from the emergence of the Economic and Monetary Unit
(EMU) (see, e.g. Coeurdacier and Martin, 2009; Fratzscher and Stracca, 2009; Hale and Obstfeld, 2016).
©2021 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd
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