The Many Faces of Sovereign Default

In recent years we have witnessed a surge in sovereign bond defaults in emerging markets. This is unfortunate because when a country defaults, almost everyone loses (aside from restructuring advisory and law firms). Creditors lose for sure. So does the country’s citizenry, which has likely felt the ill effects of the slippery slope into default and then also the aftereffects, such as higher borrowing costs and, therefore, investment return hurdles.

At GMO, however, we evaluate everything as a potential opportunity. In this case, the unusually high default rate and resulting low bond prices present a terrific total return opportunity among defaulted and distressed emerging debt issues.

In the past five years, we count 13 instances of sovereign default in countries with an international bond market presence, a significant increase on the historical average default rate of about one per year. 1 When evaluating each sovereign default within our emerging debt investment process, we consider the path to default because different paths imply different likely outcomes. In Exhibit 1, we categorize recent defaults into three path-to-default groups: the “standard playbook” or traditional defaults, the “geopolitical and sanctions” group, and the “repeat defaulters.”


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The standard playbook default is the most, well…standard of the categories. These are countries that simply became addicted to fiscal deficits and debt financing. Interestingly, most of these countries had decent reputations in the markets and a strong willingness to pay. The story goes like this: over time, debt creeps higher and is increasingly used to finance current spending such as government wages and interest payments, rather than capital spending that might increase economic growth and, by extension, tax revenues to service the debt. Then, some shock comes along that fairly suddenly throws the country into the abyss of debt crisis. In all these cases, except for Barbados and possibly Lebanon, the shock this time was the combination of Covid-19 and Russia’s war in Ukraine.