Must-know: Will a sovereign default impact your investment?

Market Realist

Must-know: Argentina defaults for the second time in 13 years (Part 2 of 5)

(Continued from Part 1)

Will a sovereign default impact your investment?

A government that defaults is generally excluded from further credit. Governments also usually face a seizure of their overseas assets in lieu of the debt that wasn’t paid back. In addition, governments often start facing political pressure from its own domestic bondholders to pay back local currency debt.

For this reason, governments rarely default on the entire value of their debt. Instead, they often enter into negotiations with their bondholders to agree on a delay or partial reduction of their debt payments. Such negotiation of debt value or debt terms is called debt restructuring or a haircut.

What has led to sovereign defaults in the past?

Past instances of sovereign defaults have happened due to one or more of the following reasons:

  • A reversal of global capital flows
  • Unwise lending
  • Fraudulent lending
  • Excessive foreign debts
  • A poor credit history
  • Unproductive lending
  • Rollover risk
  • Weak revenues
  • Rising interest rates
  • Terminal debt

How a sovereign default could impact your investment?

A significant factor in sovereign default is the presence of significant debt owed to foreign investors. Since most sovereign defaults end in partial debt cancellation or debt restructuring, bond-holders are left with no option but to accept a loss on their investments. Such renunciations can go up to 75% of the outstanding obligations.

Implications of a default for the country

The immediate effect of a default and subsequent debt restructuring for a country is the reduction of its total debt and a reduction in its interest payments on that debt. On the other hand, a default also damages the reputation of the country among investors, which restricts the ability of the country to raise any further debt from the capital market.

With a clear understanding of sovereign defaults and their implications to the investing community, let’s now move on to understanding what led Argentina to associate with vulture funds in U.S. The next part of this series offers you a quick look at the situation in Argentina. We’ll then move on to analyze Argentina’s current default situation. Argentina, a country that has attracted international brand companies in the past like Coca-Cola’s (KO) bottler Embotelladora Andina (AKO.A), Ralph Lauren (RL), and Louis Vuitton SA (LVMUY) as private consumption accounted for about two-thirds of the economy, has defaulted on its international debt obligations. U.S. investors with exchange-traded funds (or ETFs) like the Global X FTSE Argentina 20 ETF (ARGT) in their portfolio may want to reassess their holdings.

Continue to Part 3

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