That scary word "default"
Articles in the economic media are littered with the word "default," and the average reader without an economic background gets the impression that default - This is at least the local end of the world. There is a widespread desire to urgently exchange the dollars (euros, Mexican pesos or Mongolian tugriks) stashed away for something that will not be affected by this "terrible default. Let's find out what "default" really means.
There are enough defaults in the world
First of all, it should be noted that under the term "default" (Default) understand any waiver of debt obligations. In essence, default is a bankruptcy. However, in the financial world it has a narrower meaning and implies the state's renunciation of its debts. We will consider default in this particular perspective.
Let us draw a clear distinction between the concepts of "sovereign default" and "technical default. Sovereign default means the bankruptcy of the country, which led to the collapse of all economic sectors and, consequently, the inability to pay foreign and domestic debt obligations. Technical default - is the fulfillment by the state of part of its debt obligations beyond the framework of the agreements. In this case, the state remains solvent.
For clarity, here's a simple example from life. You work at a construction site. On payday, your boss tells you that there is no money and there won't be any pay. Options:
1) "No money, all stolen, save-help! Your company declares "sovereign default". Its obligations to you have not been met, and you go home with empty pockets. The company goes bankrupt because it refuses to pay you back.
2) Your company declares "technical default" and you receive two bags of cement instead of your salary. That is, the company has fulfilled some of its debt obligations to you, but has gone beyond the scope of the agreements. At the same time, the company remains solvent because of the huge amount of building materials.
Since the early 1970s, 75 countries have already declared bank default. Twelve countries defaulted on their national currencies. Default on domestic debt is declared less frequently than for external debt, because the state can repay internal debt by turning on the money machine. As for the foreign currency default 76 countries have declared, some of them more than once.
Default mechanism: a look inside
The main role in the emergence of credit problems is played by short-sighted policies of governments that willingly assume debts, but do not have the capacity to use them effectively.
The first step toward default is for the government of the borrowing country to gain comparatively easy access to global sources of financial resources: IMFThe IMF, the World Bank, the Paris Club and the largest banks in the developed world. For example, IMF management recommends that borrowers set a high interest rate on government bonds, which causes inflow of capital from investorslooking for profitable short-term investments. Huge sums of money start flowing into the borrower's economy, which has a short-term positive effect, giving confidence that the country is on the right track. As the harsh realities of life show, most of the loans may not even reach the economy - the meaning of the word "sawing", I think, does not need to be deciphered.
Sooner or later the time comes to pay back debts. As a rule, the state at its own expense can do it only partially and forced to raise money again through domestic and foreign marketswhich, with few exceptions, leads to an increase in public debt.
As long as the state's economy demonstrates a positive trend, being a real source of repayment of borrowed money, lenders continue lending money to the state without any problems. But as soon as there are the first signs of instability in the economy or political situation, the number of creditors decreases before our eyes, and the interest on debt obligations grows like a leapfrog. Bottom line, the default mechanism is already in place and its arrival is only a matter of time.
The state, of course, appeals to all kinds of financial institutions for help. Emergency external funding brings it only temporary salvation, while playing another important role. Large private capital gets an opportunity to leave the market of a troubled countryThe owner was enriched at the expense of huge profits on interest payments and the resale of debts. As the saying goes, "war is mother to some, and war is mother to others.
As a rule, the default epic is ended by the same financial sources that encouraged loans at the first stage. Sooner or later there comes a critical moment, when loans to the state are no longer available, even at the most fantastic interest rates. And since the country has no money to cover its debt, the the government is forced to declare default.
The declaration of default is followed by debt restructuring and partial debt forgiveness, which leads to major losses who bought debt at a high price and did not have time to get rid of it. The default cycle can be considered over.
It is worth noting that such default cycles can be repeated more than once. When lending to a state that has previously defaulted, creditors demand a risk premium in the form of higher interest rates on debt obligations. At the same time, the effectiveness of loans is reduced, since the reputation of the state in the global economic system has already been undermined by the previous default.
According to Joseph Stiglitz, American economist and Nobel Prize-winning economist, financial crises in developing countries are caused by erroneous policies of international financial institutions. "There is practically no doubt, - he wrote, - that the policies of the IMF and the U.S. Treasury have increased the probability of financial crises. And although this assessment seems overly critical, the development of economic globalization certainly does not help to reduce the likelihood of defaults.