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Varying consequences of sovereign debt defaults - Outside View by S.S. TARAPORE
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Varying consequences of sovereign debt defaults
Jul 13, 2015

Greece's sovereign debt is around US $355 billion or about 275 per cent of GDP. Greece defaulted on its sovereign debt on June 30, 2015 and the referendum in the country rejected austerity. The rejection of the creditors' conditions signals that Greece has openly defied the creditors. Yet there is a perception that Greece is being treated with velvet gloves as there are fears of a Domino effect of similar defaults by Italy, Portugal and Spain. Thus, some patchwork solution could emerge. High sovereign indebtedness seems to be the flavour of the season, with countries like the UK, the USA and Germany, all having unprecedented high sovereign debt-GDP ratios. The pertinent question is whether the global economy is hurtling towards a cliff from which there is no return.

What normally happens in a default

When a country openly defies creditors, the traditional approach is for a hardening of positions by creditors. Defaults have taken place in a large number of countries. To illustrate just a few, there were defaults by Zaire (1979), Zambia (1983), Sudan (1991), Kenya (2000), Nigeria (2004) and Zimbabwe (2006); furthermore, some of these countries had more than one default. For some of these countries, a harsh regime was set out. Countries in the doghouse are harshly told, for instance, that all receipts would be put into an Escrow Account from which 80 per cent would go to repay creditors and only 20 per cent would be available for the country's own use.

But much depends on which country is in default. A country like Greece is unlikely to face very harsh treatment. Being strategically placed in the Euro Zone, after some sabre-rattling by both creditors and Greece, it would not be surprising if some sort solution of via media is worked out which could be labelled as a soft solution.

The position of India

India is presently in a very strong position, with one of the lowest debt-GDP ratios (see The Reserve Bank of India Financial Stability Report No 11, June 25, 2015 page 3). Given India's low position in the preference order in the firmament of the comity of nations, India would be well advised to strictly avoid any form of brinkmanship where it would allow its debt-GDP ratio to rise to critical levels and make India vulnerable.

India's past experience in dealing with creditors has not been altogether pleasant, barring some creditors who went out of their way to help India. When India faced a critical balance of payments crisis in 1990-91, India was required to physically ship out gold to get emergency credit, despite India being one of the gold depositors designated by the International Monetary Fund (IMF). Again, while India had undertaken significant adjustment and the international community was convinced that India was on the path of speedy recovery, how was India treated? This is a saga which today's policymakers in India, as also creditor countries, should take note of. Under the IMF programme, there were very tough credit ceilings which we had fully complied with and this was recognised by creditors. As part of the IMF conditionality, India was required to maintain a minimum level of net international reserves. A bulk payment was to be made on March 31, and a bulk receipt was to come in on April 1, 1992.Our request for one day's adjustment by a creditor country was denied by the creditor country which, otherwise, was very favourably inclined towards India. Notwithstanding this, the creditor country warned that it would make public that India had defaulted. In the upshot, India met its payment on March 31, 1992, though we had to pay a very heavy price for overnight money.

Lessons for India

We, in India, have learnt the lessons of 1981-82 and 1990-92 the hard way and we should never get ourselves into a corner where creditors freely offer funds which, if taken, becomes the harbinger for being held to ransom by the international community. To India's credit, at the present time, we have built up adequate buffers and our external debt to GDP ratio is one of the lowest and our conservative management of the external sector has served us well.

Global lessons

It is essential that all borrowers keep a strict control on the extent of borrowing and that, countries do not undertake excessive borrowing which they do not have the capacity to repay. Per contra, creditor countries should ensure that they do not provide easy finance to countries which do not have the capacity to repay. Invariably, creditors are only too keen, while the going is good, to cajole countries to increase their borrowing and then rue when repayments do not come in as scheduled. Thus, avoidance of defaults requires appropriate action not only by borrowers but also by lenders.

Bigger problems on the horizon

While all eyes are on Greece, there is a rapid buildup of a problem in China. China is witnessing a slowdown in growth-a classical case of over-investment during the upswing of the cycle, resulting in a downturn. One hopes that the US $ 2.8 trillion (24-30 per cent) drop in Chinese stock market capitalization in a matter of three weeks is a short-term aberration which would be quickly reversed. If the sharp downtrend in the Chinese stock market accelerates, it could engulf the global economy in a storm of unprecedented intensity.

Caution for India

With the global uncertainties and possibilities of a contagion effect, aggressive assertions by key policymakers regarding aspirations for a 10 per cent growth need to be moderated. Shrill noises for lower interest rates need to be dampened. The possibility of the global economy being engulfed in turmoil warrants that Indian policymakers flash the amber lights.

Please Note: This article was first published in The Freepress Journal on July 13, 2015. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.


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