Vox
November 24, 2011Why do governments repay external borrowing? This column argues that myopic governments seeking popularity do not default when they are poor because they would lose access to debt markets and be forced to reduce spending. And they do not default when rich because of the adverse consequences to the domestic financial sector. This explains why governments continue servicing debt when default is beneficial for the country.
Why do governments repay external sovereign borrowing? Models where countries service their external debt for fear of being excluded from capital markets for a sustained period (or some other form of harsh punishment such as trade sanctions or invasion) seem very persuasive, yet are at odds with the fact that defaulters seem to be able to return to borrowing in international capital markets after a short while. With sovereign debt in industrial countries at extremely high levels, understanding why sovereigns repay foreign creditors, and what their debt capacity might be, is an important concern for policymakers and investors around the world.
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