The sovereign debt crisis

Debt has become a matter of concern for markets due to its rapid increase in Western countries. In 2010-2011, the sovereign debt crisis led the European Union to establish a system to protect the eurozone. Despite early signs of recovery, the size of the debt still remains a risk factor for many countries in the West.

What is sovereign debt?

This term refers to debt issued by a sovereign or generally speaking a national government. Sovereign debt may be in the form of bonds issued by a country's public treasury, credit from banks or government institutions or loans from other governments or supranational institutions. The securities involved may be traded on markets.

Why do we talk about a "sovereign debt crisis"?

Since the beginning of the financial crisis, some European countries have experienced a marked increase in their public debt, primarily due to higher spending intended to support their economy or bail out their banking systems.

Increased sovereign debt loads

  • Greece: 175% of GDP in 2013 (compared to 103% in 2007)

  • Spain: 92% of GDP (nearly tripled since 2007)

  • Italy: 128% of GDP (compared to 100% in 2007)

  • Ireland: 123% of GDP (a fivefold increase since 2007)

  • Portugal: 128% of GDP (doubled since 2007)

  • United States: 105% of GDP (compared to 64% in 2007)

  • France: 92% of GDP (compared to 64% in 2007)

From the Greek crisis to the European Stability Mechanism

In Europe, the debt crisis exploded in 2010 when Greece's public debt and deficit disrupted markets. This panic was worsened by speculation on the part of some investors, who bet that the Greek government would default on its payments. Markets started to demand that Greece pay interest rates for refinancing that were too high for its economy to bear. The risk was that Greece would default, the eurozone would splinter and the financial catastrophe would spread to other countries in the eurozone’s periphery (Greece, Italy, Ireland, Portugal and Spain). 

In May 2010, European countries and the IMF refinanced Greece's debt in exchange for a drastic budget austerity plan. Eurozone governments and the European Central Bank then quickly drew up mechanisms to lead sovereign debt markets to behave less erratically. Aid plans were created for each of the troubled countries. These actions helped create stable conditions so that necessary structural reforms, some of them very harsh, could be initiated in the affected countries.

Nonetheless, in March 2012 debt owed to the private sector was restructured with substantial losses for investors, resulting in the first sovereign default in the eurozone.

Can a government fail to pay its debts?

The Greek episode is far from the first. Sovereign defaults had already taken place in recent memory, such as Argentina in 2002 and Russia in 1998. However, it should be noted that unlike corporate debt restructuring, there is no mechanism for national governments to declare bankruptcy, which complicates the restructuring of sovereign debts.