Recent Research

Abstract

This paper focuses on the debt recovery channel linking the dynamics of public debt to partial sovereign defaults. We build a simple model which incorporates sovereign default and a debt recovery rule. It depends on a parameter that allows for partial debt recovery. We show that the maximum debt-to-GDP ratio that a country can sustain without defaulting is increasing, nonlinear, and sensitive to the debt-recovery parameter. A higher debt recovery parameter increases the fiscal space but worsens the financial position of a borrowing country after a default episode. We show the empirical relevance of this channel for estimating country-specific fiscal spaces.

Keywords: Public debt; Sovereign default; Recovery rate; Debt sustainability.
JEL classification: E600, F400, H630.

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Abstract

We offer a new methodology for the assessment of public debt sustainability in a stochastic economy when sovereign default taken into account. The default threshold differs from the no- Ponzi condition and depends on the post-default debt recovery rule. We distinguish sustainability and unsustainability conditions, related to alternative scenarios on the future sequence of shocks. We highlight the role of the debt recovery ratio on the whole dynamics of public debt. When a sovereign default occurs, the sustainability of the post-default debt is ensured when the haircut is sufficiently large. Lastly we provide an explanation of serial defaults.

Keywords: Public debt; Sovereign default; Recovery rate; Debt sustainability.
JEL classification: E600, F400, H630.

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