What is a Sovereign Default?

Mary McMahon
Mary McMahon

Sovereign default is a default on debt by a national government or nation-state. It is relatively rare, and when it occurs, it can create complex legal and financial problems. Since bankruptcy law does not operate on an international level, it can be difficult to seek legal penalties for a sovereign default, and assessment of future credit risks once a nation has defaulted is somewhat more difficult than evaluating risks for commercial and consumer debt.

Man climbing a rope
Man climbing a rope

Nations usually try to avoid defaulting on debt in any way possible. Sovereign default most commonly occurs because a country has taken on a large debt burden and experiences a financial crisis like a radical devaluation in currency, making it impossible to repay the debt. Nations facing default may attempt to renegotiate the loan, seeking an adjustment to the interest rate or forgiveness of part of the principal. Sometimes other nations may intervene and provide new loans with better terms to repay the debt, or offer forgiveness and grants to assist nations in default.

Creditors involved in a sovereign default can include other governments, international financial institutions like the World Bank, and investors who purchased bonds issued by the government. Government bonds are widely regarded as a very sound investment, on the basis that sovereign default is extremely rare, and investor outcry during a default can be substantial as people are angered by the loss of investments they thought were secure.

When a nation appears to be at risk of default, it is common for the nation to turn to neighbors and fellow members of political organizations for assistance with management of the debt. European Union members, for example, might call on the European Union for a bailout on the grounds that their default could have a ripple effect across the economy, harming other member nations of the EU. In these situations, the terms set by nations involved in the bailout can vary.

For citizens of a country undergoing sovereign default, hardships often increase. Nations may radically cut social service programs in an attempt to balance their budgets and people paid in a rapidly devalued currency may not be able to leave the country or access services because their savings have no value. Trade relations are typically interrupted and the security of the food supply may be threatened. People can also have difficulty accessing consumer goods along with necessities like medications, as other companies in countries may be reluctant to do business with companies in their home nation.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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