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Safety in numbers for sovereign defaulters

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The shock — and stigma — of defaulting will shrink, the more borrowers do it

As the list of defaulting emerging market sovereigns grows, more will take encouragement to follow.

A cost of living crisis is hitting the poorest in the world the hardest. Many emerging market countries are struggling as inflation has soared post-Covid and as a side effect of the Ukraine war.

Politicians are having to make tough choices. One of those choices is whether they conserve precious dollars for spending on food and fuel for their country or use them to honour debts to Eurobond investors. When sovereigns default, it is largely not because they do not have the money but because they have made a choice over whether servicing debt is the best use of limited cash in the longer term.

Sri Lanka this week finally made the decision that a default was its best choice. Others are on the brink of it. Tunisia seems to be getting close. In the case of Ukraine, analysts have said a default is almost inevitable, and even desirable, with the money spent instead on fighting off Russian invaders.

Russia, meanwhile, is in its grace period for Eurobond payments so far missed, having earlier this month declined to use its unfrozen assets to pay its bills to creditors. This is the tip of the iceberg.

The World Bank said in a recent blog post that it expects a dozen or so countries to go into default in the next year. Investors have been telling GlobalCapital that it is a risk for any non-oil producing emerging market country this year.

As more and more countries default, it will become less punitive for others to do so. Credit investors say that countries are punished later for not honouring their debts, with investors demanding much higher premiums when they do eventually return to the market. That could be the case, but there will also be some safety in numbers for these issuers — down the line this will be thought of as an exceptional year and funds need to put their cash somewhere.

A global EM sovereign debt haircut is coming. But what might start looking like a full shearing will appear to be barely a trim by the time by the umpteenth iteration. In a twist on the old maxim, when you owe the bank a dollar, it's your problem. When you owe the bank a million dollars, it's the bank's problem. And when everyone owes the bank a million dollars, it really is the bank's problem.

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