Sovereign Debt Restructurings: Key Facts from History

GIC – Drexel University Sovereign Debt Restructuring Conference – 25 February 2022

Sovereign Debt Restructurings: Key Facts from History Elena Duggar, Chair of Moody's Macroeconomic Board, Managing Director, Chief Credit Officer – Americas

February 2022

Agenda

1

Global debt in 2022: Stabilizing default rates and debt-to-GDP ratios

2

Sovereign debt restructurings: Key facts from history

2

Key messages Global debt in 2022: Stabilizing default rates and debt-to-GDP ratios »

» »

»

1

Rapid debt accumulation is often followed by financial and debt crises and economic recessions But debt has both costs and benefits Looking into 2022, the economic recovery is leading to stabilization of debt ratios Sovereign and corporate default rates peaked in 2020, declined in 2021 and will remain low in 2022

Sovereign debt restructurings: Key facts from history

2

»

1. Local-currency sovereign defaults are almost as frequent as defaults on foreign-currency debt

»

2. Debt is not the only cause of sovereign defaults

»

3. Sovereign defaults occur alongside recessions, banking crises, currency crises and other severe shocks

»

4. Average historical recovery rate on sovereign bonds is about 50%

»

5. Average time to market re-access after sovereign default is over six years

»

6. Credit standing remains stressed for several years after default

»

7. Debt restructurings provide liquidity relief but often do not reduce debt levels

»

8. Sovereign bond restructurings have generally been resolved quickly, without severe creditor coordination problems

»

9. Sovereign debt exchanges experience very high levels of creditor participation

3

1

Global debt in 2022: Stabilizing default rates and debt-to-GDP ratios

Economic recovery bends debt-to-GDP ratios

Key Takeaways

Debt ratios will likely stabilize in 2022 as growth moderates

»

Global debt-to-GDP ratios peaked in Q1 2021 across all borrower categories and declined over 2021 as economic growth recovered.

»

For the first time in history, the government debt-to-GDP ratio is the highest among borrower categories, at 104.3% of GDP as of Q3 2021. The government debt-to-GDP ratio experienced the largest increase relative to pre-pandemic levels and in 2020 overtook the global corporate debt-to-GDP ratio.

»

We expect overall debt ratios to stabilize in 2022 as the economic rebound continues but at a slower pace.

Debt-to-GDP ratios climbed to record highs, but peaked in Q1 2021 as growth rebounded (Debt-to-GDP ratio (%) by borrower category) Household 120 110

Nonfinancial corporations

Bursting of the dot-com bubble

Government

Global financial crisis

Financial corporations

COVID-19 pandemic 104.3

Debt-to-GDP, %

100

97.9

90 80

82.8

70 60

65.0

40

Q1-99 Q3-99 Q1-00 Q3-00 Q1-01 Q3-01 Q1-02 Q3-02 Q1-03 Q3-03 Q1-04 Q3-04 Q1-05 Q3-05 Q1-06 Q3-06 Q1-07 Q3-07 Q1-08 Q3-08 Q1-09 Q3-09 Q1-10 Q3-10 Q1-11 Q3-11 Q1-12 Q3-12 Q1-13 Q3-13 Q1-14 Q3-14 Q1-15 Q3-15 Q1-16 Q3-16 Q1-17 Q3-17 Q1-18 Q3-18 Q1-19 Q3-19 Q1-20 Q3-20 Q1-21 Q3-21

50

For more detail, see: Debt after COVID – February 2022: Focus on corporate debt: Returning to pre-pandemic health, 16 February 2022 Sources: IIF and Moody’s Investors Service

5

Sovereign defaults peaked in 2020 and there were no new defaults in 2021

Key Takeaways »

The one-year sovereign bond default rate for issuers that we rate jumped to 4.2% in 2020, the highest level since 1983 and 5x higher than the average default rate between 1983 and 2020.

»

There were no new sovereign defaults in 2021 but a number of defaults are ongoing, including Venezuela (November 2017), Lebanon (March 2020), Suriname (July 2020) and Zambia (November 2020).

»

Additionally, debt restructurings for Chad (unrated), Ethiopia and Zambia are being negotiated under the G-20 Common Framework for Debt Treatments beyond the DSSI.

»

There were six defaults in 2020, including Argentina’s (February 2020 default on longterm debt, following the country’s 2019 default on short-term debt), Lebanon (March 2020), Ecuador (April 2020), Suriname (July 2020), Belize (August 2020) and Zambia (November 2020).

»

Our sovereign outlook for 2022 is stable as the economic recovery eases credit pressures.

Debt burdens will stabilize for most sovereigns, albeit significantly above pre-pandemic levels.

Moody’s-rated sovereign defaults leapt to a record high in 2020 Moody's rated sovereign bond defaults

Unrated sovereign bond and/or loan defaults

12

10

Number of sovereign ratings - RHS 160 140

8

6

4

100 80 60

Number of sovereign ratings

Number of defaults

120

40 2

0

20 0

For more details, see Sovereign – Global: Sovereign default and recovery rates, 1983-2020, April 2021 Source: Moody’s Investors Service

6

Global corporate default rate peaked in 2020, declined throughout 2021 and will remain below historical averages in 2022 »

The global speculative-grade corporate default rate peaked in December 2020 at 6.9%, significantly below its previous peaks of 13% during the global financial crisis, 10% at the time of the 2001 tech bubble bursting and 12% during the 1990 recession.

»

The global speculative-grade corporate default rate fell throughout 2021 and was 1.7% in December 2021. We expect it to rise to 2.4% by the end of 2022, but to remain below the 4.1% historical average, as economic growth remains robust while funding conditions tighten somewhat.

»

In a stress scenario of significantly weaker economic growth and sharp tightening in liquidity conditions, the default rate would rise sharply given that a large share of issuers with weak credit profiles have come to market in the last few years.

Global speculative-grade corporate default rate peaked in 2020 at half its 2009 high, and will remain low in 2022 16% 14% 12%

Banking crisis and oil price shock

12.4%

Bursting of the dot-com bubble

Global financial crisis

13.4%

COVID-19 pandemic

9.6%

10% 8%

6.9%

6% 4% 0%

Dec-83 Jun-84 Dec-84 Jun-85 Dec-85 Jun-86 Dec-86 Jun-87 Dec-87 Jun-88 Dec-88 Jun-89 Dec-89 Jun-90 Dec-90 Jun-91 Dec-91 Jun-92 Dec-92 Jun-93 Dec-93 Jun-94 Dec-94 Jun-95 Dec-95 Jun-96 Dec-96 Jun-97 Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Jun-18 Dec-18 Jun-19 Dec-19 Jun-20 Dec-20 Jun-21 Dec-21 22-Jun 22-Dec

2%

Trailing 12-month global default rate for speculative-grade corporates.

Source: Moody’s Investors Service

7

Rapid debt accumulation is often followed by financial and debt crises and economic recessions Global Financial Crisis

Asian Financial Crisis

1980s “Lost Decade”

Current Debt Wave

Drivers of debt build-up:

Drivers of debt build-up:

Drivers of debt build-up:

Drivers of debt build-up:

»

Low real interest rates in the 1970s

»

Financial and capital market liberalization

»

Regulatory easing

»

»

Rapidly growing syndicated loan market

»

Heavy foreign-currency borrowing by banks and corporations

»

Run-up in private sector borrowing in Europe and Central Asia from EU-headquartered large banks

Low real interest rates and search for yield by investors

»

Rise of regional banks, growing appetite for local currency bonds, increased demand for EM debt from nonbank financial sector

Consequences: »

»

Series of crises in Latin America and the Caribbean and in SubSaharan Africa Prolonged wave of debt restructurings, culminating in the Brady Plan in the late 1980s

Consequences:

Consequences:

»

Series of crises in the East Asia and Pacific region

»

»

Contagion to Europe and Central Asia region once investor sentiment turned unfavorable

The Global Financial Crisis disrupted bank financing in 200709

»

The end of the credit boom tipped several economies in Europe and Central Asia into recessions

1970-1989

1990-2001

2002-2009

Consequences: »

Current debt accumulation is larger, faster and broader

»

But macroeconomic and policy frameworks and financial sector supervision are stronger

2010-2021

Sources: Moody’s Investors Service and The World Bank, “Global Waves of Debt”, 2021

8

Will the benefits of debt accumulation outweigh the costs?

It will depend on how productively the debt is used, country characteristics and economic cycles, financial conditions and the extent of financial market development.

Costs of debt

Benefits of debt

Interest payments Cost of rolling over debt can increase sharply during periods of financial stress

Growth Finance growth-enhancing initiatives, such as investment in human and physical capital, infrastructure, technology and cyber resilience

Debt distress High debt or rapid debt accumulation can result in costly debt and financial crises

Development and social goals Finance health, development, poverty reduction and support the improvement of social outcomes

Constraints on policy space and effectiveness High debt can limit the ability of governments to provide fiscal stimulus during downturns

Backstop the economy during crises Provide space for countercyclical fiscal policy to support economic activity and labor markets during downturns

Crowding out of private sector investment High debt can weigh on investment and long-term growth

Climate adaptation Build climate resilience and finance sustainable development and climate change adaptation

9

2

Sovereign debt restructurings: Key facts from history

Fact 1: The frequency of local-currency sovereign defaults has increased relative to defaults on foreign-currency debt There is no systematic difference in recovery rates on local vs. foreign-currency bonds EM domestic bond markets have deepened rapidly and are now much larger than international bond markets in most countries Major EM - domestic bonds

Major EM - international bonds

Rest emerging bond markets

Share of joint local and foreign-currency defaults has risen dramatically (Sovereign defaults on local-currency (LC) and foreign-currency (FC) bonds, 1997-2021)

30

In progress 9%

(Trillion US$)

25

LC bonds only 22%

20 15

LC and FC 30%

10 5 FC bonds only 39%

0

1997-2021, sample size: 46

Sources: Bank for International Settlements, IIF and Moody’s Investors Service

For more details, see Sovereign Defaults Series: FAQ: The increasing incidence of local currency sovereign defaults, April 2019 Source: Moody’s Investors Service

11

Fact 2: Debt is not the only cause of sovereign defaults The causes of the 42 sovereign bond defaults from 1997 to July 2020 can be grouped into four categories

Chronic economic stagnation, a weak fiscal position and domestic vulnerabilities combined with large external shocks and loss of investor confidence have culminated in defaults Russia (1998), Ukraine (1998-2000), Argentina (2001), Grenada (2004, 2013), Venezuela (2017), Suriname (2020)

Sovereign defaults by four stylized causes

17%

36%

3. High debt burden Persistent external and fiscal imbalances built up to an unsustainably high debt burden. Slow buildup of debt and a deterioration in debt affordability have eventually resulted in defaults Pakistan (1999), Moldova (2002), Dominica (2003), Seychelles (2008), Jamaica (2010, 2013), St. Kitts and Nevis (2011), Greece (2012), Belize (2006, 2012, 2017), Barbados (2018), Lebanon (2020)

2. Institutional and political factors Civil conflict or institutional weaknesses, such as weak budget management, mismanagement of contingent liabilities and administrative delays, have caused defaults Mongolia (1997), Venezuela (1998), Turkey (1999), Côte d’Ivoire (2000, 2011), Cameroon (2004), St. Kitts and Nevis (2013), Argentina (2014, 2019), Ukraine (2015), Mozambique (2016, 2017), Republic of Congo (2017), Ecuador (2008, 2020)

4. Banking crisis

33%

14%

Institutional and political factors Banking crisis High debt burden Chronic economic stagnation

Systemic banking crises and capital outflows have contributed to large and sudden buildup of public debt and eventually triggered defaults Ecuador (1999), Uruguay (2003), Nicaragua (2003, 2008), Dominican Republic (2005), Cyprus (2013)

Evolution of debt ratios around default differs across the four categories of sovereign defaults Government debt as a share of GDP (t = year of default) 1. Chronic economic stagnation: Argentina (2001) 3. High debt burden: Jamaica (2010) 4. Banking crisis: Cyprus (2013) 2. Institutional and political factors: Ecuador (2008) 160 140 120 100 %

1. Chronic economic stagnation

80 60 40 20 0

t-5

t-4

t-3

t-2

t-1

t t+1 t+2 t+3 t+4 t+5 Year

Source: Moody’s Investors Service

12

Defaults resulting from institutional and political factors and high debt burdens have risen since 2010 » The share resulting from institutional and political factors and high debt burdens has risen » The average debt-to-GDP ratio for sovereign defaulters is 98% since 2010, compared with 71% in the 1997-2010 period » The more recent experience has also highlighted that public enterprises’ contingent liabilities can also trigger sovereign defaults

1997-2010

After 2010

10 9

9

8

8 7 6

6 Count

» The share of defaults caused by banking crises has fallen in the last decade

Institutional factors and high debt burdens remain main drivers of sovereign defaults, while the share of defaults caused by banking crises has fallen in the last decade

6 5

5 4 3

4 3

2 1

1 0

1. Chronic economic stagnation

2. Institutional and political factors

3. High debt burden

4. Banking crisis

For more details, see Sovereign Defaults Series: The causes of sovereign defaults, August 2020 Source: Moody’s Investors Service

13

Fact 3: Sovereign defaults occur alongside recessions, banking crises, currency crises and other severe shocks »

Recessions accompanied almost 90% of the 42 defaults during 1997-July 2020

»

Systemic banking and/or currency crises accompanied 55% of defaults

»

14 defaults occurred along with deposit freezes and/or moratoriums on external private-sector debt payments

»

Environmental, social and governance (ESG) factors played a significant role in at least 36% of defaults –

Natural disasters contributed to 21% of defaults, including a wave of defaults in the Caribbean region

–

Governance risks contributed to a number of defaults (e.g., administrative delays in Venezuela in 1998, materialization of public-sector contingent liabilities in Mozambique in 2016)

–

The coronavirus pandemic was a trigger in two defaults as of the end of July 2020, Ecuador and Suriname

Economic Recession (37 cases)

Systemic Banking Crisis (14 cases)

Currency Crisis (18 cases)

Sovereign Debt Crisis (42 cases)

ESG Risks (15 cases)

For more details, see Sovereign Defaults Series: The causes of sovereign defaults, August 2020 Source: Moody’s Investors Service

14

Elevated risk of default accompanies country break-ups Key takeaways

»

We survey the events in which countries have changed sovereignty during 1983-2014, including: –

36 new sovereigns emerging from 17 events

–

three country dissolutions (the Soviet Union, Yugoslavia and Czechoslovakia)

–

12 events of gaining independence or autonomy from foreign occupation, and

–

two country unifications

»

A default by either the former or the new sovereign accompanied 75% of country break-ups since 1983.

»

Regardless of the approach taken to the division of inherited sovereign debt, wars, hyperinflation, banking and currency crises, and dramatic economic contractions generally accompanied country dissolutions.

»

Regions that gained independence also faced elevated event risks, although economic contraction was not as severe as in country dissolutions. Half of independence cases were accompanied by military conflicts and one fourth each by banking crises, currency crises and high inflation.

»

50% of independence events were accompanied by sovereign defaults, mostly on the debt of the former sovereign.

Source: Moody’s Investors Service, Elevated Risk of Sovereign Default Accompanies Country Break-Ups, May 2014

15

Fact 4: Average historical recovery rate is about 50% Fact 5: Average time to market re-access is over 6 years

Key Takeaways »

The recovery rate on defaulted sovereign bonds averaged 53% over 1983-2020, as measured by trading prices around the time of default

»

Sovereign recovery rates have varied considerably, ranging from 17% to 95%

»

Some of the largest defaults garnered low recovery rates, including Russia 1998, Argentina 2001, Greece 2012 and Venezuela 2017

»

The average period of market exclusion was 6.1 years after default, and 4.9 years after default resolution between 1997 and 2020

»

Default resolution was relatively quick, at just over a year on average

»

Market exclusion was highly correlated with the losses experienced by investors

»

The period of market exclusion and financing costs depend on the external environment and creditors’ expectations for future policy, growth and debt sustainability

Market exclusion is highly correlated with the losses experienced by investors 90 Lebanon (20)

80

Russia (98) Greece (12)

Ecuador (20)

70

Venezuela (17)

Belize (20)

Loss (%)

Cyprus (13) Zambia (20)

40

Belize (12) Ecuador (99)

Argentina (20) 50

Ecuador (08)

Argentina (01)

Seychelles (08)

Grenada (13) 60

Cote d'Ivoire (00)

St. Kitts and Nevis (11)

Dominica (03)

Nicaragua (08)

Pakistan (99) Barbados (18)

Moldova (02)

Suriname (20)Grenada (04) Mozambique (17) Belize (17) Argentina (14) Ukraine (98-00) Uruguay (03)

30

Cote d'Ivoire (11) 20

Ukraine (15)

Republic of Congo

Jamaica (13) 10

Belize (06)

Defaults in 1990s Defaults in 2000s Defaults in 2010s No reaccess (to date)

Mozambique (16)

Jamaica (10) Dominican Rep. (05)

0

0

2

4

6 8 10 Time from default to re-access (years)

12

14

16

If no re-access, time is measured from default to date (April 2021). For more details, see Market Re-Access and Credit Standing After Sovereign Default, October 2013.

Source: Moody’s Investors Service

16

Fact 6: Credit standing remained stressed for several years after default » The median government bond rating, at Caa2 at the time of default, was at B3 five years after default » Low median rating post default reflects re-default risk and the length of time it takes to address the underlying problems that caused default. The rating post default reflects any material benefits from debt reduction, remaining credit challenges and economic, policy and debt trajectory expectations Average and median rating of sovereign issuers around default, 1983-2021 Ba1

Average rating

Median rating

Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 t-5

t-4

t-3

t-2

t-1

t

t+1

t+2

t+3

t+4

t+5

Years prior to and after default Source: Moody’s Investors Service

17

Sovereign ratings have proven effective in rank-ordering default risk, with less volatility than market signals Moody’s ratings have effectively rank-ordered default risk

Market-implied measures of sovereign credit risk are more volatile, and reverse more often than Moody’s ratings

Sovereign default rates, 1983-2020

35.4%

Average annual volatility statistics (as % of issuers, 1999-H1 2021) Moody’s ratings

Bond yield-implied ratings

Short-term horizon (1-year default rate) Long-term horizon (5-year default rate)

20%

RATING CHANGES

IG issuers have less than 1% default rate over both one- & five-year horizon

13.6%

SG default rates rise sharply moving down the rating scale

12.2%

LARGE RATING CHANGES

5.2%

0%

1%

0.5%

Aaa

Aa

A

Investment-grade (IG)

Baa

Ba

19%

81%

Experiencing one or more rating change

2%

Experiencing large rating changes (>2 notches)

25%

2.5% B

Caa-C

Speculative-grade (SG)

RATING REVERSALS

0.4%

81%

Experiencing rating reversal within 12 months

Source: Moody’s Investors Service

18

Fact 7: Sovereign debt restructurings provide liquidity relief but often do not reduce debt levels » The average sovereign exited default with debt-toGDP ratio only a few percentage points lower than before the restructuring

Sovereign restructurings reduce debt-servicing costs, but are rarely followed by a decrease in the stock of debt

» For about half of sovereigns, nominal debt levels actually rose in the aftermath of the debt exchange »

Most exchanges included maturity extension and interest reduction but no nominal haircut on the principal

»

Often, new borrowing took place during the debt crisis to support the economy and the banking system

» Debt restructurings could provide time for government policy to work but they do not obviate the need for fiscal adjustment, especially in an environment of sluggish growth Source: Moody’s Investors Service, Sovereign Debt Restructurings Provide Liquidity Relief But Often Do Not Reduce Debt Levels, November 2012

19

Fact 8: Sovereign bond restructurings have generally been resolved quickly, without severe creditor coordination problems » On average since 1997, sovereign bond restructurings closed about 7 months after the start of negotiations with creditors » For comparison, the average time to resolution in the 1980s was 7-8 years » Delays were related to the parallel restructuring of official sector and commercial loan debt, and civil conflict

Fact 9: Sovereign debt exchanges experience very high levels of creditor participation » A high level of participation in sovereign bond restructuring offers has been the typical outcome: creditor participation in sovereign bond restructurings averaged 95% » “Runs to the courthouse” have been the exception rather than the rule in sovereign debt crises: only 1 out of over 40 sovereign bond exchanges since 1997 resulted in persistent litigation (Argentina) » About a third of sovereign debt exchanges relied on using CACs or exit consents included in the bond contracts in order to include a larger share of creditors in the restructuring Source: Moody’s Investors Service, The Role of Holdout Creditors and CACs in Sovereign Debt Restructurings, April 2013

20

Moody’s related publications Sovereign methodology and outlook » Sovereigns – Global: Stable 2022 outlook as economic recovery eases credit pressures, but long-term costs of the pandemic weigh on sovereigns, November 2021 » Sovereign Ratings Methodology, November 2019 Debt after COVID series »

Debt after COVID – February 2022: Focus on corporate debt: Returning to pre-pandemic health, 16 February 2022

»

Debt after COVID – September 2021: EM bond markets continue to grow, as do vulnerabilities, 27 September 2021

»

Debt after COVID – June 2021: Focus on sovereign debt: Unequal debt realities, 7 June 2021

Sovereign defaults research – Topic page: www.moodys.com/sdr » Sovereign Debt Relief through COVID, February 2021 » Sovereign – Global: Sovereign default and recovery rates, 1983-2020, April 2021 » Sovereign crises lead to sharp spikes in emerging market corporate and sub-sovereign default rates, October 2020 » Sovereign Defaults Series: The causes of sovereign defaults, August 2020 » Sovereign defaults, deposit freezes and private-sector external debt moratoriums, May 2020 » Coronavirus - Global: FAQ on the credit implications of moratoriums on private-sector debt, April 2020 » Sovereign Defaults Series: FAQ: The increasing incidence of local currency sovereign defaults, April 2019 » Sovereign Defaults Series: The Aftermath of Sovereign Defaults, January 2014 21

Elena Duggar Chair of Moody’s Macroeconomic Board Managing Director, Chief Credit Officer - Americas Credit Strategy & Research elena.duggar@moodys.com +1.212.553.1911

Claire Li Assistant Vice President - Analyst Credit Strategy & Research claire.li@moodys.com +1.212.553.3780

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Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”).

Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.

MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any credit rating, agreed to pay to MJKK or MSFJ (as applicable) for credit ratings opinions and services rendered by it fees ranging from JPY125,000 to approximately JPY250,000,000.

MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY’S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or

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