The effect of political factors on sovereign default

ABSTRACT

This aricle examines the effect of political factors on sovereign default. Using a theoretical model, we find that political instability increases the likelihood of default. To test this theoretical implication, we use a panel logit model to estimate the effect of long- and short-run political factors, along with other macroeconomic variables, on the probability of default. Data from 68 developed and developing countries between 1970 and 2010 is used to conduct the study. Our findings suggest that a country is more likely to default when (i) it has a relatively younger political regime in place; (ii) it faces a higher chance of political turnover; and (iii) it has a less democratic political system. Economic factors are also vital; a country with stronger growth and less external debt is less likely to experience sovereign default. Robustness tests using alternative measures of political risk, trade balance and EMBI sovereign bond spreads also support the baseline findings.

KEYWORDS:

• Sovereign default
• political factor
• uncertainty
• sovereign debt crisis
• policy design

JEL CODES:

• D7
• E6
• F5
• H6
• P4

Acknowledgement

I sincerely thank Jianjun Miao and Marianne Baxter for their guidance on this work, and two anonymous referees for valuable feedback. I am also grateful for the help I received from Ying Chen and Xin Yan in data collection. All errors are mine.

Disclosure Statement

No potential conflict of interest was reported by the author.

Notes

1 Hatchondo and Martinez (2010) discuss the politics of sovereign default in detail. They argue that political turnover causes sovereign default risk to increase dramatically; in contrast, a more stable political system reduces the likelihood of default.

2 An Argentinian vessel was seized in October 2012 by debtors from the 2001 default. See http://www.reuters.com/article/2012/10/24/ghana-argentina-ship-idUSL5E8LOHSL20121024.

3 EMBI spread is defined as the difference between sovereign-bond yields in emerging markets and the US Treasury bill rate.

4 See surveys by Alesina and Perotti (1995), Drazen (2000) and Gartner (2000).

5 See Drazen (2000, Chapter 14) for proof and explanation.

6 Take derivative of the first-order condition with respect of b and evaluate at b* obtains

7 Benjamin and Wright (2009) estimate the default rate across countries to be 4.4 percent for the period 1989–2006. Yue (2010) reports that Argentina’s average default rate since 1824 is 2.7 percent. Korner (2015) also finds that the sovereign default probability implied from credit default swap spreads on average is 3.3 percent per year.

8 See Rosendorff and Shin (2015) and Goertz and Mahoney (2012) for reviews.

9 See the description of the project at http://www.systemicpeace.org/inscrdata.html.

10 The scale is as follows: (1) no executive, (2) unelected executive, (3) elected, one candidate, (4) one party elected, multiple candidates, (5) only one party won seats, multiple parties are legal but did not exist, compete or win seats, (6) multiple parties compete and won seats, but one party won 75 percent or more of seats, and (7) multiple parties compete and won seats, but largest party won less than 75 percent of seats.

11 The countries included are: Argentina, Brazil, Chile, China, Columbia, Cote D’Ivoire, Dominican Republic, Ecuador, Egypt, El Salvador, Ghana, Hungary, Indonesia, Malaysia, Mexico, Nigeria, Panama, Peru, Philippines, Poland, Russia, South Africa, Turkey, Uruguay and Venezuela.