Defaulting Differently: The Political Economy of Sovereign Debt Restructuring Negotiations

Abstract

Negotiations to restructure sovereign debt are protracted affairs, and their outcomes, known as “haircuts,” range from 0 to 80 percent creditor losses. Haircuts impact states’ ability to borrow, cost of borrowing, and economic recovery; they also redistribute income—between states and creditors and between domestic interest groups. I conceptualize the interaction between governments and private creditors as a bargaining game where the government’s will to repay is private information. Creditors can make inferences about repayment based on the government’s political economy, but distributional signals are muddled when there are multiple veto players. Where additional uncertainty persists, governments can issue a public declaration of default, triggering costs in international financial markets. This costly signal separates governments that are willing to repay from those that are not and extorts greater concessions as a result. Using data on haircuts and public default declarations in market-based restructurings from 1980 to 2009, I find that governments are more likely to engage in costly signaling when they face heightened domestic constraints. When governments issue public declarations, they are subsequently rewarded with higher haircuts. Defaults do not all look the same, and the economic consequences are varied.