Definition and Measurement of Sovereign Risk Need to be Broadened, IMF Roundtable Concludes

Press Release No. 11/91
March 18, 2011

The traditional definition of sovereign risk (broadly, the probability that a country may not pay its debts) has been shown to be too narrow by the global financial crisis. Developments since mid-2008 have exposed very complex interactions between fiscal balances, public and private debt, and the financial sector.

The International Monetary Fund (IMF) held a high-level conference in Washington today to discuss the new, multifaceted and more nuanced dynamic of sovereign risk and its implications for financial stability. The event, Financial Crises and Sovereign Risk—Implications for Financial Stability, brought together policymakers and regulators from developing and emerging countries, academics, representatives from global banks, and senior Fund staff, at IMF headquarters.

“Sovereign risks have been transformed in a number of important ways as a direct consequence of the crisis and major fault lines in the financial sector. As the public sector intervened to support financial institutions, distinctions between sovereign and non-sovereign and private liabilities have been blurred, and public exposure to private risks has increased,” IMF Managing Director Dominique Strauss-Kahn said in his opening remarks.

The global crisis has seen unprecedented government support to the real economy and the financial sector. The combined effects of these interventions and the loss in revenues caused by economic slowdown have resulted in worsening fiscal balances, increased public debt, and a general deterioration in countries’ public finances. Substantial and sustained efforts to restore soundness to public balance sheets are necessary. The size, maturity structure, composition, and ownership of public debt have been altered. Investors’ risk aversion has grown and concerns of contagion among the sovereign, quasi-sovereign, and financial sectors remain at elevated levels.

In this highly uncertain context, the conventional measurements have become too limited and unable to explain the present elevated levels of sovereign risk in some countries, creating an urgent need for proper identification, measurement, and management.

“A wider definition of sovereign risk is warranted, one where core fiscal variables and the macroeconomic context are complemented with elements reflecting broader balance sheet developments, debt portfolio structure, investor base, cross-border linkages, and financial assets of a country,” Mr. Strauss-Kahn said.

The Roundtable discussed three broad areas, exploring different dimensions of sovereign risk in the context of the current financial crisis: spillovers between sovereign risk and banking sector stability; sovereign risk and its outlook for issuers and debt capital markets; and sovereign risk and its impact on ongoing financial regulatory reforms.

In closing, José Viñals, IMF Financial Counselor and Director of Monetary and Capital Markets Department, said: “The emphasis put by the panelists on issues such as the interconnectedness between sovereigns and banks, regulation and its impact on financial risk, the need for joint and credible sovereign-bank stress testing, debt issuance strategies, and the role of the central banks in mitigating liquidity versus credit risk have clearly demonstrated the need for us to look at sovereign risk in a much broader context of issues and vulnerabilities than we have done so far.”

The Roundtable offered an important opportunity to advance the policymaking community’s understanding of sovereign risk and its wider implications for markets, and provided potential avenues for the Fund’s work on financial stability and capital market issues.

Visit the conference’s webpage to see the full program and read background documents: http://www.imf.org/external/np/seminars/eng/2011/hlcfin/index.htm



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