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

IMF News, March 18, 2011

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Canonical URL: Press Release: Definition and Measurement of Sovereign Risk Need to be Broadened, IMF Roundtable Concludes

Press Release No. 11/91
Date: March 18, 2011
Event: High-level conference "Financial Crises and Sovereign Risk—Implications for Financial Stability" held at IMF headquarters in Washington.
Participants: Policymakers and regulators from developing and emerging countries, academics, representatives from global banks, and senior Fund staff.
Motivation: The global financial crisis since mid-2008 exposed complex interactions between fiscal balances, public and private debt, and the financial sector, showing the traditional definition of sovereign risk to be too narrow.

The traditional definition of sovereign risk (broadly, the probability that a country may not pay its debts) is too narrow given crisis developments since mid-2008.
"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.
The global crisis led to unprecedented government support to the real economy and the financial sector, producing:
- worsening fiscal balances;
- increased public debt;
- a general deterioration in countries’ public finances.
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.
Conventional measurements are too limited and unable to explain 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.
Key analytical dimensions to include:
- broader balance sheet developments;
- debt portfolio structure;
- investor base composition;
- cross-border linkages;
- financial assets of a country.

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;
- sovereign risk and its impact on ongoing financial regulatory reforms.

Substantial and sustained efforts are necessary to restore soundness to public balance sheets.
Panelists emphasized:
- 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;
- the role of central banks in mitigating liquidity versus credit risk.
José Viñals, IMF Financial Counselor and Director of Monetary and Capital Markets Department, noted these points as demonstrating the need to consider sovereign risk in a much broader context of issues and vulnerabilities.

The Roundtable advanced the policymaking community’s understanding of sovereign risk and its wider implications for markets.
It provided potential avenues for the Fund’s work on financial stability and capital market issues.
Conference webpage for full program and background documents: http://www.imf.org/external/np/seminars/eng/2011/hlcfin/index.htm

IMF Press Release No. 11/91, March 18, 2011.