Macroeconomic Effects of Sovereign Restructuring in a Monetary Union: A Model-based Approach

IMF Working Papers, December 26, 2013

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Objective: Assess the macroeconomic effects of a sovereign restructuring in a small economy belonging to a monetary union by simulating a dynamic general equilibrium model.
Three key modeling assumptions (in line with empirical evidence):
- Sovereign debt is held by domestic agents and by agents in the rest of the monetary union.
- After the restructuring the sovereign borrowing rate increases and its increase is fully transmitted to the borrowing rate paid by the domestic agents.
- The government cannot discriminate between domestic and foreign agents when restructuring.
Main result: Macroeconomic effects of the restructuring depend on:
- (a) the share of sovereign bonds held by residents in the country as compared to that held by foreign residents,
- (b) the increase in the spread paid by domestic agents, and
- (c) its net foreign asset position at the moment of the restructuring.
Quantitative implication: Sovereign restructuring implies persistent reductions of output, consumption and investment; these reductions can be large, particularly if:
- the share of public debt held domestically is large,
- private foreign debt is high, and
- the spread paid by the government and the households does increase.

Debt ownership composition:
- Explicit modeling of sovereign bonds held domestically and by residents of the rest of the monetary union.
Interest rate transmission:
- Increase in sovereign borrowing rate is fully passed through to domestic agents' borrowing rates.
Non-discrimination in restructuring:
- Government cannot target restructuring measures differently for domestic vs. foreign bondholders.

Determinants of macroeconomic impact:
- Share of sovereign bonds held by residents vs. foreign residents.
- Magnitude of the spread increase paid by domestic agents.
- Net foreign asset position at the time of restructuring.
Dynamic outcomes:
- Persistent reductions in output.
- Persistent reductions in consumption.
- Persistent reductions in investment.
Conditions amplifying adverse effects:
- Large share of public debt held domestically.
- High levels of private foreign debt.
- Increases in spreads paid by government and households.