This is a conversation between a student and a Professor.
Student: I have a few questions to ask about sovereign debt. Is this a right time?
Professor: Go ahead.
Student: Is it true that no country can go bankrupt?
Professor: Yes or no. If all the borrowing the country does, involve local currency which it has the power to print, there is no question of bankruptcy. All debts with interest will be repaid by printing money. On the other hand if the borrowing involves a foreign currency, say US dollar, there is a possibility the country could face bankruptcy, if it does not have enough dollars to pay the interest and principal. Having said that, Seldom do countries go bankrupt. At worst they will have their loans restructured.
Student: What is restructuring?
Professor: Assume a country borrowed 50 million US dollars payable in 5 years with a rate of interest 4% per annum. The country has to pay an interest amount of 2 million dollars every year for 5 years and return the 50000 dollars it borrowed at the end of the 5th year. If it is not able to pay back, then such a loan could be restructured.
Student: Sir, how is this done?
Professor: Tell the country to take another say 5 years to pay. A lower the interest cost. Assume that the country owes 55000 dollars (50000 principal and 5000 interest) they may now change the loan size to 55000, like a new loan with possibly an interest of 2 percent. This is a common practice in Indian banks where the non-performing assets are currently bulging up.
Student: Can the lender take the borrowed country to the court?
Professor: Yes, but the court must have a jurisdiction over the country. Recently there are interesting developments and I will appraise you on that.
Student: Sir, it is exciting.
Professor: The case in question is Argentina which has a terrible record of repaying its loan. The US appeal court has called Argentina “a uniquely recalcitrant debtor”. This country has made default a national habit over the last two centuries making you wonder why anyone would lend to it. On June 30, 2014 there is a scheduled interest payment on a set of Argentina bonds that its government wants to pay. But the court is saying that the interest may not be paid unless the country pays all it owes on bonds it defaulted on some years ago. Something Argentina says it cannot and will not do.
Student: Will Argentina obey the US appeal court?
Professor: It remains to be seen. As it stands, there is no legal procedure to resolve debts of destitute countries. There is no court to approve a restructuring plan that will wipe out some debts and convert others to equity as there is for companies.
Student: Sir, you said in class that India carries $ 430 billion dollar debt against the 310 billion dollar reserve. Do you foresee a problem for India?
Professor: Probably not. We have never defaulted before. In 1991, we came close to it but we hypothecated Gold and paid the loan with interest. Having said that, our current account deficit is a constant headache. Most of the monies that come in are FII money nearly 200 bln dollars of them. It is very short-term. If and when these guys pull their money out, both our stock and currency market goes for a toss. In 2008 they pushed down the Sensex from 21000 to 8000 in a very short period of time.
Student: Why don’t we behave like Argentina? Borrow, promise but never pay.
Professor: Yes possible but the international rating agencies will downgrade us. We are currently at BBB– an investible grade but it could be easily lowered to BB+ which is a junk status. We don’t want that right.
Student: Yes sir and thanks for this conversation.