Political costs of sovereign default : examining the impact of a sovereign’s failure to repay its debt on popularity, 1984-2012

Fil: Smith, Julia. Universidad de San Andrés. Departamento de Ciencias Sociales; Argentina.This paper uses a popularity function to study the relationship between sovereign default and government popularity. I construct a dataset of default history for 55 sovereign entities from 1984-2012. By distinguishing between different types of default, I find that defaults on foreign-currency-denominated debt held by banks, and on foreign-currency-denominated commercial debt, are correlated with a drop in government popularity. On the other hand, there is no correlation between defaults on local-currency-denominated debt and changes in government approval. I accompany these findings with case studies to hypothesize that because governments typically have more policy options to manage local-currency debt, the population is more likely to view defaults on such debt as a pro-active policy choice to obtain a socially optimal outcome. Consequently, constituents do not punish politicians who make such a decision. Conversely, defaults on foreign-currency debt are more likely to occur under a government that has run out of policy options and is left with little choice but to stop servicing foreign currency debt. Voters do not view such an outcome favorably. These findings suggest that the theory that a government may “gamble for redemption,” or delay making a socially-optimal decision to default due to the fear of political fallout, is misguided