According to Bloomberg’s Sovereign Debt Vulnerability Ranking, here is the list of countries with the highest default risk.
Sri Lanka, a country in South Asia, made its first debt default in May 2022. The country’s government was allowed a 30-day grace period to pay the overdue interest of $78 million but ultimately did not do so.
This has an effect on Sri Lanka’s economic future and also raises the crucial question of which other countries face default risk.
To find out, we ranked the countries with the highest default risk using information from Bloomberg.
The Sovereign Debt Vulnerability Ranking
A comprehensive assessment of a country’s default risk is provided by Bloomberg’s Sovereign Debt Vulnerability Ranking. It is based on four fundamental metrics:
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- Government bond yields (the weighted-average yield of the country’s dollar bonds)
- 5-year credit default swap (CDS) spread
- Interest expense as a percentage of GDP
- Government debt as a percentage of GDP
Let’s use El Salvador and Ukraine as examples to better comprehend this ranking.
Why are Ukraine’s Bond Yields so High?
Because to its ongoing conflict with Russia, Ukraine faces a high default risk. Consider a situation in which Russia were to take over the country to see why. The current debt obligations of Ukraine might never be paid off if this took place.
The value of Ukrainian government bonds has fallen to around 30 cents on the dollar as a result of a sell-off sparked by that scenario. This implies that a bond with a $100 face value might be obtained for $30.
The average yield on these bonds has increased to a very high 60.4 percent because yields grow in the opposite direction of price. A 10-year government bond issued by the United States now has a yield of 2.9 percent.
What is a CDS Spread?
A derivative (financial contract) called a credit default swap (CDS) offers insurance to a lender in the event of a default. Between the lender (investors) and borrower (in this case, governments), the seller of the CDS is a middleman.
The buyer of a CDS pays a price known as the spread, which is measured in basis points (bps), in exchange for receiving coverage. If a CDS has a spread of 300 bps (3%) then the investor must pay $3 annually to insure $100 in debt.
Given that Ukraine’s 5-year CDS spread is 10,856 bps (108.56%), an investor would have to fork up $108.56 annually to insure $100 in debt (though it is in practice an upfront payment and then constant stream of payments which implies default is likely in the very short-term). This indicates that there is minimal market trust in Ukraine’s ability to avoid default.
Why is El Salvador Ranked Higher?
El Salvador is ranked higher than Ukraine despite having lower values for the two categories mentioned above due to its higher interest costs and overall government debt.
The aforementioned information indicates that El Salvador pays an annual interest rate that is equivalent to 4.9 percent of its GDP, which is a considerable amount. Once more in comparison to the U.S., federal interest payments in that country in 2020 amounted to 1.6 percent of GDP.
El Salvador’s total unpaid debts are equal to 82.6 percent of its GDP. This is considered high by historical standards, although it is actually pretty common today.
The country’s $800 million sovereign bond matures in January 2023, thus this is the next date to keep an eye on. According to recent research, El Salvador’s default would have a severe, albeit brief, negative impact.
Another Hot Topic for El Salvador: Bitcoin
El Salvador became the first country in the world to accept bitcoin as legal tender in September 2021. This indicates that the use of Bitcoin to pay debts and fulfill other obligations is permitted by law.
Early in 2022, the International Monetary Fund (IMF) criticized this choice and urged the nation to rescind its legal tender status. These warnings were wise in hindsight, as Bitcoin’s value has decreased by 56 percent so far this year.
Although this has nothing to do with El Salvador’s likelihood of default, it does provide some potential relief. For instance, major crypto players would be eager to help the state maintain the concept of “nation-state bitcoin adoption.”