Not everyone knows what default is. In simple terms, this concept is described in popular publications. A synonym for this word is bankruptcy. But usually an analogy with this definition is rarely drawn, since the concept of insolvency has a narrower interpretation. Further consider what default is. In simple language, we will try to explain the essence of the concept.
Official terminology
Many financial professionals know what default means. This definition should be understood as a violation of the payment obligation accepted by the borrower to the creditor. In fact, this is the inability to fulfill timely repayment of debt or other terms of the contract. In a broad sense, default is any form of rejection of a debt obligation. In practice, a narrow interpretation of this concept is used. People with authority have a very good idea of what default means. In a narrow sense, it is understood as the failure of the central administrative apparatus of its debts.
Features of the procedure
Distinctive features of default can be considered by comparing it with bankruptcy. In case of insolvency of the payer (corporate or private), the creditor has the right to seize the debtor's assets. So he compensates for his losses. In many countries, bankruptcy involves a centralized process during which all claims for an insolvent company are settled. The seizure of property in this case is carried out in accordance with a court order. Assets are combined, and a competitive mass is formed from them , which is subsequently distributed among creditors in the order established by law. Such a procedure cannot be applied if a country is declared default. This is due to the fact that the seizure of the property of the debtor in such a situation is almost impossible. In the best case, creditors will be able to freeze the assets of the state that are located outside its territory, including real estate and money in foreign accounts.
Classification
The default of the state can be:
- On bank loans.
- For obligations in national currency.
- For debts in foreign money.
The default of the state on loans in national currency is announced less frequently than on external loans. This is because the government can pay off domestic obligations by issuing new banknotes.
Essence of the process
The mechanism that causes a default of a country can be represented as a cycle. At its first stage, the government gets relatively easy access to international sources of finance. They, in particular, are the IMF, the Paris Club, the Private Bank and large bankers of developed countries. Monetary Fund experts recommend needy authorities promise a high loan interest. So they can attract more investors. The prospect of making high profits really attracts the capital of world lenders. They easily transfer funds in search of the most profitable short-term investment. They invest their money in the purchase of securities issued by states. When injecting large volumes of funds, investors usually get a short-term positive result. This convinces the national elite that it has chosen the right path of development. In many cases, in practice, a significant share of borrowed capital does not reach the real sector of the economy, but settles in the private accounts of government officials. Sooner or later, the payment deadline is all the same. In this case, the government, as a rule, can only partially repay obligations at the expense of its own finances. To make full payments, he needs to raise funds in foreign and domestic markets. Only a few countries are able to stabilize or reduce their debt under such conditions. As a rule, external debt is growing rapidly.
Second phase
During a period of economic growth, investors rely on a real source of repayment of obligations. In these cases, lenders provide countries with new loans. But at the very first manifestations of political or economic instability, investors become less and less. In this case, the interest on the loan increases. Accordingly, the debt itself is increasing rapidly. In such circumstances, a country's default is only a matter of time.
Financial help
IMF emergency investment can save only for a short time. In addition to real financial assistance, the Monetary Fund carries out a number of events during which private capital gets the opportunity to leave the problem zone. Creditors who withdraw their funds on time will benefit, even if the country is defaulted. They manage to make profit on interest and as a result of the resale of debt obligations. As a result, in any case, the moment will come when no investor wants to invest in a troubled state, even at very high tariffs. Due to the lack of funds for refinancing, the government is forced to default.
Devaluation
It is often used instead of refusing to fulfill obligations. This option is usually used by countries with large domestic debt. In fact, this measure is similar to the default on loans in the national currency. In a number of cases, the government simultaneously declares its insolvency and devalues.
Probability assessment
The government, unlike a private company, does not have financial statements that could be analyzed. On a national scale, it is necessary to assess the state of the entire economic system. Particular attention should be paid to the ratio of obligations in foreign and national currencies, the amount of debt to the value of annual exports. Equally important are such microeconomic indicators as the level of GDP and foreign exchange reserves, the rate of inflation. In the process of conducting such a fundamental analysis, the question of the reliability of statistical information is more acute than when evaluating the reporting of corporate debtors. This is especially true for transition and developing economies.
Analysis methods
All types of estimates of the probability of default are divided into two categories:
- Actual - these techniques allow you to calculate an objective indicator based on statistical information.
- Methods based on the market price of bonds, stocks or derivative financial values by which a neutral assessment and risk premium are determined.
Actual indicators are calculated by rating agencies. A risk assessment determines the likelihood of losses that foreign investors may experience. The higher the country's rating, the lower the risk of default. Such estimates are of great importance for foreign lenders in choosing the optimal investment areas.
The ratio of export volume to external debt
The calculation of this indicator is considered one of the most popular methods of analysis. The larger this ratio, the easier it is for the debtor to pay off obligations. There are different estimates of the criticality of this value, but a level of 20% or more is considered acceptable. However, experts do not characterize this indicator as optimal. With an indicator of 20%, the state will be able to fulfill all obligations in 5 years by sending export profits to repay external loans. But since, in most cases, the income of private companies is taken into account, the government will be forced to expropriate it in full. In such circumstances, maintaining exports at the same level for five years is unlikely. Also, the state will not be able to fully redeem the proceeds, since this will violate the system of foreign exchange and import-export operations.
Budget
His condition is also of great importance in the analysis of the country's solvency. In particular, the ratio of income items to the amount of debt is taken into account. In this case, it is necessary to establish what part of the budget the government can devote to servicing obligations without complicating the socio-economic situation. Since income acts as a tax to a greater extent, in order to predict the situation, it will be necessary to assess the economic condition and development prospects. After that, it is necessary to analyze the difference between the received value and the volume of real deductions for servicing obligations in a specific period. If it is in favor of paying off the debt, then the government will have to borrow more.
How will default affect the state of the business sector?
The phenomenon under consideration will negatively affect the economy. As for Russia, here, first of all, the value of the ruble will drop sharply relative to the price of other currencies. Many enterprises engaged in the purchase of foreign products will be forced to suspend or completely stop work.
Many are interested in what threatens default to Ukraine. Currently, its territory is very tense. Nevertheless, it is supported by the EU, including financially. The most accurate answer to the question of what threatens the default of Ukraine can experts of rating agencies. For example, according to Moody's estimates, the crisis of 2000 was not the most negative for investors. Analysts evaluate quotes of Eurobonds, which are declared insolvent, within a month after refusing to fulfill obligations. In the near future, the default of the hryvnia is not expected. Despite the instability of the political and economic situation, the government is trying to fulfill its obligations.
Default for citizens
In connection with the imposition of sanctions against the Russian Federation, many Russians are in a panic, not knowing what to do in case of crisis. As mentioned above, the refusal to service external debt will primarily affect the state of the ruble. In this regard, experts recommend getting rid of the national currency and buying something substantial on it (household appliances, real estate). Everything that will happen after default will hit the population’s budget badly. With a sharp depreciation of the ruble, prices for consumer goods will rise. Salaries may remain at the same level or even decrease. After default, there is a high risk of loss of cash accumulations. It’s especially not worth worrying for those whose finances are not stored in ruble accounts. Companies that procured goods abroad may become insolvent so much that they will have to dismiss the staff. For people with ruble savings, analysts advise investing in a more stable currency or in gold. Profitable purchase of real estate. As practice shows, during a crisis, the cost of housing decreases at least twice. One of the most popular ways to save your money is still considered investing in foreign currency (dollar or euro). With the threat of such a crisis, the government needs to take radical measures to stabilize the socio-economic system.