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The fragile edifice of sovereign debt

Systemic, contagious sovereign crises seem to have been consigned to history. Governments can raise funds more cheaply than ever and investor demand seems insatiable. But the banking sector remains a source of instability and new threats are emerging, such as trade wars. Is complacency the biggest threat of all?


This is a golden age for sovereign borrowers and debt managers. They can borrow more cheaply, in greater size and at longer maturities than ever before. 

In August, the yield on UK 10- and 30-year gilts fell to new record lows, despite the uncertainty surrounding Brexit. The yield on 30-year US treasuries dipped below 1.5% for the first time ever. In Germany, where yields are negative across large parts of the curve, the government has issued 30-year bunds with no coupon. 

In emerging markets, Ghana, which made its debut in the bond markets in 2009 having previously been entirely reliant on loans from the World Bank and the IMF, issued 30-year bonds earlier this year. Such was demand – $21 billion for $3 billion of debt across different maturities – it is confident it can return to markets with a 50-year issue. 

The Kingdom of Saudi Arabia, which first tapped international markets just three years ago, recently raised €1 billion of bonds maturing in 2027, with a coupon of just 0.75%. The fates of these two economies are almost entirely dependent on the price of a single commodity: cocoa for Ghana and oil in the case of Saudi Arabia. 

Around $16 trillion of bonds issued by both governments and companies are now trading at negative yields. Asset managers are faced with a dilemma: buy paper that is guaranteed to be loss-making if held to maturity, or indiscriminately search for yield anywhere it is on offer. Neither is entirely irrational in a world where real interest rates are not only low, they keep getting lower. 

Between 2008 and 2018 central banks around the world cut policy rates more than 700 times. Just as talk began to turn to policy normalization, central banks have embarked on another rate-cutting cycle. It is no wonder that proponents of heterodox economics such as Modern Monetary Theory – the notion that governments can borrow as much as they want with impunity – are gaining credence. 

Harvard economics professor Kenneth Rogoff, co-author with Carmen Reinhart of the seminal work on sovereign debt crises, ‘This time is different: Eight centuries of financial folly’, sees fragility and complacency writ large. 

“In this environment of low interest rates, investors seem willing to give almost any creditor a chance,” he says. “If the processes that have held down real interest rates reverse, it could be very problematic. Given where prices are, this does not need to be a sudden or dramatic reversal, it could be relatively small changes in the global economy that have dramatic consequences in markets.” 


You do not need to have the forensic rigour of an economics professor to find vulnerabilities in sovereign debt markets. In the immediate aftermath of the global financial crisis (GFC), the prevailing economic narrative was that there would be a prolonged period of deleveraging. However, with the exception of the banking system and a handful of economies (Ireland, Spain, Portugal), indebtedness has increased across sovereigns, corporates and households. 

In ‘This time is different’, published in 2009, Reinhart and Rogoff demonstrated how, in the wake of financial crises, sovereign debt typically rises by 86%. This time was no different. According to the OECD, between 2007 and 2019 outstanding government debt did indeed double and the aggregate debt-to-GDP ratio rose from 49.5% to 72.6%. 


Harvard economics professor Kenneth Rogoff

Gross borrowings of OECD governments are set to reach a new record level in 2019 of $11 trillion. Government debt now exceeds annual GDP in Japan, Greece, Italy, Portugal, Belgium, France, Spain and the UK. McKinsey estimates that the overall global debt of governments, non-financial corporations and households has grown by $72 trillion since the end of 2007. Sovereigns account for 31% of that growth. 

Both Euromoney Country Risk (ECR) scores and data from S&P Ratings show the quality of sovereign debt has declined in aggregate. This reflects both overall indebtedness and a flood of new sovereign issuers, some of which have questionable credit fundamentals. The IMF has reported that 40% of low-income countries in sub-Saharan Africa are already in debt distress or at high risk of slipping into it. 

“The picture across emerging markets varies a lot, so tend to avoid sweeping comments about crises,” says Alastair Wilson, head of sovereign and sub-sovereign ratings at Moody’s Investor Services. “But it is true some countries have accessed capital markets opportunistically in recent years, which is a frailty. Where we see potential issues is among weaker sovereigns, particularly in sub-Saharan Africa, where low ratings reflect our lack of confidence in their ability to service debt throughout the cycle.” 

Neither the greater quantity of debt nor its declining quality have spooked investors, yet. But there are some familiar and emerging threats to this unstable equilibrium. Globalized finance remains a vector for crisis transmission and a potential direct cause of crises via the sovereign-bank nexus – or doom loop – especially in the eurozone. Sovereigns and corporates are also far more dependent on portfolio flows (bond issuance has increased 2.7 times since the GFC).

Despite unprecedented monetary stimulus, global growth remains subdued. With many policy rates around the world already at the zero bound, central banks are running out of ammunition and ideas should economic conditions deteriorate. 

Christine Lagarde [incoming president of the European Central Bank] is a French politician. Her deputy [Luis de Guindos] is a Spanish politician. You can draw your own conclusions - Andreas Dombret

Quantitative easing (QE) has already blurred the lines between fiscal and monetary policy. Many fear this risks central bank independence and credibility.

“Sovereign risk has changed,” says Andreas Dombret, until recently an executive board member of the Deutsche Bundesbank, with responsibility for financial supervision and risk. “The lender of last resort has a bloated balance sheet and is looking more and more fragile. The biggest creditor to sovereigns in the eurozone is the European Central Bank. These aren’t bond vigilantes holding governments to account for their actions. That creates a moral hazard and it is politicizing central banking. 

“Christine Lagarde [incoming president of the European Central Bank] is a French politician. Her deputy [Luis de Guindos] is a Spanish politician,” adds Dombret. “You can draw your own conclusions.”

This matters because beyond the rarefied worlds of sovereign debt dynamics, central banking and monetary policy, the political landscape is changing in unexpected ways. The post-World War II western consensus that globalization and multilateralism are unalloyed public goods is being challenged. 

The US/China trade war is emblematic of this. In turn, the retreat from globalization and multilateralism calls into question the roles of the institutions Bretton Woods spawned – the World Bank, IMF and latterly the World Trade Organization (WTO) – with unknown consequences for the resolution of future crises. 

“It has always frustrated me that investors see sovereign risk as the same as any other bond – essentially, how good is the contract and how much am I getting paid?” says Marvin Zonis, emeritus professor of political economy at the University of Chicago, Booth School of Business. “Sovereign risk isn’t like that. Countries, or rather their political leaders, can and often are capricious. [US president Donald] Trump is just one example. Trump doesn’t care about global leadership or solving global problems. That is a new risk.”


The history of sovereign crises teaches us one lesson: economies can be subject to severe and sudden shocks. 

Markets are complex systems with unpredictable feedback loops that are impossible to model. In August 2007, few thought that the problems at two obscure hedge funds and a sudden spike in Libor would snowball into the biggest financial and economic crisis since the Great Depression. 

Stock markets were at record highs and the volatility (Vix) index at all-time lows. Lightning struck from a clear blue sky.

Investors, economists and policymakers, however, are subject to ‘present bias’. They extrapolate current trends far into the future. The policy response to the GFC was a classic example. Other than reining in the banking system by insisting on bigger capital buffers, the basic prescription was more of the same. 

The communiqué from the London G20 meeting in April 2009 sums up the policy response: “unprecedented and concerted fiscal expansion”; a commitment to “sustainable globalization” and a pledge of $750 billion to the IMF “to overcome this crisis and prevent future ones”. 

It was, perhaps, the high watermark of conventional post-war, neo-liberal economic policymaking. 

The result has been an enormous increase in public-sector debt and greater use of bond financing as banks have retreated from cross-border lending. 

“Bond debt has increased and so has the number of new sovereign issuers,” says Roberto Sifon-Arevalo, managing director, head of analytics and research, global sovereign and international public finance ratings, at S&P Global Ratings. “Nearly all sovereigns have a higher debt-to-GDP ratio and the average sovereign rating is between one and two notches lower than 2007.” 

We continue to see this play out. The largest growth in rated sovereigns has been in emerging markets and lower down the rating scales.


Author Michael O’Sullivan

Michael O’Sullivan, until recently chief investment officer of Credit Suisse’s international wealth management division and author of ‘The levelling: What’s next after globalization’, calls complacency over debt levels “scandalous”. 

“The prevailing mood seems to be that debt doesn’t matter, but that is misguided in the extreme,” says O’Sullivan. “The GFC showed how quickly the investment climate changes, and there are many sovereign issuers with short or poor track records that could be susceptible to even small shifts in investor confidence.”

O’Sullivan cites the recent experience of Argentina as illustrative of the damage that can be wrought by a “sudden stop” – a loss of confidence followed by a reversal of portfolio flows. 

With banks reining in lending, many countries are more exposed to portfolio flows. The weak ones will be found out - Michael O’Sullivan

On one day in August, Argentina’s currency dropped 25.3% against the dollar, the stock market tumbled 37% in dollar terms and 10-year debt fell to 57 cents on the dollar, from 77c. Yields rose from 10% to 15%. 

“With banks reining in lending, many countries are more exposed to portfolio flows,” says O’Sullivan. “The weak ones will be found out. Argentina has already had a record $56 billion IMF bailout, which was supposed to provide a safety net. But sentiment can turn so quickly. Argentina didn’t miss a debt payment and there wasn’t a change of government. There was a primary election.”

Sudden stops are a particular vulnerability for emerging countries with under-developed capital markets and limited pools of domestic savings, such as insurance companies, pension and mutual funds. Domestic savers have liabilities in their own currency and are largely indifferent to exchange rate fluctuations as long as they are not extreme. This explains the persistent home country bias in investment. 

Vulnerability to a sudden shock plays a role in ratings. 

“Sudden stops lead to defaults, it is a very simple equation,” says Moody’s Wilson. “Any instance where a government balance sheet is highly reliant on external investors increases vulnerability. We factor this quite strongly into our ratings methodology, particularly for issuers we consider to be less able to maintain the confidence of external investors, which tends to be characteristic of countries lower down the ratings scale.”


However, local-currency denominated emerging market debt has become an important asset class. A total of $21.1 trillion of EM local currency-denominated debt is split evenly between sovereign and corporate issuers ($10.3 trillion and $10.9 trillion, respectively). 

Since 2000, EM debt has grown at a median rate of 20% annually. Corporates are the fastest growing segment, accounting for approximately 60% of net new issuance. 

This repudiation of so called ‘original sin’ – hard-currency issuance – which played a pivotal role in Mexico’s Tesobono Crisis of 1994 and the Asian debt crisis between 1997 and 1999, is widely regarded as a positive. However, Rogoff, for one, is not so sure. 

“I always thought the idea of ‘original sin’ as pretty naïve,” he says. “It relates to a specific period in the 1980s when high inflation effectively barred emerging markets from borrowing in their own currency. Default on locally denominated debt is just as prevalent as external default historically, and problems in the corporate sector can make sovereigns vulnerable.” 

We don’t believe that anything that has been done so far short-circuits the doom loop - Alastair Wilson, Moody’s

EM crises often begin with illiquidity and end in insolvency. Investors can exhibit herd-like behaviour. When debt is broadly distributed, no single creditor can solve the problem, but a herd can trigger it. As domestic banking and capital markets deepen, this risk is mitigated to a degree, although financial market liberalization can also create problems. 

A 1999 study, ‘The twin crises: The causes of banking and balance-of-payments problems’, by Graciela Kaminsky and Carmen Reinhart, showed that 18 of 26 banking crises occurred within five years of financial market liberalization. The Russian crisis of 1998 played out remarkably quickly, immediately following the privatization of state assets and the progressive removal of restrictions on foreign participation in the Treasury market and the stock market. 

EM investors were in a state of panic as the Asian crisis unfolded and there was a broad reversal of flows into emerging markets, including Russia. By July 1998 monthly payments on Russian debt were 40% higher than the country’s monthly tax collection. A bank run started with deposits falling by 15% in August. The Russian banking sector was almost entirely renationalized. 


The GFC showed that systemic financial crises are not a quaint relic of the past or the preserve of emerging markets. Rogoff demonstrates that the incidence of banking crises proves to be remarkably similar in both high and middle-to-low-income countries. What is different in highly developed financial markets is that runs can afflict any financial intermediary with leveraged portfolios funded by short-term borrowing.

That explains how the spike in Libor and the credit crunch in 2007 was the catalyst for what followed. Just as in a typical bank run, when liquid assets do not cover deposit withdrawals, the inability of investment banks to fund positions via Libor, repo or other means, led to a scramble to sell assets. 

Liquid assets became illiquid as everyone rushed to the exits at the same time. Mark-to-market losses soared, forcing fire sales. A liquidity crisis became a solvency crisis that forced governments across the developed world to bail out their banks. As banks repaired their balance sheets, credit creation stalled and the real economy slumped. International trade in 2009 was falling at a faster pace than in 1930. 

In 2010, Andy Haldane, then the chief economist of the Bank of England, estimated that the total cost of the crash, including both bailouts and foregone growth, at between $60 trillion and $200 trillion, or between one and five times global GDP. 

“To call these numbers ‘astronomical’ would be to do astronomy a disservice,” he said.

The ripple effects of the GFC converged into a potentially existential tsunami for the eurozone between 2010 and 2012. 

A distinctive element of the eurozone crisis was the ‘doom loop’. Banks can hold supposedly risk-free sovereign debt at a zero capital-weighting. In the eurozone, this means any euro-denominated sovereign. 

As contagion from Greece spread to Portugal, Italy, Spain and Ireland a danse macabre began in which rising sovereign yields put pressure on bank balance sheets, and the threat to the financial system raised the prospect of bailouts, putting further pressure on sovereigns. In October 2011 Dexia, already the recipient of a €6.4 billion bailout in 2008, collapsed, spreading panic throughout the eurozone. 

In the wake of the crisis, policymakers pledged to break the doom loop. Most believe the measures taken since have been necessary but not sufficient. The Single Supervisory Mechanism (2012) has improved regulatory oversight. The Single Resolution Mechanism (2014) was designed to allay fears of a return to large taxpayer-funded bank bailouts weighing on a single sovereign. 


Alastair Wilson, head of sovereign and sub-sovereign ratings at Moody’s Investor Services

“We don’t believe that anything that has been done so far short-circuits the doom loop,” says Moody’s Wilson. “The resolution regime is the most important part of that attempt, but we don’t think it will work. It might work when an individual bank gets into trouble through bad decision-making, but we don’t see it changing how governments respond to a systemic crisis.”

Markets appear to agree. In June 2018 when the Five Star/League coalition looked set to take power in Italy, two-year government bond (BTP) yields doubled and credit default swaps on the country’s banks spiked. The same dynamic was replayed last autumn during Italy’s fractious budget negotiations with the EU. 

If numbers are important, the doom loop looms larger than ever. During the height of the eurozone crisis Italian banks held €240 billion of domestic debt; the figure today is over €400 billion. French banks have €285 billion of exposure to Italian debt.

Italy matters. It is 15% of eurozone GDP, it is the third largest economy and accounts for 20.8% of public debt. Its economy is 5% smaller than in 2007 and its debt-to-GDP ratio is 133% (among the OECD nations only Japan and Greece are more indebted). All three big credit rating agencies rate Italy’s sovereign debt just two notches above junk.

Former Bundesbank official Dombret offers a chilling assessment: “I think Italy has a serious problem. It could blow up the eurozone. That is not my central scenario, but the levels of debt make things very unpredictable. I’ve worked in markets, and one lesson you learn is that sentiment can sour very rapidly – particularly when there is political instability.” 

Rogoff agrees. 

“I think it is still too early to say the eurozone crisis is over,” he says. “My Italian economist friends were generally confident they could muddle through in 2012. The tone has changed since the populists arrived on the scene. I don’t expect the eurozone will have the same members in 20 years’ time. They are in a bad marriage and eventually the strains will prove intolerable.”

To break the doom loop Dombret has long argued that sovereigns should carry a risk weighting, although he acknowledges that whenever the subject is raised weaker government debtors quickly rally to maintain the status quo. 

For O’Sullivan, the lack of sovereign risk weightings not only reinforces the doom loop, it encourages poor behaviour.

“There is not a single rational economist or investor in the world that thinks that Italian sovereign debt should carry a zero risk-weighting on bank balance sheets,” he says. “It is not only a systemic risk to the eurozone, it also gives the Italian government a ‘free pass’. A captive buyer keeps yields artificially low and that then gets compounded by QE. It emboldens the populists in Italy to say and do stupid things.” 


The banking system may also provide a foretaste of an emerging trend that threatens to heighten sovereign risk: deglobalization. Eurozone banks have been in the vanguard. Their total foreign loans and other claims dropped by $6.1 trillion, or 38%, since 2007. German banks held two-thirds of their assets outside Germany in the run up to the GFC; that has since fallen to one-third. 

In March 2017, Barclays issued a report called ‘The future of globalization’. It showed that globalization has been subject to cycles through history. Trade openness, measured as exports and imports as a percentage of GDP, peaked immediately before World War I at 38.1. The modern era of globalization accelerated in the 1990s with the Maastricht Treaty in 1992, the North American Free Trade Agreement in 1994, and the creation of the World Trade Organization in 1995. But trade openness did not regain its 1914 heights until the early 2000s. 


A new era of hyper-globalization began with China’s admission to the WTO in 2001. Trade openness peaked at close to 50 but has begun to decline. That has accelerated as the US has sparked trade wars and imposed tariffs. The report’s main author, Christian Keller, head of economics research at Barclays, admits surprise about how fast things have escalated.

“We wrote the report when we did [early 2017] because we took Trump’s campaign promise to declare China a currency manipulator at face value. He didn’t do that until relatively recently. The first year of the administration was all about the domestic agenda. Since then the focus has shifted to China and trade. The whole confrontation has been ratcheted up to a point where it is difficult to see any ‘off ramps’.” 

Zonis at Chicago is unambiguous about the result of trade wars and deglobalization: “The one sure result is lower economic growth because trade drives growth. If this process of deglobalization continues, there will also be more political unrest and greater sovereign risk.” 

Rogoff believes globalization has been a big factor in holding down real interest rates through disinflation and portfolio diversification. 

“I wrote a paper once where the central argument was trade frictions have surprisingly big implications for financial flows and financial markets,” he says. “Globalization has allowed for larger current account deficits and has pushed down yields. If you do anything to disrupt that, there can be major knock-on effects, including for asset prices.” 

The fact that Peter Navarro has somehow become the Rasputin of US trade policy is both bizarre and frightening - Kenneth Rogoff, Harvard

Barclays’ Keller thinks the effects of deglobalization will be felt first in industrializing emerging market countries that have become increasingly integrated into global value chains. These include countries such as China, Malaysia, Thailand and Vietnam and the former Warsaw Pact countries in eastern Europe. 

“The thesis is quite simple,” says Keller. “The winners from globalization will become the marginal losers in a process of deglobalization. We could shift back to a pattern more familiar in the 20th century when the big commodity exporters in emerging markets come to the fore.”

Almost the first act of the Trump administration was to tear up the Trans-Pacific Partnership, a treaty that was arguably a stroke of US diplomatic genius, providing a regional economic bulwark against China. 

If the US has been the main catalyst for deglobalization via trade wars, it has also unleashed other potentially destabilizing forces.

Former US Treasury secretary Larry Summers, who was instrumental in organizing the $50 billion US-led bailout of Mexico in 1994 and the creation of the G20, commented recently: “Under president Trump, the US concept of a community of nations working together to pursue each their own interests, but cooperatively, has been put to rest in favour of an alternative construct, in which the world economy is seen as a near zero sum game… When the leading and most-influential and agenda-setting nation is operating with that kind of philosophy, sustaining global cooperation becomes more difficult.” 

O’Sullivan at Credit Suisse believes this repudiation of global leadership will have serious consequences in future crises. 

“If you go all the way back to [US Treasury secretary Nicholas] Brady and the resolution of the Latin American debt crisis in the late 1980s, to [US Treasury secretary] Robert Rubin and Summers in the Mexican crisis, then the Asian crisis and even the GFC, the US has been an architect of stability,” says O’Sullivan. 

“Now it is the provocateur of volatility. It has gone from resolving emerging market crises to risking causing them by imposing tariffs on China and Turkey in 2018.” 

Trade war

The US retreat from multilateralism is most evident in the trade war. It could have referred China to the WTO but chose not to. The US has also blocked the appointment of judges to the WTO appeals court. With two more judges retiring in December, the WTO risks death through malign neglect. 

“The fact that Peter Navarro [Trump’s director of the office of manufacturing and trade policy] has somehow become the Rasputin of US trade policy is both bizarre and frightening,” says Rogoff. “Even his best ideas are half-baked – and that is reflected in US actions on trade.” 

This is causing some to call into question the future role of the World Bank and IMF.

“The US doesn’t care about the WTO,” says Zonis. “That’s obvious. But I would go further. I do not believe the US cares about the World Bank. It appointed a president [David Malpass] who has been openly hostile toward it. The US is perverse, stuck in the past and is not exerting any form of global leadership. It doesn’t care about the WTO, the World Bank or even the IMF. My view can be simply stated: the US has abandoned these global institutions.”


Andreas Dombret, until recently an executive board member of the Deutsche Bundesbank

That is a change with the recent past. Dombret relates a conversation with US Treasury secretary Timothy Geithner during the first Greek bailout in May 2010. The Troika – the European Commission, ECB and IMF – had agreed the terms. 

“Geithner asked why he hadn’t been consulted in more detail as the US had a blocking vote in the IMF,” recalls Dombret.

“Dominique [Strauss-Kahn] gently but firmly pointed out that the main parties had cooperated and found a solution, and that was the IMF’s role. The solution was in the best interests of the US, because it was in the best interest of Europe. I can’t imagine the US administration accepting that now. They think in transactional terms – of winners and losers.” 

O’ Sullivan thinks the WTO is no longer fit for purpose and that the World Bank should move its headquarters from Washington to Africa to stay relevant. He also believes the IMF needs to be overhauled and that many of its functions – such as surveillance and capital raising – can now be performed better by central banks with a macro-prudential focus and the private sector. 

Old IMF hands still believe it has a role to play. 

Rogoff, the IMF’s chief economist between 2001 and 2003, says: “The IMF is always only one serious crisis away from being very relevant.” 

Barclays’ Keller, who left the IMF just before the GFC, says the lack of crises in the 2000s had many staff members convinced their destiny was to morph from a financial crisis fire-fighter into a global economics statistical agency. 

“We were very wrong about that,” he says. “The IMF remains important and the US retreat from leadership around the world may make that even more the case. The IMF’s current role in Argentina is an example, and if it came to a debt crisis elsewhere, perhaps among the new sovereign borrowers in sub-Saharan Africa, the IMF would likely be left to sort it out.” 

However, it is also the case that regional institutions are emerging that mirror the new multi-polar world order. The Beijing-headquartered Asian Infrastructure Investment Bank was launched in 2015 with participation from 44 regional powers and 28 other countries, including the UK. A European Monetary Fund has been mooted, with strong backing from French president Emmanuel Macron and commission president Jean-Claude Juncker. 

The role new regional institutions will play in resolving future crises remains to be seen. During the GFC, central banks seized the agenda and the only game in town was monetary policy. The fiscal stimulus envisaged by the London G20 communiqué largely consisted of government bank bailouts with special lending facilities and QE supplied by central banks. 

“In Europe, and to some extent the US, everything currently trades off a QE price,” says O’Sullivan. “Investors are second guessing when QE will return because they know there is little scope to cut interest rates in a downturn. Europe already has negative deposit rates. The last 11 US recessions have begun with the federal funds rate at 5% or higher; it is currently 2%.” 

Straying into fiscal policy has made central banks both inherently more political and a dominant force in markets. This mattered less when politicians and central banks had broadly aligned policy objectives. But the rise of populists is a new threat to central bank independence. 

The distributional effects of QE have overwhelmingly favoured the owners of financial assets. Modern Monetary Theory (MMT) looks to redress this balance, hence its embrace by the left. US Democratic representative Alexandria Ocasio-Cortez has already endorsed it, as has the former chief economic adviser to Bernie Sanders. It is widely expected to gain traction during the Democratic primaries. In the UK, the Labour Party has its own twist on the idea, ‘people’s QE’. 

MMT would reduce central banks to mere agents of national treasuries and finance ministries. Trump is already using his favourite bully pulpit, Twitter, to intimidate the Federal Reserve into cutting rates further, blaming it for every dip in US equity markets. 

The ECB will soon have two former politicians at its helm, and the Bank of Japan has done everything prime minister Shinzo Abe has asked of it to deliver his ‘three arrows’. 

Rogoff believes independent central banks have been almost too successful in delivering their inflation targets. The latest IMF World Economic Outlook forecasts inflation in advanced economies of just 1.6%. This has bred complacency that ultra-low interest rates will persist and monetary stimulus, however extreme, is risk-free. 

“A big driver of this backlash against globalization and central banks is that the vast majority of investors, traders and policymakers have forgotten about inflation,” says Rogoff. “They have only ever seen disinflation. They say: ‘It’s a 20th century phenomenon and markets are too integrated and efficient now. It just can’t happen.’ Well, I’m afraid this time is not different. I expect to see inflation return, not just in vulnerable emerging markets but in a more widespread way.” 

Bank of America Merrill Lynch reported that in the last week of August, government bond funds “registered their largest inflow ever, after a record print the week before”. Investors clearly believe more rate cuts, more QE and more of the same are on the way. 

But financial market bubbles caused by wrong-headed policy have been a recurring cause of economic distress. Since the GFC, central banks and politicians have seemed content to let the debt money-go-round keep on turning, while failing to address the underlying economic challenges of relatively low growth, under-investment and slowing productivity.

“It’s been an amazingly quiet period for sovereign crises, anomalous even, perhaps only seen in two prior periods in the run-up to 2007 and just before World War I,” says Rogoff. “If you talk to people inside the IMF, they are not feeling calm. They have seen this movie before. Things can change very quickly. Deglobalization could be a catalyst, so could inflation caused by poor policymaking. What is harder to predict is when systemic crises occur. But it is a question of when.” 


Lessons from the best and the rest

Delving into Euromoney Country Risk’s 37 years of data is instructive. The overall aggregate ECR has fallen by 6.12 points. 

The best performing region is central and eastern Europe, where countries benefited from the end of communist rule and joining the European Union. 

Two of the worst have been western Europe and North America, the epicentre of the GFC. Among emerging markets, south Asia is the worst performing, followed by Africa. 

At the country level, the best performers in terms of improving overall ECR scores have been Malta, Israel and Poland. Both Poland and Malta joined the European Union in 2004. Wherever you stand on Brexit, it is clear these countries have benefited from being part of a large economic free-trade area. 

The worst performer is Venezuela, with Greece not far behind. Perhaps more surprising, of the large economies the UK and France have the poorest performance in terms of the decline in their overall scores. However, it is worth noting that both started 1982 when the data began with higher scores than any country has managed to maintain in aggregate in the 37 years since then (a perfect 100 for the UK and 99 for France). 

To give the data greater nuance than the headline scores, we performed a simple quantitative analysis using a methodology derived from Rogoff. This divided the 196 countries into three groups: a premier league with an aggregate country risk score one standard deviation above the mean score; a mid-division group within the standard deviation; and a laggards’ league, with a score one standard deviation below the aggregate.

Ignominious list

The laggards league reads like a who’s who of war-ravaged failed states, economic basket cases and brutally repressive regimes. North Korea tops an ignominious list that also includes the likes of Afghanistan, Somalia, Cuba and Iran. The mid-division group (within the standard deviation) is, unsurprisingly, the largest. There are 141 counties in total. 

That stratum includes the likes of Myanmar, Libya and Zimbabwe, which are flirting with relegation to the laggards’ league. Those vying for premier league promotion are the Czech Republic, Cyprus and Slovenia. Bermuda is in a play-off position, closely followed by two Middle East countries, Israel and Saudi Arabia. 

The top of the premier league is perhaps the most intriguing group. It is led by Switzerland, followed by Norway and Luxembourg, with Denmark, the Netherlands and Sweden in a tightly grouped chasing pack. These leaders have several things in common. They are all small, European, highly open economies integrated into global financial and trade flows with reputations for transparency and good governance. 

Of the large economies, Canada, the US, Germany, the UK and France perform best (despite the absolute decline in their ECR score in the case of the last two). Other small open economies, such as Austria, Finland, Australia and Singapore, also feature in the top 15 of the premier league. 


A select group of 10 countries have retained premier league status throughout their ECR history: Denmark, Finland, Luxembourg, the Netherlands, Norway, Singapore, the UK, the US, and West Germany/Germany. France has been in the top league for every year other than 2016. 

This confers clear advantages over other borrowers, such as ready access to capital markets and cheap funding. Rather like its football equivalent, being in the top league of ECR scores makes staying there easier. 

The data suggests that promotion from the bottom league to the top is all but impossible. Only one country in the history of ECR has achieved this: Chile. In 1985, its ECR score fell to an all-time record-low of 11.6. Only seven countries currently have a lower ECR score, including Djibouti, Eritrea and North Korea. Chile made it back into the premier league first in 1992, before slipping into mid-division again. It has been in the top league since 2011. 

Relegation events are often caused by financial crises. After 10 years each of premier league status between 1982 and 1998, both Malaysia and Thailand dropped into the mid division and have never returned. Of the countries worst hit by the eurozone crisis of 2011/12 – Portugal, Ireland, Greece and Spain – only Ireland has managed to get back in the top division. 

Slowly deteriorating debt dynamics can also take their toll. After 29 years in the top flight, Japan was relegated in 2012 and has stayed in the mid division. 

The ECR data suggests strongly that once the trust of investors is eroded, it is very hard to win back. Budding treasury secretaries and debt managers would do well to focus their PhD theses on Chile, Ireland and the 10 premier league perennials. Teasing apart, what makes them stand out may offer a policy path to long-term debt sustainability. 


Since 1982, Euromoney has been assessing sovereign risk through its Euromoney Country Risk (ECR) survey. ECR provides access to transparent and independent crowd-sourced country risk ratings. It enables users to monitor, anticipate and make judgements. 

ECR’s expert contributor panel provides real-time scores in 15 categories relating to economic, political and structural risk. The consensus scores are combined with data from the IMF/World Bank on debt indicators and survey data on sovereign access to international capital markets. The accumulated output from these data sources creates the overall ECR score for over 165 individual countries. 

For more information, please contact: ECR programme manager Chen-Ta Sung (

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