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Sovereign Debt Management Case Study

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2.6 – Sovereign Debt Management - Impact of the global financial crisis:

The world faced unprecedented global financial crisis (GFC) which started in 2007-08 and all the macroeconomic policies including monetary policy and SDM were impacted by resultant turbulence. As economic growth slumped and recession had set in, financial markets had turned volatile with global risks increasing significantly. Due to bailouts by the governments and monetary policy measures by the Central Banks, the debt shifted from the balance sheets of distressed banks to the central banks and governments.

The governments and central banks in advanced economies acted in unison to counter the effects of the crisis and stimulate a quick economic recovery. Central banks
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Euro zone nations were confronted with banking sector weakness and distress and large budget deficits resulting from past profligacy. Many Euro Zone nations borrowed heavily, mostly from external sources during the decade preceding the GFC. The borrowings were spurred by availability of easy credit. Blundell-Wignall and Slovik (2010) rightly observed that two inter-related crisis have confronted Europe: first a banking crisis, originating from losses due to the decline in asset prices such as housing and capital market losses; and second, a sovereign debt crisis due to poor fiscal management which is exacerbated by recession and transfers to help banks. The idea of Euro Zone with economic, commercial and financial interdependence carried seeds of vulnerability as economic volatility could quickly spread to other countries, resulting in a domino effect when confronted with the…show more content…
Excessive focus on cost minimization led to issuance of short-term debt and foreign currency debt. Most of the debt was held by non-residents. The risky debt structures exposed the countries to substantial refinancing, re-pricing and currency risks. The manifestation of stress is evident especially in the case of Greece, Ireland and Portugal. These countries had similar external debt structures and dynamics. As at the end of 2009, more than 70 per cent of sovereign debt of Portugal, Greece and Ireland was held by non-residents. Greece had large maturities during 2010-19 and huge rollover costs resulting in the country not able to rollover debt and stood at the brink of default, leading to political and economic turbulence. The country was bailed out by IMF and Europe but is beset with economic strife. The debt strategy pursued for cost minimization has jeopardized the fiscal situation of these countries and the financial stability of the Euro zone.

In late 2010, the sovereign debt crisis had worsened and peripheral Euro zone countries like Greece and Ireland were forced to pay very high interest costs as they faced very significant adverse movements in yields. There were apprehensions of sovereign defaults and concerns about stability and future existence of Euro were expressed. To address the situation, Europe’s finance ministers created European Financial Stability Facility with a
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