Are bad governments a threat to sovereign defaults? The effects of political risk on debt sustainability
In this paper, we ask whether the level of political risk in a country threatens its debt sustainability

Political risk is a significant determinant of bond yields and economic growth in both developed and emerging markets and we develop a debt sustainability analysis model with both channels using a country ratings proxy of political risk. Political risk also affects a sovereign’s willingness to pay and it can render debt unsustainable, triggered by changes in the rating level, volatility or both. Conversely, sustainability can be restored through reforms that can be as effective as large-scale quantitative easing programmes. The political effects on debt are especially large for high-debt countries during periods of high interest rates, and have an impact on debt management through the choice of optimal financing maturities.
Comments from Hans Geeroms, Ivo Maes, Jonathan Ostry, Lucio Pench, Lennard Wesley and Jeromin Zettelmeyer are gratefully acknowledged. This study was partly funded by the NextGenerationEU initiative in the framework of the Italian GRINS (Growing Resilient, Inclusive and Sustainable) project (GRINS PE00000018 – CUP B73C22001260006) and the Cyprus Academy of Sciences, Letters, and Arts.
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