Working paper

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

Publishing date
21 January 2025
F

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. 

Corresponding author: [email protected].

About the authors

  • Samantha Ajovalasit

  • Andrea Consiglio

  • Giovanni Pagliardi

  • Stavros Zenios

    Stavros Zenios is a Cypriot citizen with a long career in the USA. His current research focuses on sovereign debt issues, especially in relation to the challenges posed by climate change and political risks. He is working on the development of stochastic dynamic models for debt sustainability analysis and risk management for sovereigns, on sovereign contingent debt, and on the asset pricing effects of political risks. He has published more than 150 articles in leading academic journals, encyclopedias, and handbooks, and edited numerous collected works. He regularly appears on national media discussing issues relating to the economy, transparency and corruption and is consulted by the international press on Eurozone crisis issues. He was Vice chairman of the Cyprus Council of Economic Advisors and served on the Board of the Central Bank of Cyprus.  He served two terms as President of UNICA-Universities of European Capitals and two terms as Rector of the University of Cyprus.

    He is a Professor of Operations Management and Finance at Durham University (UK), on sabbatical leave from the University of Cyprus, where he has been a Professor of Finance and Management Science since 1991. Prior to that, he was a tenured faculty member at the Wharton School, USA, where he remains a Senior fellow of the Financial Institutions Center.

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