Later, all the waves of lending to foreign governments in the 1870s, in the late 1920s, in the 1930s, in the 1980s and in recent years were seen with at least some occurrence of repayment breakdown.
[3] Rogoff, Reinhart, and Savastano indicates that serial default is only loosely related to countries’ indebtedness levels and other fundamentals.
Permanent exclusion from international capital market (Eaton and Gersovitz)[4] or random re-entry rules which are not price-dependent (Aguiar and Gopinath)[5] (Arellano)[6] are regarded as the crucial ways to punish and restrict the borrowers’ decision to choose default in early literature.
[5] From these literatures, it is clearly that countries with more volatile and persistent output shocks are more likely to face higher spreads (lower debt issuing price) and thus more likely to fall into default traps.
Although borrowers can get fresh lending again, they need to pay higher interest rates than the case they did not default in the past.
As a result, the ratio of debt to expected output increases and induce a higher probability of future default.
Rogoff, Reinhart, and Savastano supported this relationship by tracing a history of default back to 1820s.
From the 1970s to 2002, the 9 Latin American default countries like Argentina, Brazil, Chile, Colombia, Egypt, Mexico, Philippines, Turkeys and Venezuela had their average institutional investor ratings (approximate as repayment probability) as 39.4 and average debt to GNP ratio as 44.1, while the no default countries like India, Korea, Malaysia, Singapore and Thailand had 61.8 as their repayment probability and 27 as average debt to GNP ratio.
De Paoli, Hoggarth and Saporta demonstrated the relationship between external debt-to-GDP ratio, bond spreads and credit ratings in figure1.
After president De La Rua resigned on December 20, 2001, Congress appointed Rodriguez Saa as the interim president on December 23, 2001, and the next day, Rodriguez Saa announced the suspension of all payments on debt instruments (similar to default), which was linked to a decline in sovereign bond prices (post-default spreads lower than pre-default spreads).
Policymakers in emerging markets need to internalize the country-specific “safe” debt threshold which depends heavily on the country's default and inflation history.
Other factors from economic, political and institutional perspectives are also needed to be considered to find the safe debt threshold.