Abstract: Sovereign default and restructurings should, in theory, lead to creditor punishment through higher borrowing costs or capital market exclusion. However, empirical evidence shows that punishment is inconsistent and not uniform across defaulters. We argue that this disconnect can be explained by examining the role of geopolitical relationships, particularly with the United States, in shaping sovereign credit outcomes. US support conditions the expectations of both borrowers and creditors by providing a fiscal cushion and subsidized insurance. This dynamic incentivizes supported states to engage in riskier financial behavior, increasing their likelihood of default. Paradoxically, post-default US support continues to signal a greater ability to pay compared to non-supported states, reducing creditors’ incentives to punish. Using data on commercial defaults from 1970 to 2012, we find that states with higher levels of US support are more likely to restructure their debts. After restructuring, these states face lower borrowing costs and experience shorter periods of exclusion from bond markets. Our findings highlight how international political dynamics shape both the likelihood of default and subsequent market reactions, contributing to our understanding of the complex interplay between geopolitics and sovereign debt.
Moderator: Maggie Peters