A country defaults occur when a country is unable or unwilling to pay the debts on due time. Though country defaults happen rarely, it is not an unusual scenario. From 2000 to 2022, countries like Argentina, Greece, Venezuela, Ecuador and Sri Lanka defaulted on their debts.
The causes of country defaults vary from nation to nation. The main reasons can be a political disorder, high debt, economic stagnation, banking crisis, and mismanagement of funds. Before we go on to know what happens when a country defaults, let’s take a quick look at what a country default is to understand it properly.
What Is Meant By Country Default?
Consider this example to understand the individual or business default. For instance, you take a loan from a bank to build your home. You must pay this money back with interest in the next few years in installments. The installment period, legal processes, and other things differ based on your financial conditions.
You may have to pay an installment every month, or you can pay a portion of the loan every year. It all depends on the creditor and your financial situation. Let’s say you failed to pay your installment after some time due to your bad financial condition. What will happen then? You will receive calls from the bank to pay the installment. You will get letters, and even the officials will visit your house.
If you are unable to pay the required amount after some time, the bank will sell your property to recover their money. Now, you have no home and no money. So technically, you are bankrupt or defaulted at this point. The next time you go to a bank to request a loan, they might hesitate to grant your request and may charge higher interest due to your bad economic situation.
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If a company or business defaults on its debt, its ratings go down, and its stock market value starts decreasing. The company has to sell its assets to pay the debt, making it difficult for them to start a new business.
Country default is the same as an individual or company default, but it is much more complicated. Political instability, legal risks, economic growth periods, and other things affect a country’s economy. A nation requires money to pay previous debts, make roads, hospitals, schools, and a lot more. When a country gets a loan from a creditor and cannot pay the debt on time, it is known as a default. The government gets 30 more days to pay the debt, and if it is still unable or unwilling to pay the debt, the country is officially in default.
A sovereign default happens due to various reasons like a weak economy, high debt accumulation, chronic stagnation, political instability, and poor financial management. A recession or a pandemic can increase default risks.
There are two different kinds of defaults: technical default and contractual default. Technical default can occur due to a problem at the backend, and it does not have any long-term consequences. A technical default occurred in 1979 in the U.S., but payments were made within a few weeks, so everything went back to normal.
A contractual default, on the other hand, has different consequences. It happens when a country doesn’t pay the debt even after the 30-day grace period. As of now, you are familiar with country defaults; let’s move forward to learn what happens when a country defaults.
What Happens When A Country Defaults
The consequences of a default are not the same for every country because every sovereign reacts to a default differently. One thing remains the same for almost every country that they are not able to get loans from other countries or banks. Even if they get a loan from a creditor, they will have to pay a higher interest.
The value of a defaulting country’s economy decreases to a great extent, creating a lot of problems. The imports become too expensive, and exports become cheaper. The export business has to suffer a lot during this period. Foreign countries tend to buy more and more products from a defaulting country because they are way cheaper than before. In this period, the export business touches the sky, which positively affects the country’s economy.
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A defaulting country can also ask for a restructuring loan, which means extending the debt payment date or reducing the total payment. A country’s default can severely affect the lives and living standards of people in that country. A bank crisis can also happen as people want to withdraw all their funds to avoid losses. In such cases, the government usually closes all the banks to stop money withdrawals.
The stock market may crash in a defaulting country becomes no one will want to buy any stocks. GDP growth decreases, and the country loses its reputation all over the world. The output or revenue generation can be forgotten for a few years in a defaulting country. Unlike individual or business default, the property of a country cannot be repossessed, but there is a threat of invasion from other countries in this situation. This happened once in 1880 when Egypt defaulted, and Britain tried to occupy it.
Is Pakistan About To Default?
Covid-19 and the political crisis in the past few years have brought a lot of problems to Pakistan’s economy. Now, there is a thought that Pakistan is about to default as it is unable to pay its debt. But it is not true. A country defaults only when the government is unable to pay the debt or declares that it will not pay the loan in due time.
For now, everything is under control. Pakistan has not declared that it will not pay the debt; instead, they have said it will pay all the debts on time. Pakistan takes the loan in dollars and has arranged the payment for the current cycle. But now, the State Bank of Pakistan has run out of dollars, which is a serious problem for a country like Pakistan that runs on dollars. Pakistan has to import petroleum, gas, oil, wheat, and other products, and that too in dollars.
SBP has no dollars now, so they charge 8% more to confirm the payment. Pakistan’s currency is also losing value against the dollar, which will create even more problems for the government to pay the debts in 2024. So, for now, we can say Pakistan is no longer at default risk, but the coming years can be difficult.
Pakistan is trying to get loans from IMF and other donors to balance things. But things can get worse if they can’t get the loans from these donors.
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A country default is not surprising as it can happen to any nation due to various reasons like financial mismanagement, a corrupt government, a pandemic, economic stagnation, and more. The defaulting country has to suffer a lot for a few years before it is able to stand on its feet again.