Crypto popularity across EU nations
Countries with the highest default risk in 2022
In May 2022, the South Asian nation became Sri Lanka defaulted on the debt for the first time. The country’s government was given a 30-day deadline to cover $78 million in unpaid interest, but ultimately failed to pay.
Not only does this affect Sri Lanka’s economic future, but it also raises an important question: which other countries are at risk of default?
To find out, we used data from Bloomberg to rank the countries with the highest default risk.
Sovereign Debt Vulnerability Ranking
Bloomberg’s Vulnerability rating for sovereign debt is a composite measure of a country’s default risk. It is based on four underlying calculations:
- Government bond interest rates (the weighted average yield on the country’s dollar bonds)
- 5-year spread for credit default swaps (CDS).
- Interest cost as a percentage of GDP
- Government debt as a percentage of GDP
To better understand this ranking, let’s focus on Ukraine and El Salvador as examples.
| Country | Rank | Government bond Dividend (%) |
5-year CDS spread | Interest expense (% of GDP) |
National debt (% of GDP) |
|---|---|---|---|---|---|
| 🇸🇻 El Salvador | 1 | 31.8% | 3376 bps (33.76%) |
4.9% | 82.6% |
| 🇺🇦 Ukraine | 8 | 60.4% | 10,856 bps (100.85%) |
2.9% | 49% |
1 basis point (bps) = 0.01%
Why are Ukraine’s bond yields so high?
Ukraine has a high default risk due to the ongoing conflict with Russia. To understand why, consider a scenario where Russia were to take control of the country. If this happened, it is possible that Ukraine’s existing debt obligations will never be repaid.
That scenario has led to a sale of Ukrainian government bonds, pushing their value down to nearly 30 cents on the dollar. This means that a bond with a face value of $100 can be bought for $30.
Because interest rates move in the opposite direction to price, the average yield on these bonds has risen to a very high 60.4%. As a point of comparison, the yield on a US 10-year Treasury bond is currently 2.9%.
What is a CDS spread?
Credit default swaps (CDS) are one type derivative (financial contract) which provides a lender with insurance in case of default. The seller of the CDS represents a third party between the lender (investors) and the borrower (in this case governments).
In exchange for receiving coverage, the buyer of a CDS pays a fee known as spread, which is expressed in basis points (bps). If a CDS has a spread of 300 bps (3%), this means that to insure $100 of debt, the investor must pay $3 per year.
Applying this to Ukraine’s 5-year CDS spread of 10,856 bps (108.56%), an investor would have to pay $108.56 each year to insure $100 in debt. This suggests that the market has very little faith in Ukraine’s ability to avoid default.
Why is El Salvador ranked higher?
Despite having lower values in the two metrics discussed above, El Salvador ranks higher than Ukraine due to its larger interest expense and total national debt.
According to the data above, El Salvador has annual interest payments equivalent to 4.9% of GDP, which is relatively high. Compared to the US again, US federal interest costs were 1.6% of GDP in 2020.
Overall, El Salvador’s outstanding debt is equal to 82.6% of GDP. This is considered high by historical standards, but today it is actually quite normal.
The next date to watch will be January 2023, as this is when the country’s $800 million government bond matures. Recent research suggests that if El Salvador were to default, it would experience significant, but temporary, negative effects.
Another hot topic for El Salvador: Bitcoin
In September 2021, El Salvador became the first country in the world to adopt bitcoin as legal tender. This means that Bitcoin is recognized by law as a means of settling debts and other obligations.
The The International Monetary Fund (IMF) criticized this decision in early 2022, calling on the country to revoke legal tender status. In retrospect, these warnings were wise, as Bitcoin’s value has fallen with it 56% year to date.
While this is not directly related to El Salvador’s default risk, it opens up potential opportunities for mitigation. For example, major players in the crypto space may be willing to help the government keep the concept of “nation-state bitcoin adoption” alive.
