Sovereign Default and Public Debt: What role for Fiscal Rules?

Public debt has increased steadily over the years, leaving many countries at risk of debt distress and even pushing some to default. This paper analyses the impact of sovereign default on post-default debt-to-GDP ratios in 144 countries from 1980 to 2019. Applying the entropy balancing method, we provide robust evidence that sovereign defaults are associated with higher debt-to-GDP ratios. Furthermore, we find that the effect of default on debt is robust to alternative scenarios, empirical methods, and dynamic effects. We also provide evidence on the channels that underpin these findings and show that the impact of default on debt is through economic contraction (decreased economic growth) and reduced access to international financial markets. Finally, the findings show that both the presence of fiscal rules (and its constituent parts) and the strength of fiscal rules (that is, the credibility of the fiscal rules) are important in reducing the impact of default on debt. These findings underscore the importance of public debt management and domestic reforms to improve the long-term sustainability of debt. The findings also emphasize the importance of strong fiscal institutions and fiscal policy credibility in managing the complexities of debt accumulation.