Eli5 How does defaulting on debt effects a country?


For instance recently Srilanka defaulted and i would like to understand how has their situation changed after the default announcement as compared to how it was lets say a month before the default?

In: 17

Your credit rating turns to shit.

It’s the same as if I lend you money and you default. I most likely won’t lend you money again and I’ll tell our friends not to lend you money either. Even if we do lend you money, we’re going to charge you high interest to compensate for the risk.

You can’t get money easily now, so you can’t buy a car or a house as easily. Your quality of life decreases.

Same with Sri Lanka. Investors won’t pour money into the country, development of infrastructure (and businesses) slows, less tax revenue, higher unemployment, lower quality of life for the citizens.

I should add that Sri Lanka currently has a 30 day grace period to figure out how to pay though. So shit won’t completely hit the fan until they go past this preemptive default.

Countries dont live in a void.

They trade with other countries, and for that they need to exchange their local currency for a external banking corrency, Dollar, Euro, Yuan, Ruble…

also countries have to finance public works, products, spending, the idea is that if everything goes well, the money comes back in the form of taxes, tarrifs, levys,

You build a road, people use those roads to take their goods to the markets, or go to work, so they generate wealth which they pay taxes on,

Or you build a port, so people export and import stuff, that means customs tarrifes, it means more jobs since you´re manufacturing, it means jobs in the dock.

so countries take on loans, they can be external loans from international banks, world bank, IMF,

They can be internal loans, like issued goverment bonds anyone can buy.

Now if the goverment fails to repay these loans it can bring upon several effects.

– Your currency becomes worthless on an international market since its not trusted and theres no backing for it, so its hard to buy euros, dollars, yuans… so importing becomes very hard.

– No one will buy your debt, so future financing becomes very hard, basically no one will loan you money.

– your external reserves and goverment property aboard can be repoed, usually diplomatic property (embassy and consulate equiptment and vehicles) are protected by diplomatic immunity, but other goverment property like imports awaiting delivery, millitary equiptment, private planes, currency and precious metal reserves in forigne banks, stuff like that can be expropriated. there was a case with Christina Kitchner, President of argentina at the time which had to take commercial flights becuase if she took the official presidental plane outside argentina, it would be expropriated. then again Argentina is a never ending cycle of corruption.

TL;DR : basically your money becomes worthless, no one loans you money ever again, and any of your property that goes outside the country can be expropriated.

The way most international trade is conducted, financial instruments don’t actually change hands. That is, if a country asks for three million dollars in food aid, the lender doesn’t transfer three million dollars into a bank account somewhere; instead, it’s (generally) part of a package of inter-government trade and investment deals and import/export arrangements that runs its course over a few months or years.

A country that defaults on its obligations will often find it harder to negotiate future trade agreements with their lenders, or re-negotiate existing deals; they haven’t completed their end of the current deal, and chances are they won’t be able to do so for a long time, so the terms of a new arrangement are likely to be less favorable for them.

In terms of the actual effect defaulting will have on a country’s economy: in the short term there won’t be that much of a problem; prices for various commodities may rise a bit, imports may be a bit more expensive, and export tariffs may be placed on certain goods so the government can collect some money and start paying off their debts through trade.

In the longer term, it gets a bit more problematic. You can’t just keep slapping tariffs on everything forever, and *nobody* likes having to pay higher taxes for any longer than necessary. Your international colleagues *may* choose to forgive *some* of your debt, but probably not *all* of it, and again, they’re probably not going to be willing to give you such a good deal the next time you come to the negotiating table.

That’s about as ELI5 as I can get. 🙂

Default on debt means you can’t pay back the money you owe. It’s kind of like going bankrupt for a business or a person.

Now what does that mean ? Well in simple terms it means what you think it means. The country that defaults keeps the money it owes and no one wants to give this country money again.

Just like if a person goes to the bank and asks for a loan that they then can’t repay, the bank won’t give them money again.

Now it is a bit more complex than that. Default also means that assets of this country can be seized to back back the loan etc.

Usually most countries care about the US financial system and paying the loans it owes to it. But a country doesn’t have to take loans just from the US. It can be loans from citizens etc. so not all defaults are the same.

Another interesting thing about defaults is what’s happening in Russia right now. Russia will likely soon have a default on a loans it owes to US creditors, but only because US governments won’t allow Russia to make a payments. That’s right. It’s like you wanting to return your loan to the bank but the banks saying no you can’t do it. And then arresting you for missing payment. Its very strange but in Russia’s case this “default” won’t scare away investors from let’s say China. Because they know Russia can pay back. They don’t just because the US doesn’t let them.

Btw the loans that countries take are called obligations or sovereign debt. And the interest on these depends on how likely the country is to default among other things.

If you don’t pay back your debts, then *everyone knows you don’t pay back your debts*.

If your friend borrowed money from you, promised to pay it back, didn’t pay it back, and then asked to borrow more…would you give them more money? Probably not. Same situation here – once a country defaults, no one will lend them any more money – which probably means they’re screwed, because they’re already out of money to begin with.