Official Sovereign Debt

Abstract

This paper studies sovereign debt from official lenders empirically and theoretically. We document that official sovereign debt is more than half of the total sovereign debt in emerging markets and tends to flow in during default episodes. We then develop a model in which a sovereign borrows from official and private lenders, can partially and selectively default on each, and faces bond prices that compensate for default losses. Official debt differs from private debt in that it is of longer duration and more concessional after a default. Default does not preclude borrowing, and episodes end when the sovereign repays accrued obligations and deleverages to sustainable debt levels. A main finding is that longer-duration official debt carries greater debt capacity because it can constrain future governments from borrowing and allows future pledgeable resources to strengthen its repayment incentives. Our model rationalizes the stylized facts, including that official debt flows in during defaults and the sovereign ends the episode with a portfolio of longer-duration official debt. Counterfactuals show that Pareto-improving voluntary swaps exchanging one type of debt for another can be feasible and provide guidance for the contractual design of official debt.