International Sovereign Spread Differences and the Poverty of Nations

Farzana Alamgir and Alok Johri

Department of Economics Working Papers from McMaster University

Abstract: We find that national poverty head-count ratios and country default risk (measured as sovereign bond spreads) are positively correlated. For example, a nation with 40 percent of the population below the poverty line faces an average spread that is 120 basis points higher than a nation with 10 percent of extremely poor households. This correlation is robust to controlling for a number of variables including the country’s debt, Gini coefficient and its per capita GDP. We build a sovereign default model to help explain this correlation which incorporates two types of households – those earning average income and those at the poverty line. The government runs a social safety net which taxes the average income household in order to transfer consumption to the poor. A political constraint which ensures that all households wish to participate in the safety net program constrains the fiscal choices of the government. The novel aspects of the model are calibrated using South African data on household income dynamics, its poverty line and aggregate social transfer rate while the usual calibration targets in the literature are also deployed. A variant of this benchmark economy with more poor households displays higher default risk than the benchmark economy. The interaction of international borrowing terms with the social safety net and with the political constraint account for this result. Political defaults occur when the non poor find the safety net too weak to support and this occurs when too large a fraction of taxes will be needed for debt repayment. These political defaults raise overall default risk relative to a model with non-political defaults and they occur more often in economies with a larger proportion of poor households. We show that the correlation between the proportion of poor and level of spreads in the model is not driven by the increase in inequality implied by increasing the proportion of poor households. We also show that the worse borrowing terms faced by the economy with higher poverty come with welfare losses due to the lower debt that it can afford and that it would default much less frequently if it faced the same terms as the low-poverty economy.

Keywords: sovereign default; country spreads; poverty rates (search for similar items in EconPapers)
JEL-codes: F34 F41 G15 H63 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2022-10
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:mcm:deptwp:2022-06

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