Unique Features Of Sovereign DebtBy Dr Sampson O. Amoafo - Daily Graphic
4/25/2012 8:01:16 AM -
What is the basic difference between sovereign and corporate debt?
A major difference is that corporate debt is issued by a private entity; whiles sovereign debt is issued by a public entity (local, municipal, regional or national government).
Technically, sovereign debt has a backing or guarantee from a nation; it is therefore, unlike every other kind of debt.
A very important characteristic of a sovereign debt is that the people who borrow the money or contract the loan are not always the same people who must pay it back. Beneath this fact are grave risks and heavy responsibilities.
Separating the sweetness of borrowing money from the bitterness repaying it contradicts a basic principle of justice – which stipulates that the consequences of an act should be borne by the actor, not on an innocent third party.
Unfortunately, sovereign debt violates this principle. One group of citizens (those who have not yet been born or reached voting or taxpaying age) will eventually be taxed to repay a debt incurred by another group (the contracting citizens).
The temptation this presents for a politician is nearly irresistible. The beneficiaries of today’s borrowing do vote in the next election; however, the eventual payers of the debt do not.
Thus, the people who would most logically urge restraint and moderation in sovereign borrowing matters remain, at the time of the borrowings, mute and disenfranchised as a consequence of the lateness of their birth.
No one is likely to object, if the benefit will itself remain and contribute to the welfare of the future generations that will need to repay the accumulated debt.
For example, a bridge or a dam, a road network or public waterworks and sanitation are projects that contribute to societal welfare, to growth and development, as well as, it is long lasting if well maintained to benefit the payers of the debt.
The crux of the debate is the non-productive nature of the colossal fiscal stimulus policies being implemented by many countries, borders instead on state borrowing to cover large and chronic budget deficits, or to finance items such as discretionary bailouts of failing commercial enterprises, pay gargantuan judgment debts, rather than to shore-up existing infrastructure which contributes to development.
Now, it might be argued that similar issues are raised whenever a legal “grey-area” like a state or a corporation borrows money.
By law, the entity is a legal being that can sue or be sued, and therefore, a debt that is contracted by such an entity does not belong to its constituent members (shareholders).
By the time a corporate debt falls due in the future, for example, the board of directors, the management and the stockholders who were present at the time of the incurrence of the debt may have all gone.
This analogy between borrowings by sovereign countries and by corporations can be broken down along three areas:
• First, any new shareholder of the corporation makes a voluntary decision to buy the stock of the company. Due diligence by a prospective investor will reveal the company’s financial position. However, individuals do not elect the location of their birth. By the very act of being born, a person involuntarily assumes a responsibility for repaying the debts of the nation in which that event occurs.
• Second, shareholders have direct means of monitoring and disciplining corporate managers in matters such as contracting of debt. The accountability of government officials to their citizens is in many countries far more mute.
• Third, the law in many countries imposes duties on corporate managers and directors to avoid self-dealing and to exercise prudent business judgment in carrying out their responsibilities. Under some legal systems, individual officers or directors can be held personally liable for corporate failings of certain kind. On the contrary, government officials do not usually operate under similar legal standards.
Sovereign borrowing raises fundamental questions of political philosophy. In what relationship do government officials stand vis-à-vis the nation and its citizens when the officials enter into contracts that bind the nation to future obligations? Are the government officials the agents of, or trustees for, the citizens? And can one be an agent of a principal (a future generation of citizens) that is not yet in existence?
Much may turn on whether this agency characterisation is more than just symbolic. An agent owes a fiduciary duty to its principal, the highest form of duty. Any type of self-dealing by the agent is inconsistent with this duty. Moreover, a third party that colludes in a breach of this duty by the agent has forfeited any right to enforce the resulting contract against the faithless agent’s principal.
Again, an argument could be made that the managers and directors of a corporation stand in a similar relationship to their principal, the company and its shareholders. The difference is that a body of domestic law will usually delineate this relationship in the corporate context and will prescribe the legal consequences for third parties if they knowingly deal with corporate managers who are breaching their duties to the company.
Most people lend money with the objective of making money. The loan itself may be ill-conceived, shallowly researched and badly structured, but at least the motivation for it is usually straightforward – profit. Not all loans to sovereign borrowers are this simple.
The most common form of sovereign financing that results from an mixture of lender motivations is a bilateral (government-to-government) credit granted for the purpose of stimulating exports of capital goods from the creditor country, acquiring geopolitical influence over the debtor, assuring long-term access to raw materials or energy supplies or inducing the borrower to purchase military hardware from the lender.
A lender’s fear of not being able to recover a credit granted to a sovereign or a corporate borrower is an altogether salutary emotion. It engenders caution on the part of the lender. It counsels diligence in investigating the debtor’s capacity and willingness to pay. Most importantly, it sits on one of the lender’s shoulders and whispers “beware” at the very moment when an imp on the other shoulder is probably muttering the word “bonus”.
However, a bilateral lender with mixed motivations will be at least partially sedated to these fears. Such a lender will have accomplished some of its objectives in making the loan (securing geopolitical influence, stimulating exports or locking in access to natural resources) even if the money is not repaid on time. This can be a uniquely harmful aspect of lending to sovereigns because it tends to promote over- ending/borrowing.
In conclusion, there are basic differences between sovereign debt and corporate debt. Among the basic differences are the responsibilities of those contracting the debt, objectives of extending and contracting the loan, the agent-principal relationships and responsibilities, etc.
The writer is an economic consultant and former Assistant Professor of Finance and Economics at Alabama State University. Montgomery, Alabama. firstname.lastname@example.org