The Coming Sovereign Debt Crisis

By Nouriel Roubini and Arpitha Bykere

In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to foes. The severe recession, combined with a financial crisis during 2008-09, worsened the fiscal positions of developed countries due to stimulus spending, lower tax revenues and support to the financial sector. The impact was greater in countries that had a history of structural fiscal problems, maintained loose fiscal policies and ignored fiscal reforms during the boom years. Going forward, a weak economic recovery and an aging population is likely to increase the debt burden of many advanced economies, including the U.S., Britain, Japan and several eurozone countries.

In 2008 and 2009, the decisions by these governments to do "whatever it takes" to backstop their financial systems and keep their economies afloat soothed investor concerns. But if countries remain biased toward continuing with loose fiscal and monetary policies to support growth, rather than focusing on fiscal consolidation, investors will become increasingly concerned about fiscal sustainability and gradually move out of debt markets they have long considered "safe havens."


Most central banks will withdraw liquidity starting in 2010, but government financing needs will remain high thereafter. Monetization and increased debt issuances by governments in the developed world will raise inflation expectations. These governments will have to offer higher real yields or investors will move to more attractive emerging markets. Some countries will continue to witness increased credit default swaps. Higher yields and interest cost on debt will also hurt economic growth—by crowding out private consumption and investment, and reducing government's productive spending. Several factors will likely influence investors' perception about sovereign risk—a country's debt financing ability, its status as a "safe haven" relative to other developed economies, politicians' commitment to undertake fiscal reforms, exchange rate movements, and the debt maturity structure.

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Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics. Arpitha Bykere is a Senior Research Analyst at RGE.