Vol 8 (2011) - Issue 5

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Can Countries Go Bankrupt?

1. Introduction

The recent financial crisis of 2007 has brought the issue of sovereign bankruptcy back to the forefront of the international community. With the collapse of the banking system and governments assuming private liabilities, there has been a migration of private debt to the public sector. This migration of debt has subjected the public finance of countries to severe economic pressure and raises concern of whether sovereigns have the ability to sustain their existing and increasing debt obligations. There is no doubt that sovereign debt if utilised properly 'can have positive effect on the economy' but when such debt becomes unsustainable due to overborrowing or lack of proper utilisation, it can lead to payment imbalance, budgetary deficit and eventual default.

Walter Wriston, the former CEO of City Bank, believes that sovereigns will always have the ability to meet their debt obligations. He argues that 'countries don’t go bankrupt since their assets always exceed their liabilities, which is the technical reason for bankruptcy'.

In contrast to his view, Adams Smith believes that 'when it becomes necessary, a State should declare itself bankrupt in the same manner as when it becomes necessary for an individual'. Furthermore, Wolfang Shäuble, the German minister of finance, while commenting on the 'emergency liquidity aid' provided to some European Union (EU) countries stated that 'it must in principle still be possible for States to go bankrupt'.

The two different views expressed above represent the debate among legal scholars as to whether a country can go bankrupt. This paper will contribute to this debate by examining from a practical and legal perspective, the possibility of a country going bankrupt.

First we will consider how government debt works by discussing the underpinning issues in sovereign bankruptcy, a distinction between sovereign default and bankruptcy will be made. Secondly, the statement made by Walter Wriston will be examined by making reference to practical and historical examples to determine if sovereigns can go bankrupt. Thirdly, the lack of any legal mechanism for dealing with sovereign bankruptcy and the practical difficulty of applying existing principles of bankruptcy to sovereigns will be discussed. Finally, this paper will conclude by establishing that legally sovereigns do not go bankrupt but practically it is possible for them to do so.


2. Underpinning issues in sovereign bankruptcy

In order to effectively determine if sovereigns can go bankrupt, it important to understand how public (government) debts work. Sovereign debt can be defined as 'any debt obligation of or guaranteed by an autonomous government' and such debt obligations can be domestic or external. Reinhart and Rogoff distinguish domestic and external debt by categorising them into:

1. Government domestic debt: 'are debts issued under and subject to national jurisdiction, regardless of the nationality of the creditor or the currency denomination of the debt; therefore, it includes government foreign-currency domestic debt'.