Concessional credit lines for sovereigns in financial distress

Title: Concessional credit lines for sovereigns in financial distress

Summary: This paper quantitatively assesses the macroeconomic effects of concessional credit lines for sovereigns in financial distress and shows how accessing credit lines could alleviate sovereign risk and contribute to macroeconomic stabilisation. 

Authors: Yasin Mimir (ESM), Yasin Kürsat Önder (Ghent University)

Abstract: In a world with high public debt and frequent external shocks, crisis prevention is less costly than crisis resolution, highlighting the importance of sovereign access to credit lines during financial distress. We assess the macroeconomic effects of concessional credit lines in a quantitative endogenous sovereign default model. The government can issue non-contingent long-term debt and access concessional credit lines from international financial institutions only during financial distress. These credit lines are long-term, non-defaultable, have grace periods and extended to countries with sound economic fundamentals. Our model, calibrated to Portugal, a representative small open economy in the euro area, shows that credit lines of 10% of GDP, if fully used when drawn, reduce sovereign spreads by 120 basis points and halve the default risk in response to exogenous shocks that increase the government’s gross financing needs. Although credit lines improve household welfare by alleviating default concerns when first introduced, grace periods may slightly increase long-term debt and spreads if not combined with the enforcement of fiscal rules.

Non-technical summary

Disclaimer: This Working Paper should not be reported as representing the views of the ESM. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the ESM or ESM policy. No responsibility or liability is accepted by the ESM in relation to the accuracy or completeness of the information, including any data sets, presented in this Working Paper.

Keywords: Sovereign debt, default, credit lines, grace period, stigma premium

JEL codes: E44, F34

Source: European Stability Mechanism | Working Paper Series | Volume 2025 | No. 70 | April 2025 | 31 Pages
 

Copyright © European Stability Mechanism, 2025 | All rights reserved. Any reproduction, publication and reprint in the form of a different publication, whether printed or produced electronically, in whole or in part, is permitted only with the explicit written authorisation of the European Stability Mechanism.