Quiz 21: International Lending and Financial Crises

Business

I agree to the reasoning that since governments cannot go bankrupt it is safe to lend to foreign governments. Sovereign defaults are situations where governments declare themselves to default and will not pay its debt obligations as we have witnessed in the past, however this will severely affect their ability to borrow in the future as other countries will refuse credit in the future. Besides this the country can also go into a banking crisis, an economic crisis and/or a currency crisis as internationally there is a chance of write off which urges the sovereign under debt to not default but only as a last resort which keeps the lenders confidence with lending to governments. Based on the various events we have witnessed like the Grexit or the crisis of 1980s, there were international agencies like IMF who came in agreement to restructure the deals and requested participation of other nations to deal with such disasters. As we have witnessed various types of crisis in the world occur, the international financial system also has pushed various methods to avoid any sort of default especially to fail the same way in the past crisis's.

To begin with, there were a dozen of developing countries who announced that it will be unable to repay large foreign debt. The reasons were mainly due to the tight monetary policy in the US due to a high inflation. While the real interest rates remained high, industrial countries went into severe recession, developing countries exports declined and commodities prices also plummeted. This also affected the repayment capability of various borrowers at such high interest rates. As a result, many smaller banks had to sell off the loans to be repaid and this took a toll on larger banks. The larger banks rescheduled debt repayment and loaned smaller amount out so that this could be repaid. As a result, private lending went down in this period as well existing long-term debt to developing countries doubled during the period making it an even more significant net loan to national product ratio.

In a case where an international tax set by one of the lending countries, especially if the country is having a market power this will lead to a gain to those countries which imposes a tax. In our case if the country imposes a 2% tax on international lending, provided the country has a market power the country's government will continue to pocket that tax making a new equilibrium with other countries and the world. However, in case all the countries with a market power impose tax on lending this could lead to an increase in international lending tax which will be at 4% in case there are two countries. In such a scenario the international lending will shrink as compared to a free lending position. This also proves that such increase in tax at most can only lead to a scenario where one country gains but most likely will lead to a scenario where both countries will suffer loss in the long run.