The UK and US are among the top five countries which saw the biggest increase in the average cost of insuring against sovereign debt defaults in the past year, according to global specialty (re)insurance group Chaucer.
Chaucer’s research suggests the cost of Credit Default Swaps (CDS) has seen a large increase in the past year amidst global economic volatility, reflecting concern by investors that countries may default on sovereign debt.
“CDS are used to ‘insure’ against a default on the debt of a third party, including a government,” the firm explains.
Chaucer notes that the UK saw the third largest increase in the cost of CDS, with a 106% spike over the last twelve months, adding that the prospect of further interest rate rises to quell stubbornly high inflation has “alarmed” investors, who remain wary of the UK’s economic prospects.
The firm continued, “The yield on ten-year bonds recently soared to above 4.5% – the highest levels since the peak of the Global Financial Crisis, whilst the country’s debt pile exceeded GDP for the first time since 1961.”
Meanwhile, the US, which saw an 85% increase in CDS, narrowly avoided a debt crisis and potential default, as an agreement to suspend the debt ceiling until 2025 was struck.
The biggest riser in Chaucer’s study, Pakistan (255%), has been hit by the devaluation of its currency, the rupee; political instability following the expulsion of Imran Khan as prime minister; and devastating flooding, says Chaucer.
Ecuador, in second place, with a 243% increase in CDS cost, has also experienced political turbulence in the past year.
Chaucer suggests that global economic instability has increased demand for political risk insurance, particularly for corporates operating in countries where there is a higher risk of governments defaulting on national debt.
Jonathan Bint, Senior Analyst and Underwriter at Chaucer, said, “The risk of defaults is not just confined to developing countries. Major global economic players are increasingly facing the prospect of prolonged economic difficulty.”
Chaucer’s research also found that other forms of insuring against government default, such as ‘contract frustration insurance’, have seen costs rise in the past year.
Governments facing recessions are more likely to cancel corporate contracts to reduce their spending, says Chaucer, adding that ‘Contract frustration insurance’ offers protection for companies that suffer losses in the event of a counterparty failing to deliver on a contract.
Bint went on, “Although the likelihood of countries such as the UK or US actually defaulting on their debt obligations is low, that’s not to say that there is no financial risk for creditors. Contract frustration insurance can go some way towards allaying fears amongst corporates.”
