Government debt crises and interest rate rises lead to 43 sovereign debt downgrades in the past year

- Insurers are seeing an increase in demand for contract frustration insurance

- Concerns that “cash strapped” governments might renege on commercial contracts

Sovereign debt worldwide has been downgraded 43 times in the last year, says global specialty (re)insurance group Chaucer*.

A combination of high inflation and rising global interest rates have led to increased concerns over the ability of a growing number of countries to pay their debts. Countries which have seen their government bonds downgraded in the past year include the United States, France, Argentina, Tunisia and Bolivia.

The rise in interest rates make it harder for governments to service their debts as they are having to pay higher coupons on new bonds and higher payments on index linked bonds – that can lead to an increased risk of default.

Governments with large amounts of dollar-denominated debt are in an even more perilous position as the strengthening value of the dollar over the last decade raises the cost of servicing that debt.

Increased concerns over the state of public finances globally have boosted the demand for contract frustration insurance, which insures businesses against non-payment or cancellation of contracts by Governments.

“When Governments find themselves under financial pressure, they are increasingly likely to breach contracts that they or other public sector bodies have with businesses. As a result of this uncertainty, businesses are increasingly seeking to mitigate the risk of contract cancellations by Governments and state-owned entities (SOEs) by ensuring that they have a safety net. Contract frustration insurance is thus a way for businesses to shield themselves from resulting losses.”
“There is far more interest in contract frustration insurance in countries around the BBB credit range. This was not the case even five years ago as these are regions that have traditionally been considered as being stable.”
Jonathan Bint
Senior Analyst and Underwriter

One area of increased demand is from investors backing infrastructure projects in emerging markets – a public sector body that is under financial pressure might be tempted to try and change the terms of the “offtake agreement” or other contractual payments they are meant to pay for use of that infrastructure development.

Heightened political instability across Western and Central Africa has unnerved businesses operating in the region. Coups in Niger and Gabon have increased concerns that sudden changes of government might also lead to public sector bodies reneging on contracts.

“Businesses find it particularly uncomfortable when there is a high risk of regime change in regions that they operate in. When control is shifting around between governments the risk of contracts being cancelled increases.”
Jonathan Bint
Senior Analyst and Underwriter

As the global economic outlook deteriorates, businesses caution over cancelled contracts is extending far beyond just emerging markets. Insurers are also seeing increased interest in contract frustration insurance for projects in emerged mid-size economies that are usually considered ‘safe’ investment destinations.

*Analysis of sovereign debt ratings data from ratings agencies Fitch Ratings, Moody’s and S&P Global Ratings, year ending October 30

Published on 08.01.2024