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My Introspective

by Laurus Nobilis
My BrainCast

Strategic Management

How Can State Bankrupt? (I)

 

State Bankrupt

 

What causes the state to declare bankruptcy? What are usual symptoms of bankruptcy?

 

Posted: May 2010


"They say that states cannot go bankrupt", recently told German Chancellor Angela Merkel. And after a short pause added: "This is not true." Country declares bankruptcy when they cannot meet its obligations. State debts balloon was last bubble that could burst.

The consequences are painful for the entire population because of bankruptcy, following a strong reduction of the standard of living due to unemployment and inflation, loss of savings and the weakening currency

In the blackest scenario it means that citizens have to pay health care services and scholarships from their pockets. They need to rely on the savings.  Civil servants positions are not secure any more. The guarantee of the state-bank for the savings in commercial banks is not worth much. It also means the increase of crime because the state cannot provide the same quality of public services as before bankruptcy, and this is reflected in quality of police work. Since citizens feel less secure, the social unrest and anarchy is more probable. State, of course, is not bankrupt in the classical sense, but simply revealed the inability to pay for its financial obligations. This means the government cannot pay its obligation toward foreign loans, but also cannot timely and fully pay for the salaries of governmental employees. Pensions are in jeopardy too.

Bankruptcy of the country means that it is no longer capable to service outside debts. Domestic and foreign banks are no longer willing to finance the government. The government budget is functioning with the minimum amount. The private sector is avoiding risks of investments and is trying to minimize activities, in order to reduce risks. The salaries, pensions and social welfare are reduced. State slips into a deep recession, thereby further reducing the possibility of its internal funding.

The consequences for the state are different from those for citizens or legal entities, as the country's sovereignty prevent the possibility of seizing of assets or income. Greece cannot be saved from the abbeys of the bankruptcy by seizure of islands, along the population, as was the case with Alaska. Russia sold Alaska to Americans together with local population.

Confiscation of property by creditors is not possible since there is no mechanisms neither courts for such decisions. The state that declares bankruptcy decides what to do next. State can sell the property to repay debt or can take another loan to repay previous debt.

Bankruptcy of the country means that it is no longer capable to service outside debts. Domestic and foreign banks are no longer willing to finance the government. The government budget is functioning with the minimum amount. The private sector is avoiding risks of investments and is trying to minimize activities, in order to reduce risks.



There is no international legal mechanism that would verify the fact that some state bankrupted.  Also, there is no bankruptcy courts that would process the bankruptcy process. Who than declare bankruptcy? It is up to individual state to declare bankruptcy and to inform creditors that they will not be able to continue paying debts. It is a political decision of the state to inform other states, private banks and other international institutions. For example, the Mexican government informed US about bankruptcy, during the crisis at the end of 80s and beginning of 90s.

The declaration of bankruptcy is formal act, since everybody knows that some state bankrupted. The state that declared bankruptcy is still lead but its government, but it is usual that the government is changed, since bankruptcy is usually followed by political crisis that leads to change of government.

How do we know when the state is close to bankruptcy? There are several important warnings. First warning is the share of deficit and public debt to GDP and growth rate of debt. The second is the ability to service debt, the solvency of the state and the interest rates at which the state still can borrow in the country and abroad. The third is economic growth and competitiveness, especially in foreign markets. Important information can be seen from social sustainability of the system and political stability. 

 

 

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