Sovereign debt downgrades grow as inflation bites

Sovereign debt worldwide has been downgraded 78 times by the top three ratings agencies (Fitch, Moody’s and S&P Global) in the last year, compared to 58 downgrades that sovereign debt received in the previous year, according to Chaucer.

Rising interest rates, inflation and a stronger dollar have led to increased concerns over the ability of an increasing number of countries to service their debt. Countries which have seen downgrades in the past year include Mexico, Turkey, Chile and Sri Lanka.

The worsening outlook for heavily indebted nations has already led to one default this year, when Sri Lanka failed to meet its debt payments in May.

The Sri Lanka default was caused by the Government’s decision to stop paying its mounting debts in order to conserve its foreign currency reserves for the importation of vital materials, including fuel.

Jonathan Bint, senior analyst & underwriter at Chaucer says: “More and more countries are struggling to pay their bills, which makes it ever more likely they will cancel or seek not to pay contracts with businesses.”

Due to the uncertain global environment, businesses are increasingly looking to mitigate the risk of contract cancellation by governments. Insurers are therefore seeing increased demand for contract frustration insurance as businesses seek a safety net.

Delayed or cancelled megaprojects

One area of demand is from private equity investors supporting infrastructure projects in emerging markets who are now looking to additional insurance against potential losses caused by governments cancelling infrastructure projects.

Other businesses which are particularly concerned about suffering losses as governments come under financial pressure include construction companies with contracts related to infrastructure projects, as well as the energy and mining sectors.

Jonathan Bint says: “As the increase in sovereign debt downgrades suggests, the risk of losses from cancelled government contracts is likely to grow further.

”Even countries such as the UK have been known to cancel major commercial contracts during times of economic stress. Contract frustration insurance is a way for businesses to shield themselves from subsequent losses.”