What is the meaning of debt crisis?

Written by walter johnson
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A debt crisis deals with countries and their ability to repay borrowed funds. Therefore, it deals with national economies, international loans and national budgeting. The definitions of "debt crisis" have varied over time, with major institutions such as Standard and Poor's or the International Monetary Fund (IMF) offering their own views on the matter. The most basic definition that all agree on is that a debt crisis is when a national government cannot pay the debt it owes and seeks, as a result, some form of assistance.

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The Bond Market

Standard and Poor's rates economic entities in terms of their credit worthiness. Credit worthiness internationally can be measured, among other ways, by following the divergence between long-term and short-term bond prices adhering to a specific country. Standard and Poor's defines debt crisis formally as the divergence between long- and short-term bonds of 1000 base points or more. Ten base points equal a 1 per cent rate increase. Therefore, if the interest rate on long-term bonds is 10 per cent above short-term bonds, the country is in a debt crisis. Less formally, this means that investors in international bonds see a country as failing economically. Therefore, the long-term prospects of the relevant national economy are bleak, meaning that the rate for long-term bonds rises quickly.

Default and Rescheduling

The International Monetary Fund, in its substantial literature on debt, rejects the concept of default as an important part of a debt crisis. This is because since Ecuador's default in 1999, there have been few of these. Banks are interested primarily in avoiding default, which would mean the total write off of the loan. Instead, banks want to see at least a portion of their money returned. Therefore, the IMF sees debt rescheduling as the main ingredient in debt crises. More formally, if a debt is renegotiated --- or rescheduled --- at terms less advantageous than the original loan, then the country is formally in a debt crisis.

Write Downs

Another useful measure of debt crisis is the writing down --- or writing off --- a loan amount. This means that the creditors of a specific national economy have largely given up on the ability of the country to pay its debts, and therefore, renegotiate the loan such that the principle amount is lower. This will lower the country's credit rating substantially, but it will provide some debt relief.


The loss of some national sovereignty is a more specifically political --- and less formal --- part of the debt crisis experience. The IMF states that coercive restructuring of a country's finances is a clear marker of a debt crisis. Banks and the national governments that protect them want to see their money returned, if not now, then some time in the future. Therefore, the World Bank, the IMF or even other countries can begin the process of forcibly restructuring a country's economy so as to produce more tax revenue, profit or whatever will lead to eventual repayment. The IMF, when assisting a country, only does so on the condition that the country radically revamps its financial and economic system. Therefore, the connection between receiving assistance from the IMF and forcible restructuring is a variable that points to a debt crisis that has reached a critical point.

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