Imagine you are on a ship, stranded in the middle of a sea, you are desperately searching for a shore, hoping that you find one soon, but all your efforts go in vain. Then, you start going further into the sea, hoping that one day the waves will wash you ashore! The chances of you reaching the shore are minimal, you will probably get consumed by the sea, but even when you know that, you still hope for the best.
This is how you can describe the situation of an obligor who has been given a "selective default" status! To make it easier for you, let's paraphrase, replace the word ship with "financial entity", sea with "debt", shore with "way to settle the debt", and waves with "economic reforms and monetary policies". Hope you got it now!
What Does Selective Default Mean?
There are various credit rating agencies in the world. They rate the solvency of every significant financial entity in the world. Standard & Poor's, is one of the most influential agencies, which analyzes the creditworthiness of an entity, and provides them with a status. The status that Standard & Poor's give, generally range from AAA to D. Where AAA implies that the obligor will surely meet his financial liabilities, a D status, connotes "Default", indicates that the obligor, will not be able to fulfill any of his financial commitments. The penultimate status SD, is an acronym for "Selective Default".
"An obligor rated "SD" has failed to pay one or more of its financial obligations (rated or unrated) when it came due. An "SD" rating is assigned when Standard & Poor's believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner." ~ According to Standard & Poor's
What are the Repercussions?
This nature and intensity of the repercussions will completely depend on the type of the obligor and the measure of financial debt. If it is a small entity, then consequences won't affect many people, but if a country is given a SD rating, then it has many adverse implications. Here we discuss few of the consequences that a country faces, when it is rated SD.
Investors Back Out
When you are sure that something won't give you any returns, will you invest in it? So, when a country is given a SD rating, the investors tend to withdraw their money from any bank affiliated to the country. This obviously worsens the situation.
No More Loans
A country with a SD rating, desperately seeks a bailout, but no major bank in the world is keen to lend them money. The major banks are in a dilemma, since feel that any bonds from the banks of the debt-ridden country cannot serve as a valid collateral.
World Economy Jolted
The world economy is bound to go for a toss, if any country is given the SD status. Logic will suggest that, the SD rating will be subsequently followed by a D status, and the world economy will eventually have to bear the brunt of the debt of the SD rated country.
How to Handle SD?
Selective Default is very difficult to deal with. Assistance and cooperation from other financial entities is essential to deal with such a situation. Practically thinking, an SD rating simply means buying more time to meet financial obligations. To handle the SD situation, the obligor can be provided with emergency liquidity funding, and due date of the payment of the debts can be extended, but with a higher rate of interest.
Greece is a paradigm of a country facing the selective default situation. Only international cooperation and funding can help Greece. If Greece defaults, it will probably be the first western country to do so. One thing is certain, ambivalence can never solve crisis, apt financial measures should be taken pronto, to deal with the debt.