Partial Defaults

Can we please stop using the term "partial default"? It annoys me, mainly because nobody has a clue what it means. Jean Pisani-Ferry, for instance, on the subject of Greece, talks about "a vicious circle in which its debt would become more and more expensive to service, leading finally to partial default" — without ever defining the term. And the Economist, this week, serves up this:

Debt incurred in a foreign currency is another matter. Countries that run persistent current-account deficits eventually reach a crisis. The time-honoured answer is to devalue, or depreciate, the currency so that exports can become more competitive and the deficit can be closed. (Britain appears to be following this route at the moment, willingly or not.)

For foreign creditors, such a devaluation represents a partial default (just as for domestic creditors of conventional bonds, inflation is a creeping default).

This is annoying on two levels. Firstly, it’s really unclear, in this passage, whether we’re talking about foreign-currency debt or local-currency debt. The first sentence quite explicitly talks about foreign-currency debt, but everything else seems to refer to the local currency. After all, if foreign creditors buy debt denominated in dollars, they don’t much care what happens to the peso, so long as the country remains current on all its obligations.

But more generally, the word "default" here is used to mean "losing money on your bond investment" — an unhelpful broadening of meaning of what is actually a very useful word. Default refers, or should refer, specifically to credit risk: the risk that the debtor doesn’t make the payment he’s contractually obliged to make. If the contract specifies that the debtor is obliged to deliver a certain number of pesos on a certain date, then if he does that, he hasn’t defaulted.

A foreign creditor might still be unhappy, if those pesos aren’t worth very much, but that’s because he was taking foreign-exchange risk on top of credit risk. And a domestic creditor might be unhappy for the same reason, because he was taking inflation risk by buying nominal debt. But just because you have unhappy creditors doesn’t mean you’re in default, partial or otherwise.

The term "technical default", by contrast, is useful: it helps differentiate payment default from other breaches of contract. If I’m in violation of my covenants, but I’m still making interest payments in full, then I’m in technical default.

There are two circumstances where the term "partial default" might be apropos. The first is something like Ecuador’s situation right now, where the country has defaulted on its 2012 and 2030 global bonds, while remaining current on its 2015s. And the other one would be if a creditor literally paid only part of what he owed. If I borrow $20 until Friday, and then on Friday I only pay you back $10, that could be considered a partial default. But in the world of capital markets, I can’t recall ever hearing of such a partial payment being made.

But in general the idea of a partial default is not well defined, and as a result no one really knows what it’s meant to mean. So much better to just say exactly what you mean, rather than use this vague and unhelpful term.