What is a Selective Default

Imagine you are on a ship, stranded in the middle of a sea, desperately searching for a shore, hoping to find one, but your efforts go in vain. You start going further into the sea, hoping one day the waves will wash you ashore! Your chances of reaching the shore are minimal, you may get consumed by the sea, but even when you know it, you 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!

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 financial obligations (rated/unrated) when it came due. "SD" rating is when Standard & Poor's believes obligor has selectively defaulted on a specific issue or class of obligations but will continue to meet its payment obligations on other issues or classes of obligations in timely." ~ Standard & Poor's 

This nature and intensity of 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.

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.

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.

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.

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 has been a paradigm of a country facing the selective default situation. Only international cooperation and funding did  help Greece. To avoid default, the EU loaned Greece enough to continue making payments.

Since February 2015, various European authorities, private investors have loaned Greece 294.7 billion euros, the biggest financial rescue of a bankrupt country in history. Greece has repaid 41.6 billion euros. It has scheduled debt payments through 2059. One thing is certain, ambivalence can never solve crisis and apt financial measures need to be taken.