The worst of the global financial crisis has passed. But the next leg of this severe recession has yet to cripple the weakest balance sheets among sovereign nations.

Before 2010 is over, possibly sooner, some countries in the Baltics, Balkans, Eastern Europe and Central America will join the list of battered credits that have reneged or defaulted on their foreign debt obligations. It’s hard, if not impossible, to imagine that we won’t witness a major sovereign government debt default in the course of this economic cycle.

As governments worldwide continue to pile on massive amounts of debt to fund an economic expansion amid the worst credit deflation in 75 years, the odds are growing that one or more sovereign nations will default on their foreign debt. Many countries, even mighty Germany have struggled to raise international funds to plug their budget gaps; since last October Germany has scrapped or reduced the size of four bond auctions.

If Germany and other core euro zone nations are struggling to raise funds then imagine what lies ahead for weaker sovereign credits?

Candidates for default include Latvia, Lithuania, Estonia, Romania, Ukraine, Kazakhstan, Hungary and possibly several other emerging market countries. It is also possible, though unlikely, that Italy or Greece might default. Even Ireland, virtually bust, is a potential candidate.



As the next phase of this crisis turns into an acute and deep recession, governments will come under pressure to spend even more money to rescue joblessness and growing economic discontent. As this next round of spending develops later next year or in early 2011, several nations will come close to the brink of default as finances become too stretched.

Already since last year Ecuador has defaulted while pressure on several other nations grows by the day. These countries are struggling to raise international funds to secure budgetary needs and in all likelihood will default. The IMF, or International Monetary Fund, will not be able to avert every funding squeeze; it’s lunacy for the IMF to hand out money to a nation just so that it may avoid a default. This is what happened in Ukraine and Iceland among many other nations over the last six months. How long can this strategy work effectively if economic conditions relapse later in 2010 once this round of fiscal spending draws to a conclusion?

Credit spreads or the difference between benchmark government bonds in the United States and Germany compared to weaker national bond markets in places like Ukraine and Greece continue to show stress. These spreads have not declined significantly over the last 60 days as equities and other capital markets have rallied.

Also, Latin America, which has largely escaped this credit crisis (except Argentina, which remains an economic lost cause) might take a turn for the worst if commodities prices resume their downtrend. One could make a case that a currency and debt “bubble” is now in play in Brazil – the largest economy in the region. The real currency has skyrocketed since 2003 while interest rates have collapsed. Does Brazil really deserve to be investment grade? The BOVESPA stock index trades north of 50,000 – not exactly a bargain, either.

In all likelihood it seems quite plausible that one or more sovereign borrowers will default before this crisis finally concludes. Germany will probably bail-out core Europe. But it’s up to the IMF to tackle peripheral emerging European nations if they default. The IMF can’t rescue everybody if a string of defaults begins to unfold like dominos. The chain reaction will be too violent.

Avoid emerging market debt. Credit spreads have now rallied to just 488 basis points or 4.88% above ten-year U.S. Treasury bonds. That is not reflective of the upcoming challenges affecting emerging market debt and the enormous task faced by an overwhelmed IMF.