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Strategic Sovereign Defaults Under International Sanctions

Sanctions induce political instability. We present a model where sanctioned regimes may decide to repudiate their public debts in order to keep internal support. To be effective, this strategy requires the share of foreign debt to be larger than the minimum quota of population which is needed for regime support. Combining the data we highlight that more than a third of all sovereign debt crises in the 1970-2001 period are connected to an international sanction episode. To rule out endogeneities, we propose an innovative instrumental variable based on foreign policy cycles. Results confirm that sovereign defaults reduce sanctions' destabilizing impact. When the scope for internal financial transfers is particularly narrow, debt repudiation releases resources for public spending, invalidating chances of overthrow. Lastly, we report evidence of sizeable anticipation effects which contradict the enforcement theory: high chances of receiving sanctions in the future imply a current 20% rise in probability of strategic default.