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Hidden Debt Revelation and Optimal Default
Hidden public liabilities are a pervasive but poorly measured feature of sovereign balance sheets. When they are eventually revealed, they can reprice sovereign risk overnight and compress the policy space between painful fiscal adjustment and default. This paper studies optimal sovereign default following the revelation of hidden debt. We develop a quantitative model of optimal sovereign default following a hidden-debt revelation and apply it to Senegal‘s 2024 shock, in which an incoming administration uncovered more than ten billion dollars in off-balance-sheet obligations, revising central-government debt upward by 50 percentage points of GDP. We embed the revelation as a one-time upward shift in the initial debt stock within a small open economy model with long-term bonds, downward nominal wage rigidity, and output costs calibrated to Senegal‘s monetary union environment. The baseline model predicts that default would have been optimal from 2023 onward, once the retroactively corrected debt-to-GDP ratio crossed the default threshold of 107 percent. Since Senegal has not defaulted as of early 2026, we provide conditions that rationalize continued repayment with income dynamics that are consistent with either optimism about mean reversion or gambling for redemption. Under this no-default calibration, the country is solvent but fragile: an adverse income shock of 3 percent would lead to an expected time to default of less than one year. Both calibrations point to the same conclusion: Senegal moved from a position of moderate fiscal risk into a regime of acute vulnerability after the revelation of its hidden debt.
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