1.
Introduction
 Definition of sovereign depts:
Sovereign dept is issued by the government and is also known as
government dept, public dept and national dept. It will give the opportunity
to government to borrow money for a variety of reason like financing public
investment in order to boost the employment and increase the investment.
The level of sovereign depts and its interest rates will reflect the saving
preferences of a country’s business and residents, as well as the demand
from foreign investors. In addition, the sovereign of a country is a liability of
the citizen country since the dept can only be paid off with revenues that
the governments collect such as taxes.
Finally, the sovereign dept are an index that can rate the government by
indicating to investors how financially is considered to be and to determine
how easy or difficult for the country’s government to borrow money to
funds its operation.

Importance of sovereign dept in the global
economy:
 The ability to issue a dept has an important instrument to the
government that can help the economy from the impact of adverse
macroeconomic shocks. Moreover, the presumed identify of those
investors has depended on the type of government issuing the dept.
 They have two type of government dept: risky government dept
often associated with emerging market (EM) and safe government
dept related to advanced economies (AE).
 For safe AE dept, the presumed investor has been mixed between
foreign and domestic banks who fly to safety during global economic
downturns.
 The ability of countries to issue safe haven government dept has
been central to questions of international role of these issuers
 Finally, according to these two types of government dept literatures
give the motivation to investors to hold the dept and to be sustained.
2.Types of sovereign depts:
Domestic dept: are more a diverse group made up of a country’s own
central bank, other banks and financial institutions, state and local
governments, large institutional investors (such as pension funds,
mutual funds and insurance companies and individual investors
External dept: external dept can be called as foreign dept who
consist primarily of foreign governments whose central bank
previously purchase government bonds issued by the nation. They
are borrowed from foreign lenders, including commercial banks,
governments or international financial institution. This loan including
interest must be paid in the currency in which the loan was made. In
order to earn the needed currency, the borrowing country may sell
and export goods to the lending country.
Multilateral dept: is a dept that country burden owned to
international financial institutions (IFIS) such as the international
monetary funds (IMF) and the world bank. This type of dept will be
preferable for creditors as providers of core development and
balance of payment loan as IFI status. This status means that
payment must be given the highest priority, over private and bilateral
government (government to government). Finally, IFI status
determine the creditworthiness to the economic policies.
3-Causes of sovereign dept:
 Boom and Bust: during periods of growth, governments become optimistic
and wish to borrow more to fund investment in the economy for higher
growth in the future, so investors see these developing as a source of
potential growth offering better returns than stable economies like US.
Finally, when economy is in the bad situation it will lead to tax revenues dry
up, confidence evaporates and government struggling to meet repayments.
 Rising interest rates: High inflation has caused the FED to rase interest rates,
this will push up borrowing costs around the world. When US rates increase,
investors find it more attractive to save the US because there is a combination
of security and high yields in the US. At the end, the highest rates us can
develop economies and to push up their interest rates to continue attracting
credit and this makes developing economies sensitive to interest rates.
 Devaluation in the exchange rate: Most of sovereign dept is denominated in
dollars. A devaluation in the local exchange rate can increase the cost of
repaying foreign creditors that it can soon run out of foreign exchange
reserves as the currency devalues. As the currency devalues can affect
negatively spiral with the devaluation encouraging investors to sell off assets
and local inhabitants to try and sell the domestic currency and buy foreign
currency.
 Covid and 2022 inflation: All the potential economic problems have been
exacerbated by recent events which have caused both supply-side and
demand-side shocks. Firstly, many countries which relied on tourism saw
Covid hit domestic tourism, causing a fall in foreign exchange earnings and
a rise in unemployment as the tourist sector was badly hit. Just as there
were signs of recovery in early 2022, the Ukraine war caused a devastating
rise in commodity prices, notably food and oil. For commodity importers,
such as Sri Lanka, Kenya and Egypt, this has worsened their balance of
payments and reduced foreign earnings. With countries struggling to
import basics like food and fuel, there are no funds left over to pay debt
interest payments.
 Printing Money: when countries face domestic pressure of not paying wages
and purchase basic item, there is a temptation for central banks to print
money and provide temporary relief to governments struggling to meet
demand. However, printing money at a time of falling output cause inflation
to accelerate the situation worse and in the falling the value of currency.
N.B(Simon hone fina nghayyir printing money la money laundry?)
 Poor policy: dept crisis usually involves some degree of bad policy that can
rapidly cause a developing economy to unravel. For example, case of
Argentina has been poor political management, with successive
governments borrowing, failing to manage the economy, leading to low
growth, high inflation and an inability to meet future dept payments. So, at
the end the conclusion will be that that government can have a political
incentive to take risks in borrowing, knowing that the future costs of excess
dept will not be faced for a few years, likely by a different government.
 Rising government dept: Higher level of borrowing can be damaging for
developing economies which have limited opportunities to sell dept to
domestic markets.
 Sanctions: Russia has a dept repayment not because I can’t or doesn’t want
to pay but since the electronic methods of repayment are not open to Russia.
 Euro Default: In 2010-14, several Eurozone economies faced rising
interest rates and the risk of default because of the unique circumstances
of the Euro. At the time, monetary policy was set by the ECB and countries
did not have the ability to devalue exchange rates, or increase the money
supply to provide liquidity and buy any shortage of bonds on the market.
The result of this was that markets feared many countries with high budget
deficits could face liquidity problems and there was an exodus from
countries like Italy, Ireland, Greece and Portugal.
4.Risk of sovereign depts:
Sovereign risk is the probability that a foreign nation will either fail to meet the
dept repayment and dept payment or obligation. It is one of many unique risks
that an investor faces when holding forex contracts such as currency exchange
risk, interest rate risk, price risk and liquidity risk.
 Let’s talk about currency risk:
Anyone can face a sovereign risk that are exposed to a foreign country when
foreign exchange traders and investors face the risk that a foreign central bank
will change its monetary policy and affect currency trades. For example, a country
decides to change its policy from one of a pegged currency to one of a currency
float, it will alter the benefits to currency traders.
 Political risk:
Sovereign risk also impacts the personal investors to owning a financial
security if the issuer resides in a foreign country. For example, an American
investor faces sovereign risk when he invests in a South American based
company. This kind of situation can arise if that South American country
decides to nationalize the business or the entire industry that make the
investment worthless unless there is reasonable compensation made to the
investor.
In political risk, the government are willing to pay back its dept for their
government leadership but it can decide to not payback the dept in case of a
change government or countries with unstable situation. This makes a critical
component of investing in sovereign bonds and rating agencies take into
account willingness to pay as well when evaluating a sovereign credit.
A government have the ability to pay of its economic position. A country with a
strong economic growth will likely have the ability to pay its dept and usually
be reflected in a high credit rating by the major rating agencies. But when the
country faces many crises and the economy turn into negative way a weak
currency will be present, little ability to collect taxes and unfavorable
demographics may be unable to pay back its dept.
Finally, in order to issue bonds from external debt market, many countries
seek credit rating from the largest and prominent rating agencies to encourage
investor confidence in their sovereign dept.
 Default Risk:
The default risk appears when they have a severe political, economic problems
including war, revolution, corruption and mismanagement or a financial crisis.
When sovereign defaults appear on dept economic growth affect negatively
that can slow or reverse and could lose value against the US dollar, boosting
inflation in countries who heavily reliant on imports.
References:
https://corporatefinanceinstitute.com/resources/fixed-income/sovereigndebt/#:~:text=Summary,debt%20owed%20to%20domestic%20creditors.
https://www.investopedia.com/terms/s/sovereign-debt.asp
https://fbf.eui.eu/wp-content/uploads/2022/06/HARDY_FangHardyLewis_SovInvestor.pdf
https://www.santander.com/en/stories/sovereign-debt
https://ips-dc.org/multilateral_debt
https://www.economicshelp.org/blog/170821/economics/what-causes-a-government-to-default-on-itsdebt/
https://www.investopedia.com/terms/s/sovereignrisk.asp#:~:text=Sovereign%20risk%20is%20the%20po
tential,to%20a%20sovereign%20debt%20crisis.
https://www.investopedia.com/terms/s/sovereigndefault.asp#:~:text=What%20Is%20Sovereign%20Default%20Risk,denominated%20in%20the
%20national%20currency