Sovereign Debt: Overview and Features (2024)

What Is Sovereign Debt?

Sovereign debt is issued by a national government and referred to as government debt, public debt, and national debt. Governments borrow for public investments and to boost employment. The level of sovereign debt and its interest rates reflect the saving preferences of a country's businesses and residents and the demand from foreign investors.

Key Takeaways

  • Sovereign debt is debt issued by the government of an independent political entity, usually in the form of securities.
  • Several private agencies often rate the creditworthiness of sovereign borrowers and the securities they issue.
  • Countries with stable economies and political systems are typically viewed as having better credit, allowing them to borrow on more favorable terms.

Features of Sovereign Debt

Governments acquire sovereign debt by issuing bonds, bills, debt securities, or loans from countries and multilateral organizations like the International Monetary Fund. Sovereign debt may be owed to foreigners or the country's citizens and can be denominated in domestic or foreign currency. Although lenders always take on default risk, sovereign borrowing has several distinct characteristics.

  • Unlike private borrowers, governments can raise tax revenue, and most also issue their currency.
  • Governments can be overthrown by regimes that refuse to honor their debt obligations or incur economic sanctions that may cause their debt to lose value.
  • Sovereign borrowers in default are rarely subject to legal enforcement, and creditors often find it hard to target the defaulted sovereign's assets.
  • Some sovereign debt securities have linked coupon payments to a country's economic growth rate, though such GDP-linked bond issues are relatively rare.

Short-term U.S. government and foreign debt securities maturing within months are known as Treasury bills, T-bills, or simply bills. A sovereign or private debt security with a duration measured in years is called a bond.

Credit Ratings and Default

The U.S. has historically been viewed as the world's safest credit risk. The country has never defaulted on its debt, and it remains the issuer of the world's reserve currency. The three-month U.S. Treasury bill rate has traditionally been a benchmark "risk-free" interest rate.

However, in August 2023, Fitch Ratings downgraded the long-term ratings of the United States to "AA+" from "AAA" based on the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to "AA" and "AAA" peers over the last two decades with repeated debt limit standoffs and untimely resolutions.

As of September 2023, Standard and Poor's assigned AAA sovereign credit ratings to Australia, Canada, Denmark, Germany, Liechtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden, and Switzerland.

In a default, the creditors' main leverage lies in the resulting loss of international capital markets access for the defaulting sovereign and its likely need to negotiate a debt settlement to be able to borrow again. Some academic studies have found prior defaults have little or no effect on future lending terms. One concluded that higher losses in sovereign debt restructurings were associated with more prolonged periods of market exclusion and higher borrowing costs.

The Limits of Sovereignty

Sovereign countries may pool some sovereign powers, such as in a currency union like the eurozone, wherein all members use a currency issued by a supranational authority. The shared currency can facilitate trade flows and economic integration.

The eurozone was challenged in 2011-2013, when its economically weakest members were priced out of public debt markets, leaving them without the traditional policy tools of deficit spending and currency devaluation amid an economic downturn. The European sovereign debt crisis abated once European Union institutions, including the European Central Bank, guaranteed and restructured those member states' sovereign debt.

Sovereign Debt vs. Economic Growth

Traditionally, advice for sovereigns facing a possible default included austerity policies aimed at controlling spending and economic liberalization initiatives promoting growth. Economists Carmen Reinhart and Kenneth Rogoff published research suggesting higher levels of sovereign debt were associated with slower economic growth.

Critics have challenged the data and note public-sector austerity frequently leads to economic slumps. Experiences in Japan and the U.S. have cast doubt on the debt-to-GDP ratio as a debt sustainability measure. In both instances, increases in the ratio were not associated with meaningful increases in interest rates on sovereign debt.

Modern monetary theory (MMT) suggests a sovereign currency issuer's borrowing capacity is limited mainly by the rate of inflation it's willing to tolerate. In this model, taxes are raised to cool inflation rather than to offset government spending.

Who Owns Sovereign Debt?

Sovereign debt is owned by foreign governments and private investors. As sovereign debt is primarily issued via bonds and other debt securities, both individual investors and foreign governments can purchase these government securities.

Who Owes the U.S. the Most Money?

As of September 2023, the countries that hold the most U.S. debt are Japan ($1.1 trillion) and China ($822 billion).

Which Country Has No Debt?

The countries with the lowest national debt in relation to GDP as of 2022 are Brunei Darussalam (2.06%), Kuwait (2.92%), Turkmenistan (5.19%), and Timor-Leste (7.49%).

The Bottom Line

Sovereign debt is used by a country's government for a variety of reasons, such as to pay for public infrastructure. When a government has more expenses than the money it has raised in taxes, then it turns to debt to finance those expenses.

Sovereign Debt: Overview and Features (2024)

FAQs

Sovereign Debt: Overview and Features? ›

Sovereign debt is used by a country's government for a variety of reasons, such as to pay for public infrastructure. When a government has more expenses than the money it has raised in taxes, then it turns to debt to finance those expenses. International Monetary Fund. "Sovereign Debt."

What are the features of sovereign debt? ›

Sovereign debt is the government debt owed by a country, a sovereign nation. The debt exists in the form of government-issued securities and direct loans from financial institutions. Sovereign debt is often broken down into debt owed to foreign creditors versus debt owed to domestic creditors.

What are the advantages of sovereign debt? ›

We are listing out some advantages of sovereign debts below.
  • Boosts Growth: Countries meet their deficit by borrowing, which is used to fund the country's developmental projects. ...
  • Gives a Desirable Direction to Economy: Sometimes, nations need to decelerate the economy.
Jan 31, 2024

Who owns sovereign debt and why does it matter? ›

Private non-bank investors absorb disproportionately more sovereign debt supply than other investors. Moreover, non-bank investor demand is most responsive to the yield.

What happens in a sovereign debt crisis? ›

For sovereign debtors it may mean financial autarky, severe and protracted recession, and a worsening in poverty and other social indicators. 1 For creditors, it usually means (sooner or later) recognizing losses in their portfolio.

What is sovereign debt in simple terms? ›

Key Takeaways

Sovereign debt is debt issued by the government of an independent political entity, usually in the form of securities. Several private agencies often rate the creditworthiness of sovereign borrowers and the securities they issue.

What are the four features of a sovereign state? ›

A sovereign state is a state that has the highest authority over a territory. International law defines sovereign states as having a permanent population, defined territory, a government not under another, and the capacity to interact with other states.

What is the purpose of sovereign debt? ›

Overview. Public debt, or sovereign debt, is an important way for governments to finance investments in growth and development. However, it is also critical that governments are able to continue servicing their debt and that their debt burden remains sustainable.

How does sovereign debt work? ›

Sovereign debt is the sum of outstanding bonds and loan obligations of a country's central government. Governments may issue debt to finance essential public investments, to meet the demand from institutional and individual investors for safe assets, or to prolong unsustainable overspending and enable graft.

What is the risk of sovereign debt? ›

Managing sovereign debt risk is crucial to maintain economic stability. High levels of debt can lead to reduced investor confidence, higher borrowing costs, and potential default.

Who owns the most US sovereign debt? ›

Nearly half of all US foreign-owned debt comes from five countries. All values are adjusted to 2023 dollars. As of January 2023, the five countries owning the most US debt are Japan ($1.1 trillion), China ($859 billion), the United Kingdom ($668 billion), Belgium ($331 billion), and Luxembourg ($318 billion).

Who has the largest sovereign debt in the world? ›

Profiles of Select Countries by National Debt
  • Japan. Japan has the highest percentage of national debt in the world at 259.43% of its annual GDP. ...
  • United States. ...
  • China. ...
  • Russia.

Who holds US sovereign debt? ›

There are two kinds of national debt: intragovernmental and public. Intragovernmental is debt held by the Federal Reserve and Social Security and other government agencies. Public debt is held by the public: individual investors, institutions, foreign governments.

What happens when a country defaults on sovereign debt? ›

It has serious economic consequences for the nation, making it expensive or impossible for it to borrow money in the future. It also causes domestic turmoil. Many banks, pension funds, and individual investors keep some of their assets in sovereign bonds. The nation's financial failure ripples through its economy.

Who buys sovereign debt? ›

Private non-bank investors, mainly investment funds, increase their holdings of sovereign debt by more than other investors as the sovereign's total debt expands. They fund nearly 70% of increases in sovereign debt. Further, non-bank investors are the most responsive to changes in sovereign yields.

Has any country defaulted on sovereign debt? ›

The prospect of sovereign default is scary for investors, but many countries have never defaulted on their debts. Ecuador has defaulted 10 times in modern history, and Venezuela has defaulted 11 times.

What are the important features of sovereignty? ›

Sovereignty entails hierarchy within the state, as well as external autonomy for states. In any state, sovereignty is assigned to the person, body or institution that has the ultimate authority over other people in order to establish a law or change existing laws.

What are the main features that distinguish debt from equity? ›

"Debt" involves borrowing money to be repaid, plus interest, while "equity" involves raising money by selling interests in the company. Essentially you will have to decide whether you want to pay back a loan or give shareholders stock in your company.

What are the 5 types of sovereign? ›

Ans: There are five types of sovereignty which include (a) Titular sovereignty, (b) Legal and political sovereignty, (c) Internal and external sovereignty, (d) Popular sovereignty and (e) De Jure and De Facto sovereignty.

What is sovereign debt quizlet? ›

debt owned by the government.

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