Lesson 2 of 6 · 14 min
Qualitative factors: institutions, policy and the economy
A sovereign's credit rests on five qualitative pillars: sound institutions, fiscal discipline, a credible and independent central bank, a diversified economy, and a strong external position, ideally including a reserve currency.
In short
- Government institutions and policy: rule of law, property rights, a culture of repaying debt, transparent and consistent data, ease of doing business, political stability, no conflict with neighbours, and willingness to pay.
- Fiscal flexibility: the ability to adjust revenue and spending, fiscal discipline over economic cycles, effective tax collection and prudent use of debt.
- Monetary effectiveness: policy credibility, the exchange rate regime and a developed financial system. Central bank independence makes it less likely the government will monetise its debt.
- Economic flexibility: size, income per head, diversification, competitiveness and resilience to shocks. Single-commodity economies have more volatile tax revenue.
- External status: whether the currency is a reserve currency, access to external funding, and geopolitical risk. Capital controls and limited convertibility weaken it.
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