Lesson 1 of 5 · 12 min
Why and how sovereigns borrow
A national government borrows against its power to tax, so it is usually its country's safest and largest bond issuer; fiscal policy decides how much it borrows, and whether it is a developed or emerging market issuer shapes in which currency and at which maturities it can borrow.
In short
- A sovereign issuer is set apart by its legal authority to provide public goods and its power to tax economic activity in its jurisdiction. Tariffs, user fees and profits of government-owned enterprises are extra sources of repayment.
- Public accounts are often cash-based and leave out items such as depreciation of infrastructure and unfunded pension liabilities. An economic balance sheet adds expected future tax claims and promised future spending.
- Developed market (DM) sovereigns have stable, diversified economies and borrow in a widely held reserve currency at any maturity. Emerging market (EM) sovereigns grow faster but are less stable, and often borrow in a restricted currency or abroad.
- EM debt splits into domestic debt (local currency, mostly local holders) and external debt (owed to foreign creditors, including supranational loans and foreign-currency bonds).
- A DM investor in an EM sovereign's USD bond avoids direct currency risk but keeps indirect currency risk: the issuer must earn enough foreign currency to pay.
- Fiscal policy sets the level of sovereign debt; debt management policy sets its composition (short versus long term and other features).
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