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What is Sovereign Debt?

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  • Written By: Justin Riche
  • Edited By: A. Joseph
  • Last Modified Date: 30 August 2016
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The term "sovereign debt" refers to government debt that is issued as bonds by a particular nation and can be denominated in a foreign currency. Although guaranteed by the issuing government, sovereign debt is subject to sovereign immunity, which means that creditors cannot force the government to fulfill its obligation when repayment problems occur. A government can use several methods to ease its debt load, such as interest rate reduction and sovereign debt restructuring. In the worst-case scenario, a government can resort to repudiation, which simply means that it will not recognize the debt and will default.

Sovereign debt is guaranteed by the government, and in many cases, it is considered to be free of risk. This risk-free aspect mainly reflects the overall economic capacity and the politics of the issuing government. For example, the government bonds of many developed countries are considered to be the safest on the market, whereas sovereign bonds issued by developing countries are thought to be riskier. Thus, bond investors usually require higher interest rates from the latter issuer.

Developing countries typically will have sovereign debt denominated in a widely used foreign currency, such as the US Dollar. This can cause problems when the nation runs out of the foreign currency for any of various reasons. If the government cannot get its hands on this currency in sufficient amounts, making repayments to creditors can then be a major issue.

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Many factors can cause this government debt to reach unsustainable levels and cause the government to fail to meet its obligations. For instance, a country can rely heavily on its growing export activities to help service its sovereign debt. If various unexpected events lead to the shrinkage of the country's export sector, many problems can arise.

When a government is having problems servicing its debt, it can fall back on what is known as sovereign debt restructuring. This restructuring involves the adjustment of the terms of the debt, but the creditors usually have the choice to agree to this, and when they are not willing, the government can sometimes just default if it has no viable means of making repayments. Restructuring can give the government favorable terms that allow it to reschedule interest payments, reduce debt and help it to get its finances in order.

Sovereign immunity gives a government protection that a private individual would not get. This immunity makes it rather impossible to sue or seize the assets of a government that defaults on its debt. It is usually in the best interest of governments to honor their debts, however, or suffer a downgrade of their sovereign debt rating. This downgrade will make it more difficult for the government to find new creditors, thus making it difficult to finance activities that require funds raised from the debt issuance.

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