What is a Sovereign Bond

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Sovereign debt is assumed or guaranteed by a sovereign entity (a state or its central bank). It can be internal or external, when creditors are resident in the country or outside, as a result of loans and financing contracted abroad. Foreign sovereign debt may be bilateral (one country to another), multilateral (various countries) or private.

The debt can also be short, medium or long term, consist of bank loans, loans from other states, official institutions, or securities issued by the Treasury of the debtor country. These securities can be traded on the international market since bonds are issued in one or more foreign currencies. Convertible into universally recognized units of account (special drawing rights, etc.).

There are four characteristics peculiar to the market for sovereign debt and these include:

    – Ability to repudiate the debt, without a supranational authority capable of compelling the fulfillment of international contracts – although there is the adverse threat to reputation and access to future loans and the opportunity for creditors to apply sanctions against the country in default;

    – There are few assets to which creditors may have access in case of default;
    – The negotiation between creditors and debtors is an iterative process, unlike, for instance, a negotiation concerning the bankruptcy proceedings, held in a single stage;
    – Asymmetry of information between creditors and debtors, whether on the type of debtor, or on the choice of variables, that affect the amount available for payment (for example, level of investment) or the actual level of output.
A sovereign debt is issued or guaranteed by a sovereign issuer (usually a State or sometimes a central bank).

A sovereign debt can be decomposed into domestic debt and external debt by the creditors (residents or nonresidents). Short term (or for a few months), medium term or long term (up to 30 years or 50 years). The short term is the simplest for the borrower. It can be granted at a special rate (e.g, IMF advances or loans from the World Bank) that is an interest rate premium. This is based on the creditworthiness of the country as estimated by rating agencies.

Sovereign debt is based on the quality of issuers, considered more secure than some business entities (highly creditworthy countries), but is less safe because of the almost total absence of legal recourse against the defaulting states.

The ability to repay is closely related to the fiscal capacity of issuers, and therefore closely dependent on economic performance and good fiscal management of these countries. Hence, sovereign debt rating is based on such criteria, and the ratio of debt to GDP is one of the bases of assessment. The management of sovereign debt has always been an economic and political aspect.



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