What factors determine the creditworthiness of a sovereign nation?
Creditworthiness is the ability and willingness of a borrower to repay its debt obligations on time and in full. For sovereign nations, which are the governments of countries, this is a crucial factor that affects their access to international capital markets, their borrowing costs, and their reputation among investors and other countries. In this article, you will learn about the main factors that determine the creditworthiness of a sovereign nation and how they are measured and evaluated by credit rating agencies and market participants.
One of the most important factors that influence the creditworthiness of a sovereign nation is its economic performance, which reflects its ability to generate income and wealth for its citizens and to service its debt. Economic performance can be assessed by various indicators, such as gross domestic product (GDP), GDP per capita, GDP growth rate, inflation rate, unemployment rate, balance of payments, current account, and trade balance. These indicators show the size, structure, diversity, stability, and competitiveness of a country's economy and its exposure to external shocks and vulnerabilities.
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Ankush Ojha, FCA
Relationship Manager -Project Finance and also a secondary focal point to GCF.
Economic performance is a strategy driven process. The Government should set the vision, mission, values and goals properly to drive the economic performance. There should be different independent agencies which carry out the analysis of the external environment. STEEPLE (Social, Technological, Economic, Environment, Political, Legal and Ethical ) analysis should be carried out to analyse different factors affecting economic performance. Internal analysis should be done to check the consistencies of their policies. Build a strong team which identifies the gaps in the policies by simulating real data from different metrics indicating economic performance, revise the policies immediately where there are gaps and observe the new developments.
Another key factor that affects the creditworthiness of a sovereign nation is its fiscal policy, which refers to its decisions on government spending, taxation, and borrowing. Fiscal policy can have a significant impact on a country's public finances, which are the sources and uses of funds by the government. Public finances can be measured by indicators such as government revenue, government expenditure, budget balance, primary balance, public debt, and debt-to-GDP ratio. These indicators show the sustainability, efficiency, and transparency of a country's fiscal management and its fiscal space and flexibility to cope with unforeseen events.
A third factor that influences the creditworthiness of a sovereign nation is its monetary policy, which refers to its actions on money supply, interest rates, and exchange rates. Monetary policy can affect a country's price stability, financial stability, and external competitiveness. Monetary policy can be evaluated by indicators such as inflation rate, inflation target, inflation expectations, central bank independence, policy rate, money market rate, exchange rate regime, exchange rate level, and foreign exchange reserves. These indicators show the credibility, consistency, and effectiveness of a country's monetary policy and its ability to maintain macroeconomic stability and confidence.
A fourth factor that determines the creditworthiness of a sovereign nation is its political and institutional factors, which refer to its governance, rule of law, democracy, human rights, corruption, and social cohesion. Political and institutional factors can affect a country's economic performance, fiscal policy, monetary policy, and external relations. Political and institutional factors can be assessed by indicators such as political stability, government effectiveness, regulatory quality, rule of law, control of corruption, voice and accountability, civil liberties, political rights, and social indicators. These indicators show the quality, legitimacy, and accountability of a country's political system and institutions and its social capital and human development.
A fifth factor that impacts the creditworthiness of a sovereign nation is its external factors, which refer to its relations with other countries and international organizations. External factors can affect a country's trade, investment, aid, debt, and security. External factors can be measured by indicators such as trade openness, trade balance, foreign direct investment, official development assistance, external debt, debt service, debt relief, credit ratings, and geopolitical risks. These indicators show the degree, diversity, and dependence of a country's integration and cooperation with the global economy and the international community and its exposure to external shocks and pressures.
The above factors are not exhaustive and may vary in importance and relevance depending on the context and circumstances of each sovereign nation. However, they provide a useful framework for conducting a comprehensive and systematic credit risk analysis, which is the process of assessing the probability and severity of a sovereign default or distress. Credit risk analysis can be performed by credit rating agencies, which assign ratings and outlooks to sovereign debt instruments based on their methodologies and criteria, or by market participants, such as investors, lenders, analysts, and traders, who use various tools and models to estimate sovereign credit spreads, yields, and default probabilities. Credit risk analysis can help to identify and monitor the strengths and weaknesses of a sovereign nation and to compare and contrast its creditworthiness with other sovereigns.
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Ankush Ojha, FCA
Relationship Manager -Project Finance and also a secondary focal point to GCF.
There has been a paradigm shift in the assessment of overall credit worthiness. Gone are the days when "Incurred loss model" was adopted to analyse the credit worthiness of the borrower. After the sub prime crisis which triggered in 2008. and with the refinement in the International Financial Reporting Standards, "Expected Credit Loss" model has transcended the dynamics of Credit worthiness. We now assess the Probability of Default of the borrower by considering numerous factors. We also take into account the recovery factor namely ,Loss given default which gives an indication about what will be the tentative recovery in case of a default. This proactive method has increased the scope of analysis and has provided a broader view.
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Oluyemi Ayodele OLONITE - Ph.D., M.Sc, B.Sc., DipF
Researcher, Accounting, Health, World Bank, YALI US Dept. of State, French, British Council & University of Michigan.
Their attitudinal essence towards capital development, citizens and direct investments should be used as a yard stick to measure their credit wordiness.
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