fixed income 15: Credit Analysis for Government Issuers

What is the primary source of repayment for sovereign debt?

taxes and other government revenues

• (fees, tariffs, state-owned enterprise profits).

What two key aspects determine sovereign creditworthiness?

1. Ability to pay

2. Willingness to pay.

Why is willingness to pay particularly important in sovereign credit analysis?

Due to sovereign immunity, creditors have limited legal recourse against sovereign governments.

• soverign immunity: A legal principle limiting creditors' ability to force a sovereign government into bankruptcy or asset liquidation.

What are the five major qualitative factors used in sovereign credit analysis?

1. Government Institutions & Policy,

2. Fiscal Flexibility

3. Monetary Effectiveness

4. Economic Flexibility

5. External Status.

What is Government Institutions & Policy and what is considered?

• The role of institutions and policies in promoting political and economic stability.

• Rule of law, property rights, transparency, debt repayment culture, and ease of doing business.

• Political stability and absence of conflict.

What is Fiscal Flexibility and what is considered?

• A government's ability to establish and maintain fiscal discipline over time and across economic cycles.

• Tax collection, expenditure management, and debt management.

• fiscal consolidation improves debt sustainability and reduces fiscal deficits.

What is Monetary Effectiveness and what is considered?

• Measures effectiveness of central bank policy.

• Policy rates, reserve requirements, and open market operations.

• Independent central banks improve credibility.

  • reduces debt monetization → high inflation

What is Economic Flexibility and what is considered?

• The strength, diversity, and growth potential of the economy available to generate tax revenue.

• high rating: Large, diversified economies with strong and sustainable growth.

• Commodity dependence increases risk → vulnerable to price shock

• Informal economies reduce tax collection.

What is External Status and what is considered?

• How trade, capital flows, and foreign exchange policies affect debt servicing ability.

• Reserve currencies provide major advantages.

  • increases access to foreign capital and reduces default risk.

what 6 things causes a weak external status?

1. Exchange controls reduce flexibility.

2. Capital controls discourage foreign investment.

3. Limited convertibility restricts borrowing.

4. Countries may rely on IMF funding.

5. Dependence on few trading partners increases risk.

6. Geopolitical risk can weaken external stability

What three broad quantitative categories are used in sovereign credit analysis?

1. Fiscal Strength

2. Economic Growth & Stability,

3. External Stability.

What does and how is fiscal strength measure?

The government's debt burden and ability to service debt.

1. Debt burden

• Debt / GDP

• Debt / Revenue

• Higher = Lower Credit rating

2. Debt Affordability

• Interest payment / GDP

• Interest payment over revenue

how is Economic Growth & Stability measured?

1. Growth and volatility

• Average Real GDP Growth: $\frac{\text{Real GDP}_{t-1}-\text{Real GDP}_{t}}{\text{Real GDP}_{t}}$

• Real GDP growth volatility: standard deviation of real GDP

2. size and scale

• Size of economy: GDP in PPP terms

• Per capita GDP: GDP/Pop

What is External Stability and how is it measured

The ability to meet foreign currency obligations.

1. Currency reserves

• FX reserves to GDP: FX reserves/ GDP

• Reserve ratio: FX reserves/ External Dept

2. External debt

• External debt burden: LT external debt / GDP

• External debt due: External debt due in 12m/ GDP

What are non-sovereign government issuers?

Government-related entities that issue debt within a sovereign jurisdiction.

• agencies

• public banks

• supranationals

• regional/local governments

What are government agencies in credit analysis?

• Quasi-government entities.

• Created by law or statute.

• Often serve public policy goals.

• May have authority to issue debt.

How are agency bonds treated in credit matters?

• Often assumed to have sovereign backing.

• Support may be implicit or explicit.

• Rating often equal to sovereign rating.

What is the role of government development banks?

• State-sponsored financial institutions.

• Support policy or development goals.

• Often exempt or specially regulated.

How are government development banks treated in credit matters?

• Support usually explicit government guarantee.

• Often treated like sovereign risk.

• Can receive very high credit ratings.

• Strong insitutional backing

• Tax exemptions

What are supranational institutions?

Organizations owned by multiple sovereign states created to achieve shared economic or social objectives.

• world bank

credit characteristics of supranationals

• Very strong credit quality.

• Backed by member countries.

• Diversified funding sources.

• Often highly rated.

What are regional government issuers?

Sub-sovereign entities such as states, provinces, municipalities, and local authorities.

• Have taxing authority.

• But limited policy control.

• No control over monetary policy.

• More exposed to local economic conditions.

What are municipal bonds?

Debt issued by local governments (common term in the US).

What are general obligation (GO) bonds?

Bonds backed by the full taxing power and general revenues of a government.

Credit Drivers of GO

1. Local tax base strength.

2. Economic diversification.

3. Budget discipline.

4. Government support expectations.

What are revenue bonds?

Bonds repaid from a specific project’s cash flows rather than general taxation.

• Not backed by general taxation.

• Higher risk than GO bonds.

Credit drivers for GO?

• Project demand and usage.

• Revenue stability.

• Operating costs and margins.

• Economic base supporting project.

What is a key credit metric for revenue bonds?

• Debt service coverage ratio (DSCR).

  • Higher DSCR = stronger credit quality.

  • Minimum DSCR often required by covenants.