Credit Analysis for Government Issuers - Fixed Income | CFA® Level 1 Guide

Sovereign Credit Analysis

Learning Outcome Statement:

Explain special considerations when evaluating the credit of sovereign and non-sovereign government debt issuers and issues.

Summary:

Sovereign credit analysis involves assessing the creditworthiness of government debt issuers, considering both qualitative and quantitative factors. Qualitative factors include fiscal flexibility, monetary effectiveness, economic flexibility, external status, and government institutions and policies. Quantitative factors focus on fiscal strength, economic growth and stability, and external stability, using various financial ratios and macroeconomic indicators.

Key Concepts:

Qualitative Factors

These include government policies, fiscal and monetary policies, and the overall economic environment. Factors such as fiscal flexibility, monetary effectiveness, and government institutions play a crucial role in assessing sovereign creditworthiness.

Quantitative Factors

These involve numerical data to assess the ability of a government to meet its debt obligations. Key indicators include fiscal strength (e.g., debt-to-GDP ratio), economic growth and stability (e.g., GDP growth rates), and external stability (e.g., foreign exchange reserves).

Fiscal Strength

Measured by ratios such as Debt to GDP and Interest to Revenue, indicating the government's debt burden and its affordability.

Economic Growth and Stability

Assessed through indicators like GDP size, per capita income, and real GDP growth volatility, reflecting the economy's ability to sustain growth and adapt to shocks.

External Stability

Evaluated based on a country's external debt burden, currency reserves, and the ability to attract foreign investment, crucial for meeting external debt obligations.

Formulas:

Debt to GDP

\frac{\text{General Government Debt}}{\text{GDP}}

Indicates the government's total debt as a percentage of its economic output.

Variables:

$General Government Debt$ :: Total debt held by the government
$GDP$ :: Gross Domestic Product

Units: Percentage

Interest to Revenue

\frac{\text{Government Interest Payments}}{\text{Revenue}}

Measures how much of the government's revenue is used to pay interest on its debt.

Variables:

$Government Interest Payments$ :: Total interest payments on government debt
$Revenue$ :: Total government revenue

Units: Percentage

Non-Sovereign Credit Risk

Learning Outcome Statement:

explain special considerations when evaluating the credit of sovereign and non-sovereign government debt issuers and issues

Summary:

The LOS content discusses various aspects of non-sovereign credit risk, including the evaluation of creditworthiness for different types of non-sovereign government debt issuers such as agencies, government sector banks, development financing institutions, supranational issuers, and regional government issuers. It highlights the factors influencing their credit ratings, the impact of sovereign support, and the specific characteristics of their issued debt.

Key Concepts:

Non-Sovereign Government Debt

Non-sovereign government debt includes debt issued by entities such as government agencies, regional governments, and other governmental institutions that do not have sovereign credit status but are linked to the sovereign government's financial or political stability.

Agencies

Agencies are quasi-government entities that often have implicit or explicit sovereign support, leading to credit ratings similar to the sovereign's rating. They issue debt to finance public services or government-sponsored missions.

Government Sector Banks and Development Financing Institutions

These institutions are created by sovereign governments to support specific economic, social, or policy objectives. They typically enjoy similar credit ratings to the sovereign due to direct or implicit government support.

Supranational Issuers

Supranational entities are international organizations formed by sovereign governments to pursue common goals, such as economic development or poverty reduction. Their creditworthiness is often supported by their member governments.

Regional Government Issuers

Regional governments, such as states or provinces, issue debt within a sovereign's jurisdiction. Their credit ratings can vary widely and are influenced by their economic stability, fiscal management, and the national government's fiscal and monetary policies.