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CFA Level I · CFA Level I Exam · Credit Analysis for Government Issuers

A sovereign's external debt is mainly in foreign currency. Its central bank reserves are modest, its current account deficit is widening and its currency is under pressure. Relative to a sovereign with a flexible exchange rate and a large domestic investor base, the first sovereign's foreign currency credit rating is most likely to be:

The rating is most likely lower, because servicing foreign currency debt requires foreign exchange that the government cannot create. Modest reserves, a widening current account deficit and currency pressure weaken that capacity, and a weaker currency also raises the local-currency cost of the debt.

  1. Ahigher, because a weak currency boosts export competitiveness and tax revenue
  2. Bthe same, because ratings reflect only the debt-to-GDP ratio
  3. Clower, because repayment depends on scarce foreign exchange it cannot createCorrect

Explanation

Foreign currency debt must be serviced with foreign exchange earned or held in reserves. Low reserves, a widening current account deficit and currency pressure weaken this capacity, which lowers the foreign currency rating. Ratings consider more than debt-to-GDP.

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