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

An analyst compares two sovereigns with similar GDP per capita. Country X has a debt-to-GDP ratio of 40% mostly held by domestic investors in local currency. Country Y has a debt-to-GDP ratio of 40% mostly denominated in a foreign currency and held by foreign investors. Which assessment is most likely correct?

Country Y is more vulnerable because its debt is in foreign currency and held by foreign investors. A depreciation raises the local burden of the debt, and foreign holders may withdraw funding suddenly. Equal debt-to-GDP ratios ignore the currency and investor-base differences.

  1. ACountry X and Country Y have equal vulnerability because their ratios are equal.
  2. BCountry Y is less vulnerable because foreign investors are more stable lenders.
  3. CCountry Y is more vulnerable to a currency depreciation and a sudden stop in capital inflows.Correct

Explanation

Foreign currency debt rises in local-currency terms when the currency depreciates, and foreign holders may withdraw quickly. Identical ratios therefore hide different risk. Domestic local-currency debt gives the government more flexibility.

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