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FRM Part II · FRM Exam Part II · Country Risk: Determinants, Measures, and Implications

Which development would most likely increase the probability that a sovereign defaults on its foreign-currency debt?

A widening current account deficit financed mainly by short-term foreign borrowing most increases default probability. It raises external debt and rollover risk and makes the sovereign vulnerable to sudden capital outflows, whereas higher reserves, better primary balances, and export diversification all reduce vulnerability.

  1. AA rise in foreign exchange reserves relative to short-term external debt
  2. BA sustained improvement in the primary fiscal balance
  3. CA widening current account deficit financed mainly by short-term foreign borrowingCorrect
  4. DDiversification of export revenues across more trading partners

Explanation

Financing a larger deficit with short-term foreign borrowing increases rollover and liquidity risk and dependence on market sentiment. The other options each improve liquidity, fiscal sustainability, or the stability of foreign currency inflows.

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