CFA Level I · CFA Level I Exam · Fixed-Income Markets for Government Issuers
Which factor is most likely to lead a credit rating agency to assign a sovereign a higher rating on its local-currency debt than on its foreign-currency debt?
The best explanation is that the government can tax residents and its central bank can issue the local currency. These powers support servicing local-currency debt, while foreign-currency debt requires obtaining foreign exchange the government cannot create, so its rating is often lower.
- AThe government has a large stock of foreign reserves
- BThe government can tax residents and has a central bank able to issue the local currencyCorrect
- CThe government has a floating exchange rate regime
Explanation
Local-currency debt can be serviced through taxation and money creation. Foreign-currency debt requires acquiring foreign exchange, which the government cannot create, so ratings on it are often lower. Reserves and floating rates do not explain a rating gap in this way.
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