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

Which of the following developments would most likely lead a rating agency to downgrade a sovereign's foreign currency rating?

A sharp rise in short-term external debt relative to foreign exchange reserves most likely triggers a downgrade, because it raises rollover and liquidity risk for hard-currency obligations. The other developments typically strengthen or do not weaken the sovereign's capacity to repay.

  1. AA sharp rise in short-term external debt relative to foreign exchange reservesCorrect
  2. BAn increase in the share of government debt denominated in local currency
  3. CA rise in the country's national savings rate
  4. DA reduction in the fiscal deficit funded by taxes

Explanation

Short-term external debt rising relative to reserves raises rollover and liquidity risk for hard-currency obligations, a key determinant of foreign currency sovereign risk. The other options generally improve or leave unchanged sovereign creditworthiness.

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