Understanding Sovereign Debt

FOCUS on ECONOMY

Central Bank of Papua New Guinea the issuer of government securities. Picture by Raksy Heron

Standard and Poor (S&P) last month released the credit rating of Papua New Guinea (PNG) and Pacific Business Review reported the rating to be maintained at B. Before that, there have been intense debates recently on the 2014 deficit budget passed down by government in November last year. In the midst of all those intense discussions, the phrase sovereign debt seems to randomly appear. However, many people still don’t understand what sovereign debt is all about and how PNG is evaluated by international organizations about its credit worthiness. I cover in this article, sovereign debt and tie it to PNG’s credit rating given by S&P recently.

Sovereign debt

Sovereign debt is simply money or credit owed by a government to its creditors. These debts typically include securities, bonds or bills with maturity dates ranging from less than a year to more than ten years.  A source in Central Bank told me that the bank is the only issuer of government securities including the treasury bills and inscribed stocks. In another context, the phrase sovereign debt can also be used to describe future obligations like pensions, entitlement programs, and other goods and services that were contracted but not paid. Concerns around sovereign debt have been growing since World War II. During that time, many countries went into debt to finance either the war itself or the rebuilding efforts afterwards. The government of PNG, through the treasury department supports a fairly high level of public debt to pay for public investment in lean times under the premise that it can be paid back by the growth that follows. That is the reason the O’Neil Dion led coalition government pass down an historical 2.3 billion deficit budget.

Measuring Sovereign Debt

Speaking during the recently concluded Leaders Summit held in Port Moresby, acting secretary for treasury Mr Dairi Vele confirmed the credit rating of PNG to be maintained at B. How is the sovereign debt of a country measured and its credit rating given? Sovereign debt is can be measured using a variety of different metrics. Often times, these metrics are used in order to determine if a country's sovereign debt is too high given its gross domestic product (GDP) or abilities to tax its citizens. But these factors should also take into account a country' GDP growth rate, which can dramatically influence its future ability to repay debt.

The three most popular metrics are:

Total Public Debt - The total public debt is the total amount of debt outstanding. But without context, this figure isn't very informative and can be misleading. As a result, most experts look towards Debt-to-GDP and Debt per Capita as common measures.

Debt as a Percent of GDP - Debt as a percentage of gross domestic product is simply the total public debt divided by GDP. Countries with a debt greater than their GDP (or a ratio over 100%) are generally considered to be over indebted.

Debt per Capita - Debt per capita is simply the total debt divided by the number of citizens. A debt per capita that is in excess of per capita income reduces the likelihood that the government will be able to make up its shortfall through traditional taxation. Sovereign debt statistics for individual countries since World War II has been widely documented and you source them on or offline.

Sovereign Debt Ratings

Sovereign debts ratings can help investors determine the credit risks associated with a given country by taking into account not only debt levels, but political risk, regulatory risk and other factors. Some studies have shown that these ratings can influence debt costs by as much as 25% per notch. The three most popular credit rating agencies are Standard & Poor's, Moody's Investor Services, and Fitch Ratings.

Credit rating

A credit rating is an evaluation of the credit worthiness of a debtor, in this case, the government of PNG. The rafting given by S&P shows the government of PNG’s ability to pay back its debt and the likelihood of default. Credit ratings are not done using mathematical formulas. Instead, the analysts of credit rating agencies like S&P use their judgement and experience in determining what public and private information should be considered in giving a rating to a company or organization. That is how S&P came out to give the government of PNG a credit rating of B.