Credit Analysis for Government Issuers

T his learning module explores special considerations for the credit evaluation of sovereign and other public issuers that often access fixed-income markets to finance their activities.

A major difference between corporate and sovereign issuers is the use of proceeds and source of repayment of debt obligations. In contrast to corporations that fund working capital and fixed assets to generate profits, sovereign and other government issuers use debt to conduct fiscal policy, supply public goods and services, and fund other government expenditures. While companies primarily rely on operating cash f low to repay debt, governments use tax revenues and other government revenues, such as tariffs and fees, to pay interest and principal.

We analyze sovereign bonds using a combination of qualitative and quantitative factors to assess their ability and willingness to pay. Sovereign defaults are not uncommon, particularly as countries transition from emerging to advanced economies. However, in contrast to corporate issuers, sovereign bondholders are generally unable to force governments to declare bankruptcy and liquidate assets. Non-sovereign issuers, such as certain local governments or quasi-government entities, also issue debt to finance their expenditures or develop infrastructure. This debt is backed by their ability to levy local taxes or generate specific project revenue.

• Governments borrow in public markets to conduct fiscal policy and meet budgetary needs, such as the provision of public goods.
• A sovereign government’s ability to tax private economic activity causes these bonds to normally have the lowest credit risk of any issuer in a specific country. In advanced economies, sovereign debt is often considered default risk-free.A combination of qualitative and quantitative factors is used to analyze a sovereign issuer’s ability and willingness to pay.
• Greater central bank independence from the sovereign issuing entity reduces the likelihood that a national government will simply increase the money supply by purchasing domestic debt.
• A key distinction for sovereign creditworthiness is whether its domestic currency is considered to be a reserve currency, that is, one that is fully convertible and held by foreign central banks and other investors.
• Non-sovereign government debt is issued by local governments or quasi-government entities, backed by their tax revenue or specific project revenue.
• The credit analysis of non-sovereign debt backed by tax revenue has similar considerations to sovereign bonds, while project-based revenue bonds are typically evaluated based upon the cash flows associated with the underlying project.