What Is Sovereign Debt?

Definition & Examples of Sovereign Debt

Young man calculating financial bills at home
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Sovereign debt is money owed by a government to its creditors. It can be used to gauge the creditworthiness of a country.

Learn the causes and types of sovereign debt and how it's measured to become a more informed citizen and investor.

What Is Sovereign Debt?

Sovereign debt refers to the financial liability of the government of a sovereign nation to its foreign and domestic creditors. Foreign creditors are typically foreign governments that hold a portion of a country's debt, whereas state and local governments are examples of domestic creditors.

Such debts typically include securities, bonds, or bills with varying maturity dates. But the term can also be used to describe future liabilities, such as unpaid pension debt.

  • Alternate name: government debt, national debt, public debt

How Sovereign Debt Works

Governments buy and sell goods and services, distribute payments, and assess taxes in order to meet their obligations, bring in revenue, and control the economy. This combination of spending and taxation is known as fiscal policy. Under a contractionary fiscal policy, revenue exceeds spending, resulting in a budget surplus. In contrast, expansionary fiscal policy describes a scenario where spending is higher than revenue, resulting in a budget deficit. A government may resort to borrowing in such a scenario to make up the difference between spending and revenue, and that borrowing is referred to as sovereign debt. Nations typically borrow by issuing bills, notes, and bonds backed by the credit of the government.

As governments have to pay interest on the debt in the future, expansionary fiscal policy and the sovereign debt that results from it can increase the burden on taxpayers in the future. Moreover, persistently rising sovereign debt can cause foreign governments to distrust a country's assets, which can have the effect of devaluing the country's currency relative to that of others.

As such, sovereign debt reflects on a country's ability to carry out essential governmental activities and take on and repay debts. Moreover, sovereign debt ratings issued by credit-rating agencies such as Standard & Poor's, Moody's Investors Service, and Fitch Ratings can help investors determine the credit risks associated with a given country by taking into account not only debt levels but also political risk, regulatory risk, and other factors.

Types of Sovereign Debt

Government debt typically falls into one of two categories:

  • Debt held by the public: This refers to federal debt held by individuals, corporations, state and local governments, and foreign governments.
  • Intragovernmental debt: This can be regarded as the debt a government owes to itself. It refers to debt held by government accounts—for example, government trust funds, revolving funds, and other special funds.

About 90% of intragovernmental debt is held in federal trust funds, primarily for Social Security and retirement programs for federal employees and members of the military.

How to Measure Sovereign Debt

Different countries may measure sovereign debt using a variety of diverse metrics. Major measures of government debt include:

  • Gross federal debt: This is the sum of the debt a government owes other entities and the debt it owes itself. To calculate it, add the debt held by the public to the intragovernmental debt.
  • Debt held by the public: The most common and useful metric, this reflects gross debt after excluding intragovernmental debt. It's the debt metric that the CBO most commonly uses in its debt reports. The debt-to-GDP ratio, which is debt as a percentage of the gross domestic product (GDP), is often used to make sense of the debt by framing it in relation to the size of the economy. It's calculated by dividing the debt held by the public by the GDP.
  • Debt subject to limit: This amounts to gross federal debt less debt issued by non-Treasury agencies and the Federal Financing Bank.

Debt held by the public is the most useful measure of sovereign debt because it measures the outstanding debt a country has incurred to cover its deficits.

How Much Is the Sovereign Debt?

Below are the sovereign debt levels for some major countries expressed in terms of the debt held by the public as a percentage of GDP. All figures are from the latest available CIA World Factbook data, sourced in 2017:

  • United States: 78.8% of GDP
  • Canada: 89.7% of GDP
  • Mexico: 54.3% of GDP
  • Japan: 237.6% of GDP
  • Germany: 63.9% of GDP

The five most indebted countries relative to their GDP are:

  1. Japan: 237.6% of GDP
  2. Greece: 181.8% of GDP
  3. Barbados: 157.3% of GDP
  4. Lebanon: 146.8% of GDP
  5. Italy: 131.8% of GDP

The five least indebted countries relative to their GDP are:

  1. Macau: 0% of GDP
  2. Falkland Islands: 0% of GDP
  3. Hong Kong: 0.1% of GDP
  4. Brunei: 2.8% GDP
  5. TimorLeste: 3.8% of GDP

Key Takeaways

  • Sovereign debt, also known as national debt, is the debt a country owes to its foreign and domestic creditors.
  • It falls into two categories: debt held by the public and intragovernmental. Both stem from a government's borrowing activity and rise in particular under an expansionary fiscal policy.
  • Sovereign debt gives a view of a country's economic health and creditworthiness.
  • There are multiple metrics for calculating the debt, but the debt held by the public relative to the GDP is among the most common.