Sovereign Debt Risk Management

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Public debt becomes “Sovereign Debt” when international financial markets identify unfavorable changes in exchange rates. They are defined as: “bonds that are issued by the government, but in foreign currency”. This is done in order to finance the growth of the country issuing the bonds, through best practices.

Sovereign debt is a riskier investment than public debts (in some ways). This is the case in developing countries, and is more risky than in developed countries. The political, economic and social stability of the issuing country’s government is an essential factor. These factors must be considered while assessing the risk of investments. International and national investors evaluate sovereign credit rating to measure the extent of risk involved in investments.

Public debts play a significant role in the economy of the country. It is a high credit investment that has a high percentage of liquidity. The US treasury market clearly illustrates this situation. Consequently, sovereign borrowers are expected to comply with risk management best practices. The practices and regulations involved in risk management reflect the preferences of the government. Moreover, companies involved in financial markets (at an international level), have to abide by and fulfill responsibilities that represent the government. For companies in the US, this becomes a bigger challenge because the highest level of reputation has to be maintained.

As a best practice for risk management, there are clear orthodox guidelines and government objectives set by countries in the financial market. These objectives are based on targets set for annual inflation. However, the greatest challenge is that government objects are unclear in terms of risk associated and costs. In most countries in the United States, debt management policies are implemented without in-depth insight into risk tolerance and preferences.

Countries enlisted as members of the OECD (Organization for Economic Co-operation and Development), recently took positive initiatives. They recognized the shortcomings of sovereign debt and addressed the problem. Each country established an independent debt management bureau. The sole responsibility of this office is to ensure public /sovereign debt risk management.

IMF’s Stand on Sovereign Debt

The International Monetary Fund (IMF) has started taking serious interest in sovereign debt management. According to the IMF the definition of sovereign debt is more concise. It is as a process that establishes and executes strategies to manage government debts. The objective of this is to raise required funds to settle the debt.

Therefore, greater challenge is to meet the objective (government debts) at the lowest possible cost. The IMF has therefore presented a framework for countries in the United States to help achieve the objective. This IMF framework is aimed at assisting debt managers to control and identify trade-offs between risk and cost.

Why is Sovereign Debt Important?

It is important because it outlines the performance and achievements of any government. It generates information about substantial risk to the country’s balance sheets and its financial stability. Therefore, through best practices for risk management, funding, liquidity, credit and exposure to markets can be managed.

Therefore the role of the IMF in US sovereign risk management is very important for the future of US economy.

Further reading: Corporate Governance | Audit | Performance Improvement

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