Sovereign Debt
What is Sovereign Debt?
Sovereign debt is money borrowed by a national government, usually by issuing bonds, and it is the accumulated stock of past deficits.
Governments borrow by selling bonds to households, firms, banks, foreign investors and sometimes their own central bank, promising interest and repayment of principal. Debt owed in a country's own currency carries different risk from debt owed in a foreign currency, because a government can always create its own currency to pay, at the cost of inflation, while foreign-currency debt can be defaulted on outright. What matters for sustainability is not the raw dollar amount but the debt-to-GDP ratio and the relationship between the interest rate and the growth rate: if growth exceeds the interest rate, the ratio can drift down even with modest deficits. Keep the terms apart: the deficit is this year's shortfall, and it adds to the debt, which is the total owed.
Sovereign Debt: a worked example
A country has debt of $800 billion and nominal GDP of $1,000 billion, a debt-to-GDP ratio of 80%. It runs a deficit of $30 billion while nominal GDP grows 5%. Debt becomes $830 billion and GDP becomes $1,050 billion, so the ratio is $830 ÷ $1,050 = about 79%. The debt got bigger in dollars but smaller relative to the economy, which is why economists watch the ratio rather than the raw total. Had GDP been flat, the ratio would have risen to 83%.
The mistake students make with sovereign debt
The most common error is using debt and deficit interchangeably. The deficit is a flow measured over one year and the debt is a stock measured at a point in time, so a falling deficit still adds to the debt as long as it is positive. Students also assume any government can go bankrupt like a household. A government borrowing in its own currency can always pay in nominal terms; the real risk there is inflation, not a missed payment.
Sovereign Debt questions
What is the difference between the deficit and the debt?
The deficit is the amount a government borrows in a single year, while the debt is the total it owes from all past borrowing. A deficit adds to the debt and a surplus subtracts from it. Cutting the deficit slows the growth of the debt but does not reduce it.
Why do economists use the debt-to-GDP ratio?
The ratio compares what a government owes with the size of the economy that services it, which is what determines whether the debt is manageable. A larger economy can carry more debt at the same burden, much as a higher salary supports a bigger mortgage. The ratio can fall even while debt rises, provided nominal GDP grows faster.
Can a country default on debt issued in its own currency?
A country can choose to default on debt in its own currency, but it is never forced to, because it can create the currency needed to pay. The real constraint is inflation and the exchange rate, not the ability to make a payment. Debt owed in a foreign currency is different, since the government cannot print that currency and outright default becomes possible.
Formula / Example
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Related terms
Common comparisons
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