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Do sovereign debt ratios matter?

I have been trying to find an objective and easy to understand answer to this question and this is truly impressive… I’m always impressed with the truly analytical economic analysis by Michael Pettis and make it required weekly reading…

however, I have to admit that even with my slightly above average financial knowledge I have to read the article more than once to totally grasp the detailed concepts… and even more times to remember them!

So… to remember these concepts (& avoid spending 20 mins over a 5-page article) I’m going to summarize some of Michael’s articles, starting with the most recent one…

“Do soverign debt ratios matter?”

I think I can make [statement] with some confidence is that there is no threshold debt level that indicates a country is in trouble.  Many things matter when evaluating a country’s creditworthiness

These are the risk factors that affect a country’s ability to service its debts

  1. Of course debt levels – perhaps measured as total debt to GDP or external debt to exports
  2. The structure of the balance sheet matters[inverted or hedged], and this may be much more important than the actual level of debt (foreign currency debt, short-term borrowings – Mexican peso crisis 1994, Asian Currency Crisis 1997, Iceland 2010)
  3. The economy’s underlying volatility matters (think commodity dependent economies – Saudi Arabia, Canada, Australia, Iran, Nigeria, Russia, etc)
  4. The structure of the investor base matters (contagion due to highly leveraged investments)
  5. The composition of the investor base also matters (political cost of default, assets cannot be liquidated to pay debt even if assets are more than liabilities – Argentina 2002, Russia 1998)

The article is doesn’t name the likely countries to default but the recent Euro crisis has been primarily focused on the PIIGS nations (and their banks)

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