Perplexing Sovereign Debt to GDP Ratio:

between 237% Japan (April, 2017) and 59% Argentina (2018), which is more risky?

Michio Suginoo
Oct 26, 2018 · 18 min read
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  1. Can Japan pay back the sovereign debt, given at the world top record level of 236% of its GDP (April, 2017)? In other words, is Japan OK?
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  • Assumption 2) there is no willing-investors to purchase their newly issued debts.

Argentina

Now, how about Argentina? Repeatedly, our question is: while Argentine government’s ‘Gross SD/GDP Ratio’ is around 59% (Chart 1), well below the case of Japan, why is Argentine credit rating lower than Japan’s rating?

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  • Due to the depreciation of the currency, the value of its outstanding USD-denominated debt will increase in local currency term. A heavier burden going forward. (Positive)
  • If the government has to acquire USD from the market, it needs to issue its local currency first then exchange it to USD. The transaction itself will impose a further downward pressure on its own currency and increase inflationary pressure on the domestic economy.
  1. then, such a move is likely to induce speculative moves on the currency. (negative);
  2. in addition, it would compel locals to exchange their peso saving into USD via black markets for the sake of wealth preservation. (negative)
  • In addition, in the absence of hedging instruments, Argentina suffers from increasing imported prices. (This differentiates Argentina from Japan, where currency depreciation would not necessarily influence domestic prices of export products partly because there are a variety of hedging instruments available to both export producers and importers.)
  • An acute depreciation in currency could make it difficult to pass the cost to customers. As a result, production can plunge. In addition, if at a high level of inflation, there would not be any credit available for leasing or financing. This will damage imported capital goods sales to export producers.
  • In the case of an acute currency depreciation, as stated earlier in the import section, the volume of Argentina export products will stagnate due to increases in the cost of finance due to the rising interest rate as well as the cost of capital goods for production. As an example, recent deterioration in ARP actually destroyed credit available for the agricultural producers and reduced the sales of agricultural capital goods by 35%. (Bertello, 2018) As a result, the rising interest rates and the increased cost of import stagnated the volume of export productions. Thus, Argentine export volume is expected to decline.
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Japan

How about Japan? Why can Japan maintain an investment grade rating even at 236% (April, 2017) of Gross Sovereign Debt per GDP Ratio? What’s different from Argentina? Is the denomination of their sovereign debt only the difference?

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  • Step 2) on behalf of the government, the central bank issues currency in order to buy the newly issued debt;
  • Step 3) once the government receives the proceeding it uses the currency to repay the debts to the creditors;
  • Step 4) the currency either circulates into the economy or is saved in bank deposits;
  1. Inflation would reduce the real value of the legacy debt since it is denominated in the local currency: that would be positive from the perspective of solvency, as long as its legacy debts are concerned. (Positive)
  2. Inflation would increase the cost of funding toward the future. Future issuance of debt would become increasingly costly and difficult. (Negative)
  3. An acute decline in the purchasing power of money would make it difficult for Japan to issue its sovereign debt in its own currency to attract domestic investors as well as foreign investors; (Negative)
  4. Whether Japan can extend monetisation of debt, knowing that it has inflationary implication, would depend on the existing level of inflation. If inflation goes out of control, sooner or later a political decision might be made to default on or reschedule the outstanding government debt. (Negative)
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  • On the other hand, the cost of funding would be cheaper for a new debt. (Positive)
  • Monetisation would not have a material impact on inflation. (Positive)

Big Picture:

The denomination of sovereign debt, although it is not the only driver that divides economic dynamics between Japan and Argentina, is a fundamental difference in the construct of their sovereign debt management dynamics. Together with given distinct monetary conditions, foreign-currency denominated debt can deprive Argentina of its sovereignty over fiscal and monetary policies. In a way, Argentina, by issuing foreign-currency denominated sovereign debt, has abandoned its sovereign freedom to manage its fiscal and monetary policy.


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