Sovereign Debt and Challenges

Introduction

Sovereign debt is also known as government debt, public debt, and national debt. Sovereign debt is mainly used for public investment and to improve employment. It is raised through bonds and securities (domestic debt) and external borrowings in foreign currency from international institutions, such as the International Monetary Fund and foreign countries. The process involves the credit rating of sovereign debt. In September 2023, AAA sovereign credit ratings were granted to Australia, Canada, Denmark, Germany, Liechtenstein, Luxemburg, Netherlands, Norway, Singapore, Sweden, and Switzerland. There was no concrete evidence on the link between growth and sovereign debt until the findings of Carmen and Kenneth (2010). The main findings associated with 44 countries in their study were two: 1. High debt to GDP ratio of 90 % and above indicated slower growth; and 2. In case of emerging markets and developing economies the high debt-to-GDP ratio of 60% indicated much lower growth compared to the previous.

Countries with largest public debt

The nations with the largest public debt are identified by their public debt-to-GDP ratio (2025). Public debt is the total financial obligations of a nation’s government in terms of bonds and other securities drawn and acquired domestically and internationally to meet the budget shortfalls. This debt burden may be measured as a percentage in terms of Gross Domestic Product. Japan is the top nation in 2025 with 242% of GDP of public debt. The reason is to revive the economy and the public debt is drawn from domestic investors only. In 1990 it was 50% of GDP. The public debt does not hamper the economy. The second is Singapore, which has a public debt ratio of 153% of GDP in 2025. The purpose is to foster financial market development. Singapore maintains surplus budget and a huge foreign reserve, and it has no fiscal stress. It adopts the high public debt ratio to GDP with a deliberate strategic financial management. Eritrea suffers from a prolonged military conflict with Ethiopia, and it has public debt to GDP ratio of 210% in 2025. Most of the public debt is from China and other bilateral traders. It is one of the poorest nations in the world. Greece has public debt-to-GDP ratio of 149% in 2025, and this situation demands careful fiscal management.

Italy has the public debt to GDP ratio of 138% in 2025 and it remains one of the weakest economies of the Euro system due to slow economic growth, structural inefficiencies and spending on pensions and social welfare measures. Sudan has a 128% public debt-to-GDP ratio in 2025 due to economic mismanagement, international sanctions and internal conflict. Bahrain suffers from a public debt-to-GDP ratio of 131% in 2025 on account of the need to raise taxes and ensure social stability through rigid social spending demands. In the Maldives, public debt-to-GDP ratio of 125% in 2025, has to sustain financial stability through overseas borrowing, particularly from India. The USA has a 124% of public debt-to-GDP ratio in 2025 due to the impact of global financial crisis and the post COVID -19 crisis. Other reasons include rising health care costs. France has the public debt to GDP ratio of 116% in 2025 due to local conflicts and slow economic growth.

Sovereign Debt and Monetary Systems

The European monetary system functions with different parameters of economic growth unlike other monetary systems, even though every monetary system aims for sustainable economic growth. In the European Monetary system, there is one central bank, European Central Bank which regulates monetary policies of the European Union and it controls the Eurozone nations in terms of banking operations including sovereign debt. There are National Banks for nations outside the Eurozone. The foreign exchange is centrally controlled by the European Central Bank. The National banks manage the government’s debts and sovereign bonds. When the government’s debt is not managed properly, the government has to bail out, resulting in a sovereign’s debt crisis. The bank’s capital is slowly wiped out. In case of the Eurozone, the sovereign debt is managed through strict austerity programs. The National banks do not manage foreign exchange reserves and thus the international borrowings are regulated by the European Central Bank. Under Euro monetary system, no Eurozone member is permitted to print Euros to pay its debts and thus it has to follow budget constraint policies for national fiscal and structural adjustments. The sovereign risk of Eurozone results in insolvency risk. However, there is a European Stability Mechanism which grants emergency loans to resolve sovereign bond crisis. The member nations of the European monetary System have to accept strict fiscal consolidation and structural reforms. Under the Transmission Protection Instrument (TPI), it is permitted to buy bonds in the open market to stop market stability.

In other monetary system, the central bank plays an important role to regulate price stability and market stability.

ESG in Sovereign Credit Ratings

Environmental, Social, and Governance (ESG) factors are instrumental in shaping economic performance and financial risk related to sovereign debt. Every effort must be pursued to achieve ESG scores to handle long term risk and climate change problems. Now, the credit rating is calculated by incorporating ESG factors in the sovereign risk analysis.

Sovereign Debt, Climate Change, and Sustainable Development

The significance of the Paris Agreement it that it integrates sovereign debt with climate change, and sustainable development. Unfortunately, the developing nations struggle to overcome the “debt-climate trap”. The world’s nations have committed to mobilise $ 3 trillion annually to support climate action and the Sustainable Development Goals. The financing needs for climate action and the Sustainable Development Goals (SDGs) are immense, with emerging market and developing economies (excluding China) needing to mobilize an estimated $3 trillion annually. However, the current international financial architecture is not fit for purpose, with sustainable development finance often taking the form of loans rather than grants, thereby exacerbating debt vulnerabilities.