Why do rating agencies assign a different rating to the debt of a sovereign entity based on whether the debt is denominated in a local currency or a foreign currency?

Question

What will be an ideal response?

Answer 1

The reason for distinguishing between local debt ratings and foreign currency debt ratings is that historically, the default frequency differs by the currency denomination of the debt. Specifically, defaults have been greater on foreign currency-denominated debt. For example, an S&P survey of 113 countries found that since 1970 there were eight defaults by sovereigns on their local currency debt but 69 on foreign currency debt. The reason for the difference in default rates for local currency debt and foreign currency debt is that if a government is willing to raise taxes and control its domestic financial system, it can generate sufficient local currency to meet its local currency debt obligation. This is not the case with foreign currency-denominated debt. A national government must purchase foreign currency to meet a debt obligation in that foreign currency and therefore has less control with respect to its exchange rate. Thus a significant depreciation of the local currency relative to a foreign currency in which a debt obligation is denominated will impair a national government's ability to satisfy such obligation.