In recent weeks the term Sovereign Debt has been bandied about by the media leaving many people puzzled as what it actually is. What it isn’t is money owed by a King or Queen of a country – Republics do have Sovereign Debt; you don’t need a Monarch!

Joking aside, in simple terms Sovereign Debt it is borrowing carried out by a national government and which that government guarantees. The government issues “bonds” – called “gilts” in the UK – to investors and guarantees to repay the money borrowed at some future date.

Typically a government might issue a bond (which is really just an IOU) with a face value of £1 million for a discounted price. Let’s say £900,000 with a promise to pay the full £1 million in five year’s time. The person who bought the bond can sell it to someone else at a price, which will vary as the redemption date nears, or at a price that reflects the likelihood of the bond being repaid in full. The fact is that governments can, and often do, default on paying back the money they have borrowed. Sometimes the bonds will also pay interest and as you might expect the amount of interest that a country in trouble will need to pay will be larger than the amount payable by a financially sound country. This reflects the risk.

So why do governments sell bonds? It is rather simple. The only source of income for any government is taxation. That could be income tax, value added tax, council tax, taxes and duties on petrol, airline tickets, alcohol, tobacco etc. Sometimes they want (or need) to spend more money than they have collected and so just like you or me buying a car or a house they borrow – by issuing bonds. Just like you or me they sometimes have trouble paying the money back.

And there you have the problem. There comes a point when the population cannot pay more tax so the government has to cut back on spending (though Gordon Brown doesn’t see this) and borrow even more. Currently too the big problem is that the main buyers of government bonds are banks – and as we know they have problems of their own.

What a pity more countries don’t follow the example of the Isle of Man. We have no Sovereign Debt because our government is forbidden from borrowing. The Isle of Man raises taxes and these are much lower than most other countries because we don’t have to service (pay interest) on massive borrowings. The UK is now paying more in interest to banks and bondholders than it spends on the Defence Budget or the Education Budget. Crazy.

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Category: Guide to City Jargon 

One Response to “What is Sovereign Debt?”

  1. Doothe says:

    I do not generally respond to blogposts but I will in this case. Seriously a big thumbs up for this one!

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