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Despite Setbacks, Latin American Sovereigns Are Moving Past 'Original Sin'


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Despite Setbacks, Latin American Sovereigns Are Moving Past 'Original Sin'

This report does not constitute a rating action.

Many Latin American sovereigns over the last few decades have enhanced their ability to support their government debt burdens by strengthening domestic financial markets and improving their sovereign debt profiles. In other words, they reduced their reliance on external markets and thereby mitigated "original sin"--that is, the inability to issue long-term local currency-denominated debt at fixed interest rates in domestic capital markets. However, worsening debt profiles amid elevated interest rates, weakened private-sector pension funds, and low domestic savings could pose risks to sovereign ratings in the region.

The level of sovereign debt is an important factor in S&P Global Ratings' assessment of sovereign creditworthiness, but higher debt does not necessarily mean higher risk of default. We have comparatively high credit ratings on many sovereigns with high debt burdens, and the other way around (see chart 1). For example, Japan is rated comparatively high (foreign currency 'A+') but also has the highest net general government debt as a share of GDP in the world (169%). Another example is India, which is rated investment grade ('BBB-'), with net debt at 87% of GDP. In both cases, other rating strengths, including that most of the sovereign debt is in local currency and held by residents, mitigate the credit risk of high government debt.

Chart 1


The composition and level of sovereign debt have an impact on our rating analysis. However, a sovereign's capacity and willingness to meet its financial obligations depend on other qualitative and quantitative factors, mainly its institutional and economic performance. The fiscal and debt profile, monetary flexibility, and external position are also key elements in the rating (see "Sovereign Rating Methodology," Dec. 18, 2017).

Overcoming "Original Sin" Is Not A Challenge Only For Latin America

Countries that have low domestic savings typically seek financing from nonresidents, which increases their net external liabilities. Sovereigns that depend on external financial markets are more vulnerable to shocks that could worsen their access to funding and to sharp increases in debt service costs through exchange rate variations. Similarly, high dependence on short-term and floating-rate debt, both external and domestic, raises the volatility of interest costs.

To reflect the vulnerabilities associated with original sin in our sovereign ratings, we may worsen a sovereign's fiscal assessment if nonresidents hold more than 60% of the government's net commercial debt, or if more than 40% of government's debt is denominated in foreign currency or the average maturity is less than three years. Many emerging market sovereigns, and not just in Latin America, have debt profiles with these structural weaknesses (see chart 2).

Chart 2


Strong Central Banks And Pension Funds Are Key

Many Latin American countries have strengthened their monetary policies, a prerequisite for boosting domestic savings and developing domestic capital markets. Such progress has depended on bolstering central banks to control inflation and conduct credible monetary policy and, thereby, promote financial stability that encourages more financial savings.

Many governments have also boosted domestic financial savings by promoting private pension funds and other institutions that can invest in long-term government and nongovernment debt, including at fixed interest rates. Stronger domestic financial markets and more resilient debt profiles helped sovereigns to limit the negative ratings impact of the recent pandemic-induced recession.

COVID-19 Took Its Toll, Including Early Withdrawals From Pension Funds In Some Countries

The economic impact of the pandemic, including on GDP, fiscal outcomes, exchange rates, and inflation, raised net general government debt across Latin America. Chile, for example, almost doubled its general government debt as a share of GDP, and Peru's increased by over 70% (see chart 3), although the two countries maintain the lowest debt in the region. The currency composition of debt in Chile, Colombia, Peru, and Uruguay deteriorated during the pandemic, since all of them saw a jump in foreign currency-denominated debt (see chart 4). In contrast, the composition of debt remained stable in Mexico and Brazil.

Chart 3


Chart 4


The social impact of the pandemic led countries like Chile and Peru to allow people to withdraw substantial funds from their individual pension accounts to sustain their income. Such steps may have alleviated economic hardship, but by reducing pension fund assets, they also reversed some of the earlier gains that had been made in deepening domestic capital markets. The diminished capacity of domestic pension funds to purchase locally issued debt, along with low domestic savings, will contribute to more reliance on external funding, in both foreign and local currency, and expose sovereigns to higher nonresident holdings.

As a consequence of the COVID-19 shocks in a region with preexisting fiscal and other vulnerabilities, Latin America's sovereign creditworthiness deteriorated. For instance, between January 2020 and March 2022, we downgraded Chile, Colombia, Mexico, and Peru, mostly because of worsening debt and/or fiscal assessments, and we revised our outlook on Brazil to stable from positive. However, all five of these countries had made more progress than much of the region in building domestic capital markets when the pandemic hit, which helped them to mitigate its impact on the economy.

A Review By Country

Chart 5



Brazil has the highest general government debt burden among the six major Latin American countries, along with a high interest burden (interest payments to revenue). Moreover, only 30% of its debt is issued at fixed interest rates--the lowest share among regional peers. This underpins Brazil's poor debt score of '6', which constrains the sovereign rating.

Although Brazil's sovereign debt burden rose during the recent recession, its debt profile remained largely stable, limiting the potential negative effects of higher debt on the country's external assessment (which is one of its relative rating strengths). Despite its high debt burden, Brazil stands out because most of its general government debt (95%) is issued in local currency and nonresidents hold only 10%.

The sovereign enjoys easy access to funding from a large domestic market, including a sizable banking sector. Total assets of financial institutions account for over 200% of the country's GDP, which is almost as high as for Peru's, Mexico's, and Colombia's financial institution assets combined. Moreover, the low foreign currency debt helps insulate fiscal balances from exchange rate volatility.

However, given that a large share of local currency debt is short term, the rollover ratio in 2023 will be high at around 15% of total debt. A sudden increase in interest rates could hurt the sovereign's budget. Yet this vulnerability is contained by the central government's strong liquidity position and ready access to domestic buyers of its debt.


Weakening public finances, a worsening debt burden, and the long-term policy impact of political developments and public protests led us to lower our long-term foreign currency rating on Chile to 'A' from 'A+' in March 2021. Net general government debt is likely to exceed 30% of GDP in 2023, up from 15% in 2019, marking the highest increase (as a share of GDP) among regional peers. The government ran large fiscal deficits during the pandemic, largely depleting its liquid assets held in an economic stabilization fund and a pension reserve fund.

The pandemic also took a toll on the composition of the sovereign's debt. The government resorted to more external funding during the recession. As a result, foreign currency-denominated debt rose to 33% of the total sovereign debt in 2022, from 20% in 2019, making public finances more vulnerable to exchange rate volatility.

Chile has the largest private pension system in the region, with assets under management around 55% of GDP at year-end 2022. The pension funds are key buyers of government debt. During the pandemic, the government passed laws allowing people to withdraw money from their individual pension funds on three occasions to supplement household income. As a result, the assets held by these pension funds fell by 25%, weakening the funds' capacity to buy government debt. Partly as a consequence, the government now depends more on external funding, with nonresident holdings of total sovereign debt increasing to 41% in 2022 from 35% in 2019.

Responding to long-standing public demands, the Chilean Congress is likely to pass legislation to reform the country's private- and public-sector pension systems. The reform, which is likely to retain individual pension accounts, will be an important change that could have a substantial long-term fiscal impact.


In May 2021, we lowered our long-term foreign currency rating on Colombia to 'BB+' from 'BBB-' to reflect a worsening of public finances due to large deficits and rising debt. Colombia's net general government debt had remained below 50% of GDP over the past decade but increased sharply toward 60% during the COVID-19 pandemic, with interest payments reaching 18% of government revenue.

About 60% of total general government debt is denominated in local currency and 75% is at fixed interest rates. Yet due to higher financing needs that were covered mainly by international markets and multilateral lenders during 2020-2021, foreign currency-denominated debt increased compared with pre-pandemic levels (42% in 2022, from 34% in 2019), exposing Colombia to foreign exchange volatility. A weak external profile is a constraint on the sovereign rating.

The government of President Gustavo Petro has announced plans to reform Colombia's pension system. Unlike in Chile and Peru, there were no early withdrawals from privately managed pension funds during the recent recession. The private pension funds, which have assets under management of around 27% of GDP, play an important role in developing the country's capital markets and facilitating the government's long-term policy of moving away from original sin. The new pension reform is likely to retain individual pension accounts but increase the role and the resources of the government's own pension administration.


We lowered our long-term foreign currency rating on Mexico to 'BBB' from 'BBB+' in March 2020 owing to weak GDP growth prospects. However, its fiscal and debt profiles did not materially deteriorate during the pandemic, despite a modest increase in net general government debt that was much smaller than in most countries.

Mexico's moderately weak debt assessment, reflecting a net debt burden of around 50% of GDP and interest payments at 11% of total revenue, is balanced by a favorable debt profile that limits risks. Mexico has the second-most-developed bond market in Latin America (behind Brazil), with outstanding domestic debt securities amounting to 49% of GDP. Nearly 80% of central government debt is issued in local currency, and about 51% of that debt is at fixed interest rates. Moreover, the Mexican peso is an actively traded currency, distinguishing the country from regional peers and signaling significant progress in moving past original sin.

In contrast with Chile's and Peru's governments, the Mexican government undertook a pension reform in 2020 to strengthen the country's private-sector pension funds by increasing contributions. Assets under private pension fund management are equivalent to 21% of GDP as of year-end 2022. The reform should encourage growth in domestic savings, gradually boosting resources available to finance long-term investments. Thus, while Chilean and Peruvian capital markets weakened due to substantial withdrawals of pension fund assets, Mexico's financial market became sturdier.


We lowered the long-term foreign currency rating on Peru to 'BBB' from 'BBB+' in March 2022 based on both a worsening sovereign debt profile and a weaker institutional assessment. In December 2022, we revised the outlook to negative from stable owing to heightened political deadlock and uncertainty about Peru's institutional stability and its capacity to sustain continuity in key economic policies and support economic growth.

The Peruvian government approved six rounds of withdrawals from the country's private pension accounts between 2020 and 2022, and a seventh is currently in discussion. As in Chile, pension fund withdrawals helped alleviate people's cash needs amid the economic crisis. However, they also resulted in a 40% reduction of total pension fund assets under management between 2019 and 2022, which limited the ability of pension funds to buy sovereign bonds. That, in turn, pushed the government to rely more on external creditors. As a result, the share of foreign currency-denominated debt and sovereign commercial debt held by nonresidents increased, making the composition of sovereign debt more vulnerable.

Among regional peers, Peru has the lowest share of net debt to GDP (23%). Nevertheless, most of the sovereign's debt is denominated in foreign currency (52%) and is mainly held by nonresidents (66%). Still, the cost of debt service is relatively low at 7% of general government revenue, and most of the debt is at fixed interest rates (86%), mitigating interest rate risk.

Even though the development of Peru's local debt market reversed during the pandemic, its central bank played an important role in mitigating the impact on financial markets of the substantial withdrawal of pension fund investments. The credibility of the monetary authority and its success in controlling inflation are positive factors sustaining Peru's local debt markets. However, reversing the recent weakening of the sovereign's debt profile depends on a combination of fiscal and debt management policy, along with political stability and recovery of local funds.


We raised the long-term foreign currency rating on Uruguay to 'BBB+' from 'BBB' in April 2023 based on prudent fiscal execution and fiscal policy framework improvements. Our rating on Uruguay is supported by prudent and predictable economic policies and robust institutions that have underpinned consistent economic growth for over 15 years. However, net general government debt is at 52% of GDP, about 5 percentage points higher than in pre-pandemic days. Uruguay's local debt markets also remain subdued considering higher inflation than for regional peers and persistently high dollarization in financial markets. These negative factors, which weigh on the sovereign rating, have contributed to low monetary flexibility and limited the development of domestic capital markets.

At the same time, Uruguay has made progress in reducing risks embedded in its sovereign debt profile. Exposure to foreign currency is currently at 48% of total sovereign debt, compared with 88.5% in 2005. Also, most of its general government debt is now at fixed interest rates. Yet the risk of sudden movements in the exchange rate, which come with such a high share of foreign currency-denominated debt, is a negative factor in our assessment of Uruguay's debt profile.

The Uruguayan government recently passed a long-awaited pension reform to address the long-term fiscal challenge of its ageing population. Although its impact may come in the medium term, the pension reform, along with the broader contours of fiscal policy, inflation control, and economic growth, could help to stabilize the sovereign's debt burden. However, this reform lacks measures to widen domestic capital markets, which, in turn, won't have an effect on the composition of the sovereign's debt--and, hence, on moving past original sin--like in other regional peers.

Further Obstacles Are Ahead

The pandemic contributed to higher net government debt, and, in most countries, it led to an increase in foreign currency borrowing. On the other hand, pension withdrawals authorized in some countries lowered the capacity of domestic capital markets to purchase local currency sovereign debt. That led sovereigns to sell more debt to nonresidents in both local and foreign currency, raising their exposure to volatility in exchange rates and market access. However, the rating deterioration in Latin America was mild compared with other emerging markets (for instance, those in Africa), large because of the robustness of its local capital markets. Latin America's progress in overcoming original sin helped to sustain its resilience amid turbulent times, despite some setbacks during the pandemic.

Overcoming original sin is a success story that comes with some caveats. Even though issuing debt in local currency helps reduce some vulnerabilities, low domestic savings lead sovereigns to depend on external investors to buy domestic bonds. Higher domestic savings would better shield sovereigns from external shocks by providing a way for governments to borrow money from comparatively less volatile domestic sources, reducing or eliminating reliance on foreign sources of financing. However, improving the level of domestic savings is a long-term challenge.

Another difficulty is the costly policy choice that moving away from original sin entails. While issuing debt domestically and in local currency helps reduce the vulnerability of the debt stock, it is usually more expensive than issuing in foreign currency. Policymakers are then faced with a complicated trade-off--having to weigh the short-term costs against the long-term benefits when deciding whether to issue debt locally or externally.

Recently, central banks in the region have responded to inflation by raising their policy rates, thereby pushing up sovereign borrowing costs (which are approaching levels not seen in more than a decade). Amid higher borrowing prospects, elevated interest rates will translate into higher debt service, potentially worsening the fiscal profiles of some sovereigns in the region. Failure to control inflation could also contribute to worsening debt profiles if it encourages sovereigns to issue more inflation-indexed debt, another step that reverses the movement away from original sin. These risks could translate in lower credit worthiness overall.

One legacy of the pandemic-induced recession is widespread demand across the Latin America region for more effective social policies, including pensions. The way governments respond to this challenge, by either strengthening or weakening public finances and domestic financial markets, will affect sovereign ratings over the long term.

Related Criteria

Related Research

  • Eichengreen, B., & Hausmann, R. (1999). Exchange Rates and Financial Fragility. National Bureau of Economic Research.
Primary Credit Analysts:Nicole Schmidt, Mexico City +52 5550814451;
Joydeep Mukherji, New York + 1 (212) 438 7351;
Secondary Contact:Roberto H Sifon-arevalo, New York + 1 (212) 438 7358;

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