For professional clients only. The information contained within this post is not intended for retail clients.
For decades, global fixed income investors have relied on sovereign credit ratings as a key measure of creditworthiness. Yet there is a growing case that established rating frameworks can be slow to recognise changes in a country’s underlying financial strength. Their emphasis on historical fiscal performance and established credit profiles may not always capture the evolving balance sheet of the wider economy.
The contrast between the US and Japan is particularly striking. The US holds a Aa1/AA+ rating, while Japan is rated A1/A+. Yet, using our Net Foreign Asset (NFA) Model, we calculate the US’s NFA position at approximately -90% of GDP, compared with around +90% for Japan. Both countries carry substantial government debt, but their external financial positions are fundamentally different. The US benefits from the dollar’s reserve currency status and funding flexibility, while Japan’s overseas investments generate significant income and provide an important external financial buffer.
This raises a broader question: do sovereign ratings adequately reflect the financial strength of national economies, particularly where historical fiscal metrics can obscure structural changes? On a hypothetical assessment placing significantly greater weight on external balance-sheet strength, the US might sit closer to AA-, while Japan could warrant AAA. These are illustrative analytical assessments, not formal rating forecasts, but highlight the potential disconnect between conventional sovereign ratings and wider national financial strength.
The differences extend further. France, rated Aa3/A+, has an NFA position of around -20% of GDP, alongside elevated government debt and persistent fiscal deficits. Moody’s decision earlier this month to maintain its Aa3 rating, despite widespread expectations of a downgrade, surprised many market participants. Its negative outlook nevertheless acknowledged the significant fiscal and political risks ahead.
Kazakhstan, rated Baa1/BBB, illustrates why national and sovereign balance sheets need to be assessed separately. Its overall NFA position is approximately -20% of GDP, similar to France’s, but this largely reflects foreign direct investment into its resource sector rather than sovereign indebtedness. Around 70% of its gross external liabilities are FDI-related. Meanwhile, National Fund assets amounted to approximately 21% of GDP in 2025, against gross public debt of around 26%. Central bank reserves provide an additional layer of external liquidity, although these are not freely interchangeable with government assets. After accounting for public financial assets, net public debt is considerably lower than the gross figure suggests. The distinction is important: aggregate external liabilities do not necessarily translate into equivalent sovereign financing risks.
These differences become particularly relevant during periods of tightening global financial conditions and potential deleveraging. As investors reduce leverage, unwind positions and repatriate capital, the direction of international money flows can become as important as a country’s fiscal position. Economies with substantial overseas assets may benefit from foreign investment income and potential capital repatriation, providing a buffer against external financing pressures and currency weakness. Conversely, countries reliant on continued foreign capital inflows can be more exposed to outflows, refinancing pressures and exchange rate volatility. The composition, liquidity and ownership of external assets remain critical; a positive net position does not guarantee that capital will return.
Rating agencies do incorporate external finances into their methodologies. However, the weighting of institutional and fiscal factors, alongside established frameworks and historical reference points, can mean that structural changes take time to translate into rating adjustments.
Looking beyond headline government debt and sovereign ratings to assess the strength, composition and direction of national external balance sheets can reveal differences in resilience that conventional credit assessments may not fully capture. This creates opportunities for more informed, index-agnostic sovereign selection and relative value positioning.