Question

When we calculate default risk of country as difference between the rate it pays for US denominated Bonds and US treasury bonds, can we use the same spread for Bonds of country in Local currency ?

Answer 1

A spread above a risk free rate is the excess a bondholder demands for accepting the added risk. To answer this question you must first ask yourself is the bond denominated in USD more or less risky than the bond denominated in local currency? The answer is typically that the USD denominated debt of a foreign govt is more risky than its debt denominated in its own currency.

The reason for this is simple. The foreign govt earns income (tax receipts) in local currency, therefore its best for it to have it's debt denominated in local currency as well and avoid the exchange rate risk (that its debt will increase solely because it's currency has weakened vs the USD). Local currency debt also provides another more subtle benefit to avoiding default. Were the debtor nation to run into difficulty making payments on its debt, its possible to print more money (local currency) to pay off the debt. With debt denominated in USD, printing money is not an option.

So it is more beneficial for a country to denominate its debt in its own currency. Often times when a country does not it is more out of necessity than choice and there's likely insufficient demand for its debt denominated in its own currency.