Sovereign Bonds and the “Democratic Advantage”: Does Regime Type Affect Credit Rating Agency Ratings in the Developing World?

Abstract

The importance of sovereign bond ratings has grown recently as assessments by credit rating agencies~CRAs! influence the cost of capital+ Understanding how CRAs determine country ratings is difficult based on the secretive nature of these agencies+ Controlling for the common explanations in the literature, we use panel data and interviews to investigate the role of the "democratic advantage" and other determinants on bond ratings set by Moody's Investor Services, Standard and Poor's, and Fitch Ratings for fifty developing countries from 1987 to 2003+ We find that regime type and most other political factors have little effect on bond raters+ Instead, trade, inflation, growth, and bond default strongly affect sovereign ratings+ The message for policymakers in developing countries is that factors that support bond repayment are most useful for enhancing CRA ratings+The single most important visitor to a developing country was the representative from a western aid agency in the 1960s; the commercial banker eager to recycle OPEC surpluses in the 1970s; the IMF official in the 1980s, the "lost decade+" Since then, it has been the sovereign analyst from one of the leading rating agencies, Moody's Investor Services, Standard and Poor's or Fitch+The authors' names are listed alphabetically to indicate equal contribution+ For comments on previous versions of this article, we are grateful to

Does compliance matter? Assessing the relationship between sovereign risk and compliance with international monetary law

“…In line with the results reported by Saiegh (2005) and Archer et al (2007), democratic countries do not seem to experience any advantages over autocracies with respect to Institutional Investor ratings; on the other hand, the claims made by "democratic advantage" proponents are borne out by the significant negative relationship between the Polity score and the Euromoney measure. A 20 point shift in the Polity score (corresponding to a transition from full autocracy to full democracy) is associated with a 4-5 point reduction in the Euromoney risk rating.…”

“…Archer et al (2007) argue that political stability is more important for bond rating agencies' risk assessment than regime type. Political instability is likely to cause observers to downgrade the creditworthiness scores for countries for a number of reasons.…”

An Empirical Assessment of Sovereign Country Risk in the Black Sea Region

“…These regressions are implemented on a numerical representation of the ratings. This methodology, which is the one used in the present study, was also pursued by Cantor and Packer (1996); Afonso (2003); Afonso et al (2007Afonso et al ( , 2011 ;Mulder and Perrelli (2001); Rowland (2004); Archer et al (2007); Powell and Martinez (2008) and Gärtner et al (2011). There is also an alternative strand which uses ordered response models and ordered probit regressions, supporting that ratings are a qualitative ordinal measure and cannot be linear transformed, since the difference between two notches is not equal for any two adjacent rating categories (Bissoondoyal-Bheenick 2005;Bissoondoyal-Bheenick et al 2006;Mellios and Paget-Blanc 2006;Afonso et al 2007Afonso et al , 2011Jaramillo 2010).…”

“…The use of GDP per capita, indicating the wealth of people in an economy, prevails in the literature and is found almost always to be significant in capturing variation in sovereign ratings. In addition, GDP growth and inflation are often taken into consideration (Cantor and Packer 1996;Mulder and Perrelli 2001;Rowland 2004;Bennell et al 2006;Afonso 2003;Archer et al 2007;Canuto et al 2012). Another focal point of the researchers who attempt to assess CRA ratings are a country's debt metrics.…”

“…The most frequently used variables to assess sociopolitical aspects of credit ratings include government effectiveness (Powell and Martinez 2008;Afonso et al 2007Afonso et al , 2011, corruption (Mellios and Paget-Blanc 2006) and political stability (Afonso et al 2007(Afonso et al , 2011Archer et al 2007;Powell and Martinez 2008;Jaramillo 2010). Dummy variables are also used in the relevant literature to account for sovereign defaults (Cantor and Packer 1996;Mellios and Paget-Blanc 2006;Archer et al 2007;Powell and Martinez 2008;Afonso 2003Afonso , 2007Afonso and 2011Canuto et al 2012). Similar is the case with indicators of membership in a group of countries that shares common characteristics such as the EU and Latin America (Afonso et al 2007;Powell and Martinez 2008;Gärtner et al 2011) and development level indices.…”