Non-technical summary
Sovereign credit ratings are a condensed assessment of a government’s ability and
willingness to repay its public debt both in principal and in interests on time. In this,
they are forward-looking qualitative measures of the probability of default put forward
by rating agencies. This paper studies the determinants of sovereign debt credit ratings
of the three main international rating agencies: Standard and Poor’s, Moody’s and Fitch
Ratings. We build an extensive ratings database, with sovereign foreign currency
ratings, attributed by the three agencies, as well as the credit rating outlook, for a panel
of 130 countries from 1970 to 2005.
In the first part of the paper we explain the main econometric approaches to the study of
the determinants of credit ratings focussing on specification of the functional form and
the estimation methodology. There are two major strands of empirical work in the
literature: on the one hand, OLS analysis on a numerical representation of the ratings,
which allows for a straightforward generalization to panel data by doing fixed or
random effects estimation; on the other hand, ordered response models. We discuss in
some detail the main advantages and caveat of the several approaches and suggest an
original specification and a more robust estimation procedure. Our specification allows
for an important distinction between short and long-run impact of the explanatory
variables on the credit rating.
In terms of the regressors, we divide them in four main blocks: macroeconomic
performance (per capita GDP, unemployment rate, inflation rate, real GDP growth),
government performance block (government debt, fiscal balance and government
effectiveness), external balance (external debt, foreign reserves and current account
balance) and other explanatory variables (default history, European Union and regional
dummies).
The main finding is that GDP per capita, real GDP growth, government debt,
government effectiveness, external debt and external reserves, sovereign default
indicator as well as being a member of European Union, are the most important
determinants of the sovereign debt ratings. We find that the government related
variables have a stronger effect than found in existing literature.