rating in descending order form AAA to CCC-, while Moody’s system goes from Aaa
to Caa3.
[Insert Table 1 here]
2.2. Literature review
Sovereign ratings are assessments of the relative likelihood of default. The rating
agencies assess the risk of default by analysing a wide range of elements from solvency
factors that affect the capacity to repay the debt, but also socio-political factors that
might affect the willingness to pay of the borrower. For example, S&P determines the
rating by evaluating the country’s performance in each of the following areas: political
risk, income and economic structure, economic growth and prospects, fiscal flexibility,
general government debt burden, off-shore and contingent liabilities, monetary
flexibility, external liquidity, public-sector external debt burden and private sector
external debt burden.
Given that the rating materializes out of the analysis of a vast amount of data, it would
be useful to find a reduced set of variables capable of explaining a country’s rating. A
first study on the determinants of sovereign ratings by Cantor and Packer (1996)
concluded that the ratings can be largely explained by a small set of variables namely:
per capita income, GDP growth, inflation, external debt, level of economic
development, and default history. Further studies incorporated more variables.
Macroeconomic performance variables like the unemployment rate or the investment-
to-GDP ratio. In papers focussing on the study of currency crises several external
indicators such as foreign reserves, current account balance, exports or terms of trade
seem to play an important role. Moreover, indicators of how the government conducts
its fiscal policy, budget balance and government debt can also be relevant, as well as
variables that assess political risk, like corruption or social indexes. Table 2 summarises
some of the relevant related studies and findings.
[Insert Table 2 here]