Political and Fiscal Risk Determinants of Sovereign Spreads in Emerging Markets

Abstract

Using a panel of 46 emerging market economies from 1997 to 2008, this paper investigates the key determinants of country risk premiums as measured by sovereign bond spreads. Unlike previous studies, the results indicate that both political and fiscal factors matter for credit risk in emerging markets. Lower levels of political risk are associated with tighter spreads, particularly during financial turmoil. Efforts at fiscal consolidation narrow credit spreads, especially in countries with high initial public debt levels. The composition of fiscal policy also matters as higher public investment lowers spreads as long as the fiscal position remains sustainable and the fiscal deficit does not worsen.* Baldacci: International Monetary Fund, . We would like to thank Julio Escolano, Manmohan Kumar, Ashoka Mody, Jari Stehn, and two anonymous referees for helpful comments and suggestions on an earlier version, and Annette Kyobe and Sukhmani Bedi for research assistance. The usual disclaimer applies.

Macroeconomic effects on emerging-markets sovereign credit spreads

“…Hilscher and Nosbusch (2010) empirically examine this relationship and find that the terms of trade as well as the volatility of the terms of trade are significant factors affecting sovereign spreads for 31 emerging economies. Min (1998), Baldacci et al (2011) and Gibson et al (2012) among others, also report that the terms of trade have a significant, inverse relationship with sovereign spreads.…”

Macroeconomic Effects on Emerging-Markets Sovereign Credit Spreads

“…Gonzalez-Rozada and Levy-Yeyati (2008) find that the long-term foreign debt S&P ratings have explanatory power for spreads in 33 emerging economies. Baldacci et al (2011) employ a measure of political risk which is based on the Heritage Foundation economic freedom index and the World Bank governance index. They also find that political risk is an important determinant of spreads.…”

“…The most commonly used global variables in empirical bond and CDS spread studies are the VIX index, which proxies for volatility in global markets, the yield on a long-term US Treasury bond, which proxies for changes in the US economy, the default yield spread defined as the spread between corporate bonds with low and high credit rating, the returns on a US stock market index, which proxies for the global economic condition and the global business cycle, the TED spread, which proxies for changes in global liquidity, and an equity risk premium proxy, such as the earnings price ratio on a stock market index (see, for example, Longstaff et al, 2011;Gonzalez-Rozada and Levy-Yeyati, 2008;Hilscher and Nosbusch, 2010;Baldacci et al, 2011;Beck, 2001;Eichengreen and Mody, 2000).…”

Political risk assessment by multinational corporations in African markets: A Nigerian perspective

“…Previous studies have shown that the consequences of political risk differ from one African market to another and have influenced the types of international strategy that firms adopt (Baldacci, Gupta, & Mati, 2011). This means that each African market has specific political risk that differentiates one from another, therefore creating different scenarios for MNCs to assess (Bekaert et al, 2014;Quer, Claver, & Rienda, 2012).…”

“…Sub-Saharan Africa is regarded as high risk, but there are significant intercountry variations in risk perception versus actual risk. Likewise, MNCs have specific characteristics that cause them to perceive political risk differently (Baldacci et al, 2011;Bekaert et al, 2014).…”