The price of democracy: sovereign risk ratings, bond spreads and political business cycles in developing countries

Abstract

This study examines the proposition that political business cycle theory is relevant to private foreign lenders to developing countries. We find that: credit rating agencies downgrade developing country ratings more often in election years, and do so by approximately one rating level; bond spreads are higher in the 60 days before an election compared to spreads in the 60 days after an election; spreads trend significantly downward in the 60 days before an election, but then flatten out in the 60 days after an election. Agencies and bondholders view elections negatively, increasing the cost of capital to developing democracies. #

The role of sovereign credit ratings in fiscal discipline

“…The main assumption in the traditional theory of PBC is that politicians, whose preference is to stay in power, are opportunistic whereas voters are short-sighted meaning that they tend to vote for the incumbent if the conditions before the election are beneficial to them (see e.g. Nordhaus, 1975;Hibbs, 1986;Hanusch and Vaaler, 2013;Block and Vaaler, 2004). The theory hypothesizes that politicians are always faced with a trade-off between political and economic objectives.…”

“…These authors also argue that while evidence of opportunistic politicians in industrialized countries is mixed, empirical studies on developing countries mainly confirm the proposal that politicians follow their political objectives. Relevant studies include Schuknecht (1996), Berger and Woitek (1997) Block (2002), Akhmedov and Zhuravskaya (2004), and Block and Vaaler (2004), Sakurai and Menezes-Filho (2008), Klein and Sakurai (2015), Peters (2010).…”

“…The disciplining role of ratings on fiscal discipline has been studied through the lens of PBC theory around election times (Hanusch and Vaaler, 2013;Block and Vaaler, 2004) but these studies do not provide any evidence in general on how rating changes affect borrowing propensity.…”

Institucionalização Partidária e Consistência Programática: A Resposta da Esquerda a Ataques Especulativos na América Latina

“…Sabe-se, ainda, que governos com um percentual mais alto de ministros de esquerda pagam taxas de juros mais elevadas do que aqueles em que membros conservadores prevalecem (Mosley, 2003;Garrett, 1998;Leblang e Bernhard, 2000) e que ataques especulativos têm maior probabilidade de ocorrer após a eleição de um governo de esquerda, tanto em países desenvolvidos (Leblang e Bernhard, 2000) quanto naqueles em desenvolvimento (Leblang, 2002). Na América Latina, em particular, Block e Vaaler (2004) mostram que agências diminuem a classificação de risco da dívida de países que elegem governos de esquerda, enquanto Campello (2015) demonstra que estes governos apresentam risco soberano mais alto do que aqueles de tendência conservadora.…”

Sovereign risk: constitutions rule

“…On the empirical front, Block and Vaaler (2003) found that presidential elections are associated with an average one notch downgrading in the country's sovereign debt rating and that risk spreads on bonds rise in pre-election periods. They argue that sovereigns should preferably avoid issuing bonds in the six months ahead of (presidential) elections to avoid paying the election premium.…”