The role of sovereign credit ratings in fiscal discipline

Abstract

This paper investigates several aspects of the relationship between sovereign credit ratings and fiscal discipline. The analysis of over one thousand country-year observations for 93 countries during the 1999-2010 period reveals that a country's debt level is likely to increase with higher ratings, confirming the existence of pro-cyclicality and path dependence of ratings. In addition, the study finds no evidence to support the theory of Political Business Cycle, which implies that political ambitions may lead to fiscal worsening following a rating upgrade. The study findings further demonstrate that institutional quality is an important factor in the ratings-fiscal discipline nexus.

Non-performing loans and sovereign credit ratings

“…Duygun et al (2016) find that a rating upgrade is likely to increase sovereign debt because of sovereign ratings' procyclicality and path dependence. Nevertheless, they also find that the impact of sovereign rating decisions on debt varies with the degree of the country's institutional quality; in particular, rating upgrades in countries with higher institutional quality are followed by debt reductions and an improvement in the fiscal balance.…”

Fiscal Rules and Financial Systems: Complements or Substitutes?

“…A second strand of literature related to our paper assesses the determinants of the sovereign credit ratings issued by the CRAs (Cantor and Packer, ; Afonso, ; Block and Vaaler, ; Mellios and Paget‐Blanc, ; Archer, Biglaiser and DeRouen, ; Afonso, Gomes and Rother, ; Duygun, Ozturk and Shaban, ). These articles, however, do not study the effect of formal fiscal rule schemes on credit ratings and how this effect is shaped by the level of development of the domestic financial market.…”