Impacts of Sovereign Creditworthiness on Sub-Sovereign Debt Ratings in Emerging and Developing Economies

Abstract

This paper examines key determinants of the distance between the sovereign’s credit rating and the ratings of sub-sovereign foreign currency bonds, such as bond issuers’ type, debt characteristics, and global and country’s economic conditions. Using a comprehensive international bond-level database for emerging and developing economies, the double-hurdle estimation shows that sub-sovereigns appear to be rated higher than the sovereign rating when bonds are structured with securitizations. For bonds constrained below the sovereign ceiling, the Tobit regression shows strong sovereign-corporate linkage especially for financial firms. Among non-financial firms, publicly-owned debt issuers are rated closer to the sovereign than private sector issuers. This relationship remains robust to potential sample selection bias in debt issuance and the inclusion of additional controls for firm-specific balance sheet attributes. International bonds of non-financial entities issued during riskier global condition were correlated more strongly with the sovereign rating. Well-developed domestic financial market makes the distance between sovereign and sub-sovereign ratings tighter due to stronger macro-financial linkages, while a liberalized capital market widens the distance by allowing firms to mobilize more external financing. Finally, despite the recent sovereign ceiling lite policy, the sovereign-corporate relationship became significantly stronger at the peak period of the 2008-09 global financial crisis, which was reversed again due to the quantitative easing in subsequent years.

Keywords: Sovereign credit rating, sub-sovereign debt rating, international debt markets, fixed income securities, spillover effect, sovereign ceiling, global financial crisis

JEL Classification: F21, F30, G01, G10, G15