Default, Currency Crises and Sovereign Credit Ratings

Abstract

Sovereign credit ratings play an important role in determining the terms and the extent to which countries have access to international capital markets. In principle, there is no reason why changes in sovereign credit ratings should be expected to systematically predict a currency crisis. In practice, however, in developing countries there is a strong link between currency crises and default. About 85 percent of all the defaults in the sample are linked with currency crises. The results presented here suggest that sovereign credit ratings systematically fail to anticipate currency crises--but do considerably better predicting defaults. Downgrades usually follow the currency crisis--possibly highlighting how currency instability increases default risk.