The Nonlinear Relationship between Public Debt and Sovereign Credit Ratings

Abstract

This study investigates the relationship between public debt and sovereign credit ratings, using a wide sample of over 100 advanced, emerging, and developing economies. It finds that: i) higher public debt lowers the probability of being placed in a higher rating category; ii) the negative debt-ratings relationship is nonlinear and depends on the rating grade itself; and iii) the identified nonlinearity explains the differential impact of debt on ratings in advanced economies versus emerging and developing economies (previously suggested in the literature as different relationships). These results hold for both gross and net debt, and are robust to alternative dependent variable definitions, analytical techniques, and empirical specifications.

Keywords: Advanced economies, Credit rating agencies, Credit ratings, emerging markets, financial markets, non-linearities, public debt

JEL Classification: E44, E62, G15, G24