Sovereign Creditworthiness and Sub-sovereign Debt Ratings in Emerging Markets

A number of studies have documented that the credit rating of an emerging market sovereign is often the most important determinant of the ratings of sub-sovereign entities such as corporations, banks, and public sector enterprises. The sovereign rating seems to act as a “ceiling” on the ratings achieved by sub-sovereign entities (Ferri, Liu, and Majnoni 2001; Ferri and Liu 2003). Since early 2000s, the major rating agencies have relaxed their policy with a view that the corporate entity’s default risk is less tied to sovereign risk (Moody’s 2005; Standard & Poor’s 2013). Consequently, the distance between sovereign ratings and corporate ratings has been widening (Grandes and Peter 2006) and the positive link between the two appears to be getting weaker (Borenstein, Cowan, and Valenzuela 2013).

This paper extends the existing literature on the relationship between sovereign and sub-sovereign ratings in several directions. It uses a comprehensive database of foreign and local currency bonds issued by sub-sovereign entities in 50 emerging market countries between 1990 and mid-2013 to consider the various issue-level, industry, country, and global correlates of this relationship. It finds that firm ownership (public or private), currency (local or foreign), and sector (financial or nonfinancial) significantly influence the relationship between sovereign credit ratings and sub-sovereign debt ratings. It also finds that the relationship strengthened in the run-up to and during the 2008-09 global financial crisis, but weakened prior to the Asian financial crisis in 1997-98. This suggests that the rating agencies are likely to pay more attention to the creditworthiness of the sovereign when evaluating sub-sovereigns during global crisis episodes compared to region-specific crises. The findings of the paper are relevant for facilitating and monitoring access of sub-sovereign entities to international debt markets.

Keywords: Sovereign rating, sub-sovereign rating, global financial crisis, spillover effect, rating ceiling, quantitative easing.