Skip to main content
SpringerLink
Log in
Book cover

A Century of Sovereign Ratings pp 63–93Cite as

Sovereign Rating Methodologies: From Theory to Practice

  • Chapter
  • First Online:

  • 1174 Accesses

Abstract

This chapter opens the “black box” of leading CRAs’ sovereign rating methodologies. Because only Moody’s provided details about its rating criteria during the interwar years (see Chap. 5), the scope of this analysis is restricted to the “modern era” – that is, the period 1986–2010.

This is a preview of subscription content, log in via an institution.

Chapter
USD   29.95
Price excludes VAT (USA)
  • Available as PDF
  • Read on any device
  • Instant download
  • Own it forever
eBook
USD   79.99
Price excludes VAT (USA)
  • Available as EPUB and PDF
  • Read on any device
  • Instant download
  • Own it forever
Softcover Book
USD   99.99
Price excludes VAT (USA)
  • Compact, lightweight edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info
Hardcover Book
USD   109.99
Price excludes VAT (USA)
  • Durable hardcover edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info

Tax calculation will be finalised at checkout

Purchases are for personal use only

Learn about institutional subscriptions

Notes

  1. 1.

    The conclusions reported here are drawn from interviews with several senior rating analysts.

  2. 2.

    There is, however, no exact formula that combines the scores to determine ratings. As a result, we cannot consider S&P’s methodology to be much more “formalized” than that of Fitch and Moody’s at the time.

  3. 3.

    Bhatia’s analysis is particularly relevant because he was at S&P until the early 2000s prior to joining the International Monetary Fund.

  4. 4.

    This indicator represents the ratio of FC deposits in domestic banks to the sum of official foreign exchange reserves and foreign assets of domestic banks.

  5. 5.

    Enron was still rated in investment grade by Fitch, Moody’s, and S&P several days prior to its ­bankruptcy on 2 December 2001.

  6. 6.

    The three authors were David Levey, Luis Ernesto Martínez-Alas, and Vincent Truglia.

  7. 7.

    This methodological approach was initiated by Pierre Cailleteau, Guido Cipriani, Kristin Lindow, and Thomas J. Byrne.

  8. 8.

    See Chap. 1 for the various reasons behind the expansion of sovereign rating in the 1990s–2000s.

  9. 9.

    Author’s computations based on World Bank analytical classifications and http://www.standardandpoors.com.

  10. 10.

    For the rest of this section, the expression “emerging countries” refers to “low- and middle-income countries” because there was no high-income country among the emerging economies under study (with the exception of Israel and South Korea in Eliasson 2002).

  11. 11.

    Between June 2005 and June 2009 the four countries were upgraded, on average, by 3, 1.3, 0.7, and 2 notches, respectively (author’s computations).

  12. 12.

    A split rating occurs when at least two rating agencies disagree on the rating of a particular issuer.

  13. 13.

    A series of pairs includes all pairs of ratings observed for one country that is rated by two ­agencies simultaneously.

  14. 14.

    This affirmation is based on interviews and discussions held with several senior rating analysts. Further support is given by Moody’s quantitative models (Moody’s 2003c, 2004), which regard as outliers any ratings that deviate from the models’ predictions by more than two notches.

  15. 15.

    See Moody’s (2009a).

  16. 16.

    This argument is distinct from that developed by Beattie and Searle (1992a) and Cantor and Packer (1997), who find that split corporate ratings may reflect differences in rating scales.

  17. 17.

    Unlike S&P, Fitch did not upgrade Argentina from default until the country completed restructuring more than 90% of its defaulted bonds in June 2010 (Fitch 2009b, 2010b).

  18. 18.

    Cameroon was in default only on its LC debt when the split rating was observed; its LC and FC ratings were both at CCC.

  19. 19.

    It is interesting that these are all two-notch rating changes.

  20. 20.

    There is one exception: 2 months after the multi-notch downgrade, S&P upgraded South Korea by three notches.

  21. 21.

    At the time, many alarming reports highlighted the large stock of nonperforming loans (NPLs) in China. In 2006, for example, Ernst & Young estimated China’s NPL liability at USD 911 ­billion (Ernst & Young 2006).

  22. 22.

    Fitch withdrew its rating of Turkmenistan in February 2005.

  23. 23.

    Chapter 8 explores this assumption.

  24. 24.

    The Fitch ratings of Slovenia and Hungary were above those of Moody’s for 14 and 17 days, respectively. The S&P ratings of Slovenia and Lithuania were above those of Moody’s for 71 and 280 days, respectively.

  25. 25.

    No large split rating is observed for Moody’s–Fitch pairs involving Japan and for Moody’s–S&P pairs involving Estonia.

  26. 26.

    Here a high-income country is a sovereign that was continuously in the World Bank high-income category from 1986 to 2010 (World Bank 2010).

  27. 27.

    See SEC (2011) for a recent overview of the NRSROs.

  28. 28.

    DBRS, established in 1976, is headquartered in Toronto; it did not issue sovereign ratings until 2006 (DBRS 2006b). JCR was founded in 1985 and began assigning ratings to countries in 1987. R&I was established in April 1998 following the merger of Japanese Bond Rating Institute and Nippon Investor Service; its sovereign rating activity started the same year. Both JCR and R&I are headquartered in Tokyo. Dagong, a Beijing-based agency, was formed in 1994; it boosted its sovereign rating coverage in 2010.

  29. 29.

    Asian countries account for less than 26% of the JCR and R&I sovereign rating coverage.

  30. 30.

    The three exceptions are Singapore (rated AAA by the five agencies), Hong Kong (rated at the same level by JCR, R&I, Fitch, and Moody’s but one notch higher by S&P), and China (rated A+ by R&I and Fitch, but AA− by Moody’s and S&P).

  31. 31.

    These results complement Beattie and Searle’s (1992b) and Shin and Moore’s (2003) studies, which show that agencies tend to rate issuers from their home country more leniently.

References

  • Afonso A. (2003), “Understanding the Determinants of Sovereign Debt Ratings: Evidence for the Two Leading Agencies”, Journal of Economics and Finance, Vol. 27 (1).

    Google Scholar 

  • Afonso A., Gomes P. and Rother P. (2011), “Short- and Long-Run Determinants of Sovereign Debt Credit Ratings”, International Journal of Finance and Economics, Vol. 16, Issue 1.

    Google Scholar 

  • Al-Sakka R. and ap Gwilym O. (2010), “Split Sovereign Ratings and Rating Migrations in Emerging Economies”, Emerging Markets Review, Vol. 11.

    Google Scholar 

  • Alexe S., Hammer P., Kogan A. and Lejeune M. (2003), “A Non-Recursive Regression Model for Country Risk Rating”, Rutcor Research Report 9, Rutgers Center for Operational Research, March.

    Google Scholar 

  • Avendaño R., Gaillard N. and Nieto-Parra S. (2011), “Are Working Remittances Relevant for Credit Rating Agencies?”, Review of Development Finance, Vol. 1, Issue 1, January-March.

    Google Scholar 

  • Beattie V. and Searle S. (1992a), “Bond Ratings and Inter-Rater Agreement”, Journal of International Securities Markets, Summer.

    Google Scholar 

  • Beattie V. and Searle S. (1992b), “Credit Rating Agencies: the Relationship between Rater Agreement and Issuer-Rater Characteristics”, Journal of International Securities Markets, Winter.

    Google Scholar 

  • Bhatia A. (2002), “Sovereign Credit Ratings Methodology: An Evaluation”, IMF Working Paper, WP/02/170, Washington, D.C.

    Google Scholar 

  • Borensztein E. (1990), “Debt Overhang, Credit Rationing, and Investment”, Journal of Development Economics, Vol. 32.

    Google Scholar 

  • Borio C. and Packer F. (2004), “Assessing New Perspectives on Country Risk”, BIS Quarterly Review, December.

    Google Scholar 

  • Bulow J. and Rogoff K. (1989), “Sovereign Debt: Is to Forgive to Forget?”, American Economic Review, Vol. 79 (1).

    Google Scholar 

  • Cantor R. and Packer F. (1995), “Sovereign Credit Ratings”, Current Issues in Economics and Finance, Vol. 1, No.3, Federal Reserve Bank of New York, June.

    Google Scholar 

  • Cantor R. and Packer F. (1996), “Determinants and Impact of Sovereign Credit Ratings”, Economic Policy Review, Federal Reserve Bank of New York, October.

    Google Scholar 

  • Cantor R. and Packer F. (1997), “Differences of Opinion and Selection Bias in the Credit Rating Industry”, Journal of Banking and Finance, Vol. 21.

    Google Scholar 

  • Canuto O., Santos P. and Porto P. (2004), “Macroeconomics and Sovereign Risk Ratings”, January, mimeo.

    Google Scholar 

  • Dagong International Credit Rating Company (n.d.), “Building a New Sovereign Rating Standard”.

    Google Scholar 

  • Dagong International Credit Rating Company (2010a), “Sovereign Credit Rating Report of 50 Countries in 2010”, July.

    Google Scholar 

  • Dagong International Credit Rating Company (2010b), “Sovereign Rating Methodology”, August.

    Google Scholar 

  • DBRS (2006a), “Methodology – Sovereign Ratings”, February.

    Google Scholar 

  • DBRS (2006b), “DBRS Launches Sovereign Ratings Operations”, 22 March.

    Google Scholar 

  • Duff & Phelps Credit Rating Co. (1999), “Argentine Dollarization Could Begin to Pave Way To Investment Grade Rating”, 4 February.

    Google Scholar 

  • Eaton J. and Gersovitz M (1981), “Debt with Potential Repudiation: Theoretical and Empirical Analysis”, Review of Economic Studies, Vol. 48 (2).

    Google Scholar 

  • Eliasson A. (2002), “Sovereign Credit Ratings”, Research Notes in Economics & Statistics No.02-1, Deutsche Bank Research.

    Google Scholar 

  • Ernst & Young (2006), Global Nonperforming Loan Report 2006, May.

    Google Scholar 

  • Fitch IBCA (1998), “After Asia: Some Lessons of the Crisis”, 13 January.

    Google Scholar 

  • Fitch Ratings (2001a), “Turkmenistan’s Sovereign Ratings Downgraded”, 18 May.

    Google Scholar 

  • Fitch Ratings (2001b), “Fitch Upgrades Hong Kong’s Foreign Currency Rating”, 25 June.

    Google Scholar 

  • Fitch Ratings (2002), “Fitch Sovereign Ratings – Rating Methodology”.

    Google Scholar 

  • Fitch Ratings (2004), “A Review of Central American Banking Systems”, 29 March.

    Google Scholar 

  • Fitch Ratings (2005), “Sovereign Data Comparator”, December.

    Google Scholar 

  • Fitch Ratings (2007), “Sovereign Rating Methodology”, 12 October.

    Google Scholar 

  • Fitch Ratings (2009a), “Aruba”, 10 August.

    Google Scholar 

  • Fitch Ratings (2009b), “Argentina: Rapprochement with Creditors and Sovereign Ratings”, 19 November.

    Google Scholar 

  • Fitch Ratings (2010a), “China”, 15 January.

    Google Scholar 

  • Fitch Ratings (2010b), “Fitch Lifts Argentina out of Default to ‘B’; Outlook Stable”, 12 July.

    Google Scholar 

  • Fitch Ratings (2010c), “Sovereign Rating Methodology”, 16 August.

    Google Scholar 

  • Fitch Ratings (2010d), “Sovereign Data Comparator”, December.

    Google Scholar 

  • Flood R. and Garber P. (1984), “Collapsing Exchange-Rate Regimes: Some Linear Examples”, Journal of International Economics, Vol. 17 (1–2).

    Google Scholar 

  • Hu Y.-T., Kiesel R. and Perraudin W. (2002), “The Estimation of Transition Matrices for Sovereign Credit Ratings”, Journal of Banking & Finance, Vol. 26 (7).

    Google Scholar 

  • International Organization of Securities Commissions (2003), IOSCO Statement of Principles Regarding the Activities of Credit Rating Agencies, September.

    Google Scholar 

  • International Organization of Securities Commissions (2004), Code of Conduct Fundamentals for Credit Rating Agencies, December.

    Google Scholar 

  • Japan Credit Rating Agency (n.d.), “JCRs Sovereign Rating Methodology: Multi-Stage Evaluation System”.

    Google Scholar 

  • Krugman P. (1979), “A Model of Balance of Payments Crises”, Journal of Money, Credit, and Banking, Vol. 11.

    Google Scholar 

  • Krugman P. (1988), “Financing vs. Forgiving a Debt Overhang: Some Analytical Notes”, Journal of Development Economics, Vol. 29.

    Google Scholar 

  • Livingston M., Naranjo, A. and Zhou, L. (2007), “Asset Opaqueness and Split Bond Ratings”, Financial Management, Vol. 36 (3).

    Google Scholar 

  • Moody’s Investors Service (1990), “Government of Malaysia”, Moody’s Bond Survey, 26 March.

    Google Scholar 

  • Moody’s Investors Service (1991), “India”, Moody’s Bond Survey, 15 July.

    Google Scholar 

  • Moody’s Investors Service (1994a), “Taiwan”, Moody’s Bond Survey, 11 April.

    Google Scholar 

  • Moody’s Investors Service (1994b), “Republic of South Africa”, Moody’s Bond Survey, 10 October.

    Google Scholar 

  • Moody’s Investors Service (1997), “Offshore Banking Centers and Country Risk”, December.

    Google Scholar 

  • Moody’s Investors Service (1998), “Moody’s Downgrades Venezuela’s Country Ceiling for Foreign Currency Debt to B2; The Country Ceiling for Foreign Currency Deposits to Caa1; and the Government of Venezuela’s Domestic Currency Debt to Caa1”, 3 September.

    Google Scholar 

  • Moody’s Investors Service (2001a), “Bank & Sovereign Credit Comments”, June.

    Google Scholar 

  • Moody’s Investors Service (2001b), “Turkmenistan: Global Credit Research”, August.

    Google Scholar 

  • Moody’s Investors Service (2002a), “Sovereign Rating History”, January.

    Google Scholar 

  • Moody’s Investors Service (2002b), “Moody’s Upgrades Greece to A1 from A2”, 4 November.

    Google Scholar 

  • Moody’s Investors Service (2003a), “Sovereign Rating Methodology: the Implications of Highly Dollarized Banking Systems for Sovereign Credit Risk”, March.

    Google Scholar 

  • Moody’s Investors Service (2003b), “Moody’s Reports Saudi Arabia’s Baa2 Ratings and Stable Outlook Reflect Size of Oil Reserves and Diminished Risk in Wake of Iraq War”, 4 August.

    Google Scholar 

  • Moody’s Investors Service (2003c), “A Quantitative Model for Local Currency Government Bond Ratings”, September.

    Google Scholar 

  • Moody’s Investors Service (2003d), “Moody’s Statistical Handbook – Country Credit”, November.

    Google Scholar 

  • Moody’s Investors Service (2003e), “Moody’s Upgrades Bahrain’s Ratings to Baa1 as War in Iraq Has Little Impact and Reforms Continue”, 11 December.

    Google Scholar 

  • Moody’s Investors Service (2004), “A Quantitative Model for Foreign Currency Government Bond Ratings”, February.

    Google Scholar 

  • Moody’s Investors Service (2005), “Credit Opinion: Turkmenistan, Government of”, 16 November.

    Google Scholar 

  • Moody’s Investors Service (2006), “Moody’s Changes Fiji Government’s Outlook to Negative”, 6 December.

    Google Scholar 

  • Moody’s Investors Service (2007a), “Moody’s Upgrades China’s Ratings”, 27 July.

    Google Scholar 

  • Moody’s Investors Service (2007b), “Moody’s Explains Why Wealthiest Gulf States Are Not Rated Aaa”, 7 November.

    Google Scholar 

  • Moody’s Investors Service (2008a), “Moody’s Upgrades Russia’s Government Ratings to Baa1 with a Positive Outlook”, 16 July.

    Google Scholar 

  • Moody’s Investors Service (2008b), “Sovereign Bond Ratings”, September.

    Google Scholar 

  • Moody’s Investors Service (2009a), “Moody’s Assigns Caa3 Rating to Ecuador’s Bonds Post-Default”, 24 September.

    Google Scholar 

  • Moody’s Investors Service (2009b), “Moody’s Statistical Handbook – Country Credit”, November.

    Google Scholar 

  • Morgan D. P. (2002), “Rating Banks: Risk and Uncertainty in an Opaque Industry”, American Economic Review, Vol. 92.

    Google Scholar 

  • Obstfeld M. (1994), “The Logic of Currency Crises”, Cahiers Economiques et Monétaires, Vol. 43.

    Google Scholar 

  • Ratha D. (2005), Leveraging Remittances for International Capital Market Access, November 18, World Bank, Washington, D.C.

    Google Scholar 

  • Rating and Investment Information (2009), “R&I’s Analytical Approach to Sovereigns”, 8 April.

    Google Scholar 

  • Sachs J. (1989), “The Debt Overhang of Developing Countries”, in Debt, Stabilization and Development: Essays in Memory of Carlos Diaz Alejandro, ed. By Calvo G. et al., Oxford: Basil Blackwell.

    Google Scholar 

  • Securities and Exchange Commission (2003), Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets, January.

    Google Scholar 

  • Securities and Exchange Commission (2011), Annual Report on Nationally Recognized Statistical Rating Organizations, January.

    Google Scholar 

  • Shin Y. and Moore W. (2003), “Explaining Credit Rating Differences between Japanese and US Agencies”, Review of Financial Economics, Issue 12.

    Google Scholar 

  • Standard & Poor’s (1992), “Thailand’s Ratings Affirmed, Off Creditwatch”, CreditWeek, 14 December.

    Google Scholar 

  • Standard & Poor’s (1994a), “Rep. of Korea’s Implied Long-Term Rating Affirmed”, CreditWeek, 3 January.

    Google Scholar 

  • Standard & Poor’s (1994b), “Venezuela’s Ratings Cut to ‘B+’, Neg.; Off Watch”, CreditWeek, 1 August.

    Google Scholar 

  • Standard & Poor’s (1995), “Republic of Paraguay Assigned Ratings”, CreditWeek, 30 October.

    Google Scholar 

  • Standard & Poor’s (1997a), “Understanding Sovereign Risk”, 1 January.

    Google Scholar 

  • Standard & Poor’s (1997b), “Sovereign Credit Ratings: A Primer”, April.

    Google Scholar 

  • Standard & Poor’s (1997c), “Less Credit Risk for Borrowers in ‘Dollarized’ Economies”, 30 April.

    Google Scholar 

  • Standard & Poor’s (1998), “Sovereign Credit Ratings: A Primer”, December.

    Google Scholar 

  • Standard & Poor’s (2002), “Sovereign Credit Ratings: A Primer”, April.

    Google Scholar 

  • Standard & Poor’s (2003), “Asia-Pacific Banking Outlook 2004”.

    Google Scholar 

  • Standard & Poor’s (2006a), “Sovereign Risk Indicators”, 25 May.

    Google Scholar 

  • Standard & Poor’s (2006b), “Asia and Latin America: A Tale of Two Emerging Markets”, 6 September.

    Google Scholar 

  • Standard & Poor’s (2007), “Asia-Pacific Markets Outlook 2007: Conditions Will Be Favorable, But Some Threats Loom”, 3 January.

    Google Scholar 

  • Standard & Poor’s (2008a), “Sovereign Credit Ratings: A Primer”, May.

    Google Scholar 

  • Standard & Poor’s (2008b), “Federative Republic of Brazil”, 26 August.

    Google Scholar 

  • Standard & Poor’s (2009a), “Aruba”, 28 May.

    Google Scholar 

  • Standard & Poor’s (2009b), “Fiji Islands (Republic of)”, 16 December.

    Google Scholar 

  • Standard & Poor’s (2009c), “India (Republic of)”, 30 December.

    Google Scholar 

  • Standard & Poor’s (2010), “Sovereign Government Rating Methodology and Assumptions”, 26 November.

    Google Scholar 

  • World Bank (2010), World Bank Analytical Classifications.

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Economic Policy and Debt Department, The World Bank, 1818 H Street, NW, Washington, DC, 20433, USA

    Norbert Gaillard

Authors
  1. Norbert Gaillard
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Norbert Gaillard .

Rights and permissions

Reprints and permissions

Copyright information

© 2012 Springer Science+Business Media, LLC

About this chapter

Cite this chapter

Gaillard, N. (2012). Sovereign Rating Methodologies: From Theory to Practice. In: A Century of Sovereign Ratings. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-0523-8_6

Download citation

Publish with us

Policies and ethics

Search

Navigation