Sovereign credit ratings, capital flows and financial sector development in emerging markets

Abstract

How does the sovereign credit ratings history provided by independent ratings agencies affect domestic previous termfinancialnext term sector development and international capital inflows to emerging countries? We address this question utilizing a comprehensive dataset of sovereign credit ratings from Standard and Poor's from 1995–2003 for a cross-section of 51 emerging markets. Within a panel data estimation framework, we examine previous termfinancialnext term sector development and the influence of sovereign credit ratings provision, controlling for various economic and corporate governance factors identified in the previous termfinancialnext term development literature. We find strong evidence that our sovereign credit rating measures do affect previous termfinancialnext term intermediary sector developments and capital flows. We find that i) long-term foreign currency sovereign credit ratings are important for encouraging previous termfinancialnext term intermediary development and for attracting capital flows. ii) Long-term local currency ratings stimulate domestic market growth but discourage international capital flows. iii) Short-term ratings (both foreign and local currency denominated) retard all forms of previous termfinancialnext term developments and capital flows. There are important implications in this research for policy makers to encourage the provision of longer-term credit ratings to promote previous termfinancialnext term development in emerging economies.