Effect on Development

By providing independent information to investors, rating agencies facilitate access to financing in domestic and international markets and, thereby, enhance growth opportuni­ties. Credit ratings provide a relative ranking of an issuer’s creditworthiness under similar stress conditions and, thereby, facilitate determination of the risk premium required to invest in the riskier securities. Historical studies by Moody’s confirm that there is a clear pattern of higher probabilities of default (a key input into estimating risk premium) for obligations with a lower credit rating. For instance, from 1970 to 1996, the average 1-year default rate was 0.01 percent for A-rated issuers, 0.12 percent for Baa-rated issuers, 1.36 percent for Ba-rated issuers, and 7.27 percent for B-rated issuers. Default is defined as any missed or delayed disbursement of interest, principal, or both (see http://www. moodys. com).

Thus, development of credit rating agencies, together with sound accounting auditing and other information infrastructure, is a key institutional reform to help develop corpo­rate and sub-sovereign bond markets, as well as asset-backed securities markets and project
finance. This reform would complement the development of government securities markets at the central government level, which would help determine a risk-free rate as a bench­mark against which the riskier securities could be priced. Also, local governments in emerg­ing and developing economies are increasingly seeking ways to raise debt on private credit markets to finance local investments. For this purpose, development of sub-sovereign credit evaluation—and the associated information system and credit rating arrangements—has become an important topic for investors and policy markers (El Daher, 1999).

Sovereign credit ratings are seen as a fundamental factor in the global financial archi­tecture to facilitate access to foreign capital by developing and emerging markets. Rating agencies rely on a constellation of both qualitative and quantitative factors (economic structure and growth prospects, macroeconomic policies, contingent liabilities, financial sector health, political factors, etc.) in arriving at a “sovereign credit rating” as a forward­looking estimate of default probability (Beers, Cavanaugh, and Ogawa 2002). Ratings assigned to entities in each country are most frequently the same as the sovereign’s or lower, but they may be higher (because of specific structural features). Several develop­ing countries have received official assistance to obtain credit ratings as a step toward strengthening their access to international capital markets (IMF 2003a).

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