THE CORRELATION OF SOVEREIGN RATING AND BONDS' INTEREST RATE IN EU MEMBER STATES.

AuthorMiricescu, Emilian-Constantin
  1. Introduction

    In contemporary days, the need of the governments to borrow money is generated by the increased demands from citizens to cover the collective needs as most countries had to spend more public money than the revenues collected through mandatory taxes, capital income, external grants and other financial resources (Miricescu, 2011). Vacarel et al. (2003) highlighted the need for borrowing as many countries around the world are confronted with the problem of public budget deficit. Whole loans borrowed by the government, local public administration authorities and by other public institutions, along with related interest and commissions which were not paid, represent the public debt at a certain time.

    In terms of public borrowing importance, Stroe and Armeanu (2004) emphasized that the financing of temporary cash-flow problems and the budget deficit through loans instead of taxes shows some benefits, such as: efficiency, avoidance of social discontent, and relative decrease of fiscal effort over time. If interest rates are too high the government debt will increase rapidly. In this context, Vacarel et al. (2003) highlighted that the elevated level of interest rates collected on foreign loans contributed to the external debt crisis of developing countries. But Mosteanu et al. (2008) explained that because of the serious problems that faced some debtor countries, the Paris Club was founded within the international financial system that can restructure and even cancel public debt.

    For Romania, sovereign rating has a particular significance, as in June 2014 from the total public administration debt 54.14% was borrowed from the external markets. We consider that an opportunity for central public administration to decrease interest rates is sovereign ratings improving with the purpose of reducing the public debt burden.

    Figure 1 shows that government debt to GDP ratio in the Euro Area had an increasing trend, starting from 69.2% in 2000 and reaching 93.9% in 2014 Q1. Government debt to GDP ratio in the European Union started from 61.9% in 2000 and reached to 88% in 2014 Q1. Compared with 2000, the Euro Area member states increased with 24.7 percentage points (pp) in their debt to GDP ratio at the end of 2014 Q1. Compared with 2000, the European Union member states increased with 26.1 pp in their debt to GDP ratio at the end of 2014 Q1.

    In our opinion, central public authorities should have a suitable management of public debt portfolio in order to better fulfil the citizens needs on long term.

    Figure 2 shows that for 16 member states, government debt to GDP ratio exceeds the ceiling specified by Euro convergence Maastricht criteria (maximum 60%), and for 12 member states the index complies with Maastricht criteria. We find in Figure 2 that government debt to GDP ratio in the European Union member states at the end of 2014 Q1 varies from 174.1% in Greece to 10% in Estonia. In our view, large government debts lead to large interest expenses in the public budgets, and we study the influence of sovereign rating on bonds' interest rate.

    Figure 3 shows that government debt to GDP ratio in Romania had an increasing trend, starting from 12.6% in 2007 and reaching to 38.4% in 2013. Debt interest to GDP ratio in Romania also had an increasing trend, starting from 0.7% in 2007 and reaching to 1.7% in 2013. So, government debt to GDP ratio increased faster than debt interest to GDP ratio, as a consequence of sovereign bonds' interest rate diminution.

    Specialized global rating agencies are Standard & Poor's, Moody's Investor Services and Fitch Ratings. However, sovereign ratings are also provided by local or regional rating agencies, specialized services from banks, foreign trade agencies and finance journals (Miricescu, 2011).

    Sovereign ratings split countries in two clusters: (i) investment grade with ratings equal to or above BBB- (for Standard & Poor's and Fitch Ratings) and Baa3 (for Moody's Investor Services); (ii) speculative grade with ratings equal to or below BB+ (for Standard & Poor's and Fitch Ratings) and Ba1 (for Moody's Investor Services).

    An earlier version of this paper (Miricescu, 2012) was presented and published in the Proceedings of the 6th International Conference on Globalization and Higher Education in Economics and Business Administration. The paper is organized as follows: Section 2 reviews the existing financial literature regarding the correlation between sovereign ratings and the interest rate on sovereign bonds, Section 3 presents the database and research methodology used in our study, Section 4 analyzes the correlation between sovereign ratings and the interest rate on sovereign bonds for 25 developed and emerging EU member states and Section 5 concludes.

  2. Literature review

    In recent years, the correlation between sovereign rating and interest rates on bonds was studied in several quantitative papers; almost all the articles emphasize systematic analysis of sovereign ratings (Cantor and Packer, 1996). Sovereign ratings were established by the rating agencies Moody's and Standard & Poor's. Cantor and Packer's (1996) study was carried out on 49 developed and emerging countries by using a regression analysis having data for the 1987-1994 period. The authors stated that investors in sovereign bonds are excessively pessimistic, when countries with low credit ratings intend to issue government bonds on the international financial market; investors also require high yields on such securities. In order to validate this conclusion, we mention that in July 2014 Romania obtained from Standard & Poor's an investment grade rating (BBB-) and borrowed money at 4,16% interest rate compared with Germany which obtained from Standard & Poor's an investment grade rating (AAA) and borrowed money at 1,11% interest rate.

    Min (1998) analyzed determinants of difference between government bond yields in emerging economies and the US government bonds yields. The main factors identified as significant in economic terms were: (i) public debt to GDP ratio--positive influence, (ii) public debt service to exports--positive influence, (iii) net foreign assets to GDP ratio--negative influence, and (iv) international reserves to GDP ratio negative influence. According to the author, the impact of sovereign ratings on yield spread of government bonds was high.

    Reisen and von Maltean (1999) examined the impact of changes in sovereign ratings on difference between government bond yields having 10 years maturity for 29 emerging economies and the US government bond. The sovereign ratings were established by the rating agencies Moody's...

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