Did you know that appointing a well-connected Finance Minister could improve your country’s credit ratings?
So say finance experts at Bangor, Cambridge, East Anglia and Herriot Watt universities writing in the Journal of International Financial Markets, Institutions and Money.
The findings are revealed in the first study to look at the effect of political connections on the quality of sovereign ratings.
Their study of 38 Finance Ministers and their countries’ credit rating levels over an eighteen- year period, showed that professional connections between finance ministers and the top executives of the three largest credit rating agencies (Fitch, Moody’s, and S&P) led to those countries receiving higher credit ratings.
Professor Rasha Alsakka leads the Credit Risk Research Group within the Institute of European Finance (IEF) at Bangor Business School.
She explains:
“We seek to improve our sovereign credit rating, so that we can reduce the government’s cost of borrowing. Sovereign ratings are of the utmost importance to countries, since they influence ratings of other asset classes within the country and help countries to gain access to capital, enable the flow of direct investment and affect the efficiency and stability of capital markets across borders.”
“The public are also increasingly interested in sovereign credit rating news, particularly during election times, as they also infer the quality of incumbent governments.”
“Sovereign ratings involve gathering not only objective data, but also subjective information. Although credit rating agencies aim to provide unbiased, objective and independent measures of the issuers’ creditworthiness, their ratings are not immune from unconscious and implicit biases.
Our new findings suggest that professional connections contribute to the subjective component of sovereign ratings.
There are strong policy implications here, as professional connections affect countries’ ratings and hence governments’ cost of debt and economic stability.”
The work also reveals that the subjective component of ratings, captured by professional connections between politicians and top credit rating agencies’ executives, has a more pronounced role for developing than developed countries.
Also uncovered is the fact that, when requested by the sovereign country, credit ratings were on average higher than unsolicited ratings (not paid for by the governments). The study further highlights interesting differences across the three credit rating agencies in their process of assessing the creditworthiness of governments.
“Our findings offer wide-ranging implications for regulators, governments, market participants and credit rating agencies. They should recognize that conflicts of interest can be transmitted by personal connections between sovereign issuers and rating agencies, which might give rating advantages to connected sovereigns. Efforts should be made to ensure that enhanced ratings reflect the information at hand rather than subjective evaluations performed by rating agencies.
The quality of ratings is vital for the efficient functioning of financial markets, and therefore it is crucial that market participants are aware of the issuers’ true creditworthiness.”
The article’s authors are: Patrycja Klusak (Professor at Herriot Watt University and Affiliated at Cambridge University), Yurtsev Uymaz (Associate Professor at East Anglia University), and Rasha Alsakka (Professor at Bangor Business School).
