Qualitative and institutional features in emerging markets' sovereign credit ratings

Abstract

Rating agencies assign sovereign credit ratings (SCR) based on quantitative and qualitative criteria. The assessment of qualitative elements is not that straightforward, and it is mainly related to institutional features (in their political and economic dimensions). Although several papers find that institutional features, measured with traditional governance indicators, are relevant for sovereign credit ratings, the analysis of institutional elements exploiting qualitative-based measures effect is scarce. I measure perceptions of institutional and qualitative features by applying sentiment analysis and a topic classification strategy to reports on countries' developments from Fitch and the IMF. Using this measure, I examine the impact of institutional quality perception on 34 emerging markets' sovereign credit ratings and financing costs. I find that the qualitative-based measure for the institutional quality perception of at least one of the entities negatively impacts the likelihood of obtaining credit ratings below the investment-grade threshold and its improvement usually increases the probability of getting a rating on the investment-grade scale. Moreover, perceptions of qualitative and institutional features affect financing costs (measured with the CDS) through the SCR signaling. Still, there is no conclusive evidence on the impact of perceptions by themselves on the CDS. Findings highlight the relevance of institutional strengthening in emerging countries.