Sovereign Ratings and Oil-Producing Countries: Have Sovereign Ratings Run Ahead of Fundamentals?

Abstract

We investigate whether rising oil prices have resulted in over-rating of oil-producing countries by rating agencies, after controlling for fundamentals. Based on a large dataset of countries from Standard and Poor's and Moody's, we find strong statistical evidence of a large ratings premium-nearly two notches-for those oil-producing countries with a large share of net oil revenue to gross domestic product, relative to countries with similar economic fundamentals. We have some limited forecast information from the rating agencies and the effect increases when we include this information, providing further evidence that this ratings premium is not driven by expected improvements in fundamentals. This finding has significant implications for asset prices in oil-producing countries and highlights the risk that in the event of a sharp unanticipated drop in oil prices, sovereign rating downgrades of oil-producing countries could be sharper than the deterioration in their economic fundamentals.