Sovereign Credit Rating: Impact on Social Investment and Role in Financial Subordination

Abstract

This article examines sovereign credit rating methodologies and their impact on fiscal space in developing economies. While sovereign ratings are meant to reflect default risk, the biases embedded in the rating methodologies result in overly punitive rating actions in developing economies that often limit their ability to implement countercyclical policies. In addition, with a singular focus on austerity, they tend to shift focus away from critical development priorities and social welfare spending. Using panel data of credit rating changes in 133 countries over the period 2000–2020 from Moody’s, we explored the long-term trends in the impact of ratings. Negative rating actions have been intensifying in developing economies since 2010. We found that rating changes did tend to influence fiscal priorities. Downgrades lowered the proportion of spending on health and education and increased the proportion of spending on interest payments. We situate this examination of credit ratings within the framework of the financial subordination literature. We suggest that credit ratings are a new manifestation of financial subordination and have created a new dimension in reproducing and deepening the inequalities in the global financial system.JEL Classification: B5, F34, F02