Determinants of Sovereign Credit Ratings Using Ordered Logistic Model

Anne Michelle N. Andres Ruben Carlo O. Asuncion Myrlani G. Velvez

A Research Method II Paper, Department of Economics - De La Salle University-Manila

August 2005

2005 by Anne Michelle N. Andres, R. Carlo O. Asuncion, and Myrlani G. Velvez. All rights reserved. Sections of the text may be quoted without permission provided that full credit is given to the source. Comments are welcome at ruben.asuncion@dlsu.edu.ph.

Abstract

This paper focuses on the determinants of sovereign credit ratings using ordered logistic model. Using Standard & Poors credit ratings and a sample of 61 countries, the study has identified three main factors that affect sovereign credit ratings. These are: a) perception on the level or degree of corruption as seen by business people and country analysts; b) gross national income (GNI) per capita; and c) annual rate of percentage change or the yearon-year change in the consumer price index (CPI) or simply the inflation rate. The papers bottom line is that good governance is the key for countries to have high sovereign debt ratings.

Table of Contents

Page I. Introduction II. Objectives of the Study III. Scope and Limitations IV. Significance of the Study V. Review of Related Literature VI. Data Sources and Research Methodology VII. Definition of Variables VIII. Overview on Logistic Modeling IX. Findings/Result Highlights X. Conclusion Annexes 1 3 3 5 6 9 12 13 14 34 35

I. INTRODUCTION
Sovereign debt, defined as debt incurred by governments, can take the form of commercial loans or of bond issues. Particularly, developed countries are the largest issuers of bonds in world capital markets. Moreover, the structure of private capital flow to developing countries in the 1990s has dramatically changed since bond issues exceeded bank lending. As a consequence, the demand for sovereign credit ratings, i.e., the risk assessments assigned by credit rating agencies to government bonds, has significantly increased; all the more so as recent years have witnessed a significant number of debt crises in developing countries. These credit ratings significantly influence the terms and the extent to which, in developing countries especially, private and public borrowers have access in international capital markets. With the recent downgrade of the Philippines credit rating by global rating agencies, Fitch IBCA and Standard & Poors (S&P), it is very important for policy makers to know and identify the relevant determinants or factors that affect or influence such credit rating organizations. Specifically, the London-based Fitch, which had been the most optimistic about the Philippines prospects among global rating agencies, has placed the countrys rating on a negative outlook since December last year, but changed this to stable in May 2005 because of significant strides in fiscal reform, including the passage of the expanded VAT law (e-VAT). Fitch believes that in the context of the recent political crisis that the Philippines is undergoing, it is questionable whether the weakened political leadership in the country will commit the necessary political capital in the resolution of the e-VAT issue soon. On the other hand, United States-based S&P voiced concern over the countrys ability to maintain the fiscal consolidation needed to reduce the countrys high level of public and external indebtedness. The combination of delayed fiscal consolidation, protracted political stalemate, and a possible change in economic policy has shifted the balance of risk on the downside, making a stable outlook for the Philippines no longer justified, according to S&P.

We see that global credit rating agencies use several quantitative and qualitative variables (economic, social, and political) in order to assign a credit rating to a debtor or debt instrument. As a result, a very relevant issue now is to identify the various factors that are statistically significant in the determination of sovereign credit ratings. This paper will attempt to answer this particular question.

II. OBJECTIVES OF THE STUDY

This paper aims to: 1) Identify the determinants of sovereign credit ratings; and 2) Identify which factors have the largest influence on the international rating agencies decision on what rating to give to a particular country.

III. SCOPE AND LIMITATIONS

The paper focused mainly on the various economic/political indicators affecting the sovereign credit rating of a given country. Although there are two types of sovereign ratings local and foreign currency sovereign ratings only factors influencing the credit ratings on foreign currency denominated debts was studied. Note that sovereign credit ratings are an indication of a governments capacity and willingness to repay principal and interests on obligations as they fall due. A country may resort to extensive revenuegeneration measures in the form of strict tax collection or through money creation to service its local currency denominated debt. However, it must exert its best efforts to secure the foreign currency it needs in order to service its maturing foreign obligations. Further, although there are other international credit rating agencies like Fitch and Moodys, only the ratings given by the Standard and Poors were included in the analysis. Considering that foreign currency denominated debts constitute a large part of our countrys total debt, it is deemed more important to examine the various factors which have an effect on our sovereign foreign currency credit ratings which are usually the basis of foreign creditors in deciding what terms and conditions to impose on our external borrowings or whether or not they will still provide the financing we need given the risks involved.

While it is likewise necessary to ensure that the government will not default on its maturing local obligations, factors which have an effect on our sovereign credit rating on domestic debts was not included in the analysis.

IV. SIGNIFICANCE OF THE STUDY

The study will identify the explanatory variables with the most significant influence on sovereign credit ratings assigned to countries, and this is very important in helping policy makers and relevant stakeholders in decision-making and charting policies for economic development in general. In particular, it could also aid in implementing an effective mechanism that could reduce vulnerability of emerging economies, i.e. the Philippines, against external shocks. Furthermore, the results of the study will be helpful in outlining a national comprehensive economic development medium-term or long-term plan, especially in fiscal planning and the achievement of fiscal balance of the Philippines. It will help national fiscal executives anticipate, adjust and recommend legislative policies to achieve and maintain acceptable and doable sovereign credit ratings that will benefit the nation as a whole. The papers results will help explain the future behavior of global credit rating bodies, and it will help the Philippines to manage effectively a downgrade or take advantage of an upgrade of sovereign credit ratings. The results of this study further underscore the relevance of the formal adoption of inflation targeting in 2002 as the framework for monetary policy in the Philippines. With the maintenance of price stability conducive to sustainable economic development as the main thrust of the monetary authorities, this study would help aid the policymakers in the formulation of measures that could help the country in attaining a higher credit rating, thus improving the countrys access in the international capital markets as well as reducing the vulnerability that goes with it.

V. REVIEW OF RELATED LITERATURE

The increased function of credit rating agencies is indeed crucial in the access of financial resources by countries from the international capital markets. Said agencies seek to assess the capacity and willingness of a government to timely service its debt, and in accordance with pre-agreed conditions when the loans were made. Considering that ratings are straightforward pronouncements by credit rating agencies, it helps reduce the uncertainties involving government bonds over the near term (Canuto, et.al. 2004), thus aids investors in managing the risk exposure of their investments. Leading agencies include: S&P, Fitch and Moodys. Sovereign debt and default could be understood using two fundamental approaches: Willingness to pay maturing obligations Countries are reinforced to pay their obligations on a pre-agreed maturity date since this could translate into good reputation in the international capital markets, hence greater access of financial resources. However, a small economy may renegotiate its debt if cash-in-advance contracts allow it to hedge future stochastic output and lending. Debt-servicing capacity approach This model tackles the solvency and liquidity position of a country, referring to the sovereigns payment capacity. As a result, studies on the determinants of sovereign ratings have been of high importance to both developing and developed countries since these provide, among other things, insights as to the improvements of factors that lead to the path towards earning higher sovereign risk ratings. The study of Mellios and Paget shows that sovereign credit ratings are particularly affected by: per capita income, real exchange rate changes, government income, inflation rate and default history. In addition to these factors, corruption index poses significant influence on how credit rating agencies award sovereign evaluations.

A review of empirical and theoretical underpinnings of sovereign risk premium of emerging markets and how they are affected by economic fluctuations suggest that the most important country-specific predictors of sovereign spread and default probabilities are liquidity and solvency variables, credit ratings, and indicators of the quality of macroeconomic policy (Souza, 2004). In the evaluation of Canuto, et.al. (2004), the researchers analyze the factors that determine sovereign risk and the role of international credit rating agencies in the appraisal of such risk. Parallel to other undertakings as contained in international

literature, the results further validate that high sovereign credit ratings are determined by the following variables: per capita income, inflation as evidenced by CPI, economic growth, total external debt/current account receipts ratio, central government gross debt/total fiscal receipts ratio, absence of default events, level of trade openness as indicated by the sum of total exports and imports as a percentage of GDP. Using data from S&Ps and Moodys for June 2001 covering 81 developed and developing countries (29 developed countries and 52 developing countries as classified by the IMF in 2001), this study shows that the variables that exert significant explanatory power for the rating levels are GDP per capita, external debt as a percentage of exports, the level of economic development, default history, real growth rate, and the inflation rate (Alfonso, 2003). The results of a study Cantor and Packer (1996) using Moodys and S&Ps ratings in September 1995 illustrate the factors that appear to largely influence sovereign ratings, as follows: per capita income, GDP growth and inflation, external debt, extent of economic development, and default. On the one hand, these ratings aim to guide financial markets on macroeconomic fundamentals of participating sovereigns and thus, effectively affecting bond yield movements. This further strengthens the findings of other empirical studies on similar topic. In sum, empirical findings point to a host of factors that significantly explain how credit rating agencies assess sovereign risks: per capita income, inflation rate,

government income, default history, real exchange rate, and corruption perception index, which is also an indicative of the quality of governance in a country.

VI. DATA SOURCES AND RESEARCH METHODOLOGY

The cross-section data that were used in this study include: 1) sovereign foreign currency credit ratings of a sample of 61 countries as of December 31, 2004; and 2) economic and political indicators of such countries as of December 31, 2003. There is a one-year lag in indicators used to allow us to determine the credit rating that will be given in the current year based on what has transpired (actual observations) in the previous year.1 Since credit ratings assigned by the Standard and Poors are discrete and in alphabetical form ranging from as high as AAA to as low as D, the ratings were subdivided into 4 groups and transformed into numbers using the following format: 0 was assigned to the lowest ratings ranging from D to CCC+; 1 for ratings from B- to BB+; 2 for ratings from BB- to AA+; and lastly, 4 was assigned to the highest rating of AAA.2 Considering that sovereign foreign currency credit ratings are in ranks or ordinal in nature, the ordered logistic model was used to determine the factors affecting a countrys credit rating our variable of interest. Possible independent variables that were used for the analysis include: 1) gross domestic savings [% of gross domestic product (GDP)]; 2) gross national income per capita (in USD); 3) consumer price index (% change); 4) trade openness; 5) corruption perceptions index; and 6) default history of countries. As mentioned earlier, data on sovereign credit ratings came from S&P; default history of countries from the World Banks Global Development Finance 2004; and corruption perceptions index from Transparency International. The 2003 data on the rest of the independent variables came from the International Monetary Funds International Financial Statistics and World Banks World Development Indicators.

1 2

Complete list of data is presented in Annex A. Description of the alphabetical sovereign credit ratings as well as their numerical equivalent are shown in Annexes B and C, respectively.

Default history of countries was captured in a dummy variable wherein a country which has defaulted or even rescheduled its debt was assigned a value of 1; and 0, otherwise. The corruption perceptions index from Transparency International was based on a number of surveys conducted by independent institutions. Rampant corruption in the government is perceived to hamper a countrys sustainable development as funds intended to finance projects as well as the revenues generated therefrom go to the hands of crooked and fraudulent officials. The rating system used by Transparency

International is as follows: the highest index of 10 is attributed to uncorrupted countries while 0 corresponds to highly corrupt countries. Given that the ratings are in ranks, the ordered logit model that was estimated is as follows: Ratingi* = 1*Savingsi + 2*GNIi + 3*CPIi + 4*Tradei + 5*Corruptioni + 6*Defaulti where: Rating = 0, if the credit rating of a country is D to CCC+ = 1, if the credit rating is B- to BB+ = 2, if the credit rating is BBB- to AA+ = 3, if the credit rating is AAA Savings GNI CPI Trade Gross domestic savings (% of GDP) Gross national income per capita (in USD) Consumer price index (% change) Trade openness, [exports + imports (% of GDP)] Corruption perceptions index [values range from 0 (highly corrupt) to 10 (highly clean)] Default = 1, if a country has defaulted or rescheduled its debt at least once in history = 0, otherwise

Corruption -

10

The null and alternative hypotheses tested were: H0: j=0 versus H1: j>0 for j=1,2,4,5; H1: j<0, for j=3,6, at 95% confidence level (or 5% level of significance). Following are the rationale for the aforementioned a priori expectations with respect to the relationship between the sovereign credit rating and the set of explanatory variables: An increase in gross domestic savings will lead to an improvement in the credit rating because of the increase in available funds to pay maturing foreign obligations. An increase in GNI per capita means a potential increase in tax receipts, which will likewise improve the countrys repayment capacity and consequently, its sovereign credit rating. A substantial increase in percent change in consumer prices (or inflation rate) would indicate that there is a somewhat relaxed monetary policy, which could not maintain price stability. Because of this, it is expected that a high inflation rate will lead to a decrease in the countrys credit rating. An increase in the trade openness indicator, which is measured as the sum of exports and imports as a percentage of GDP, is expected to lead to an upgrading of sovereign credit ratings considering that countries will be able to generate the necessary foreign currency for debt servicing. Further, countries open to external trade will most probably exert best efforts not to default so as not to impair their trade relations with the rest of the world. An improvement in the corruption perceptions index of the country will likewise lead to an increase in our sovereign credit rating as the former is viewed by credit rating agencies as a measure of quality of governance. Lastly, countries with default histories are perceived as high credit risks that are most likely to default again; hence, a lower credit rating is assigned to such countries by credit rating agencies.

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VII. DEFINITION OF VARIABLES

Consumer Price Index general measure of the average annual changes in the retail prices of commodities commonly purchased by households reckoned from a base year and weighted by the consumption pattern or basket of the households. Corruption Perceptions Index relates to perceptions of the degree of corruption as seen by business people and country analysts and ranges between 10 (highly clean) and 0 (highly corrupt). Exports and imports of goods and services comprise all transactions between residents of an economy and the rest of the world involving a change in ownership of general merchandise, goods sent for processing and repairs, nonmonetary gold, and services. Gross Domestic Savings represent the difference between GDP and total consumption. Domestic savings also satisfy the fundamental identity: exports minus imports equal domestic savings minus capital formation Gross National Income (GNI) takes into account all production in the domestic economy (i.e., Gross Domestic Product or GDP) plus the net flows of factor income (such as rents, profits, and labor income) form abroad. The Atlas method smoothes exchange rate fluctuations by using a three-year moving average, price-adjusted conversion factor. GNI per capita GNI divided by the actual population in a given country. Inflation Rate annual rate of percentage change or the year-on-year change in the CPI. It indicates how fast or slow the CPI increases or decreases. Sovereign Credit Rating an assessment of the capacity and willingness of a government to timely service its debt, and in accordance with pre-agreed conditions when the loans were made Trade Openness measured by the sum of exports and imports as percentage of GDP

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VIII. OVERVIEW ON LOGISTIC MODELING

Logistic models are used when dealing with discrete dependent variables. Logistic regressions relate the probability of occurrence of an event, dichotomous outcomes (binary models) or multinomial outcomes (multinomial models), to a host of explanatory variables. Within the multinomial models, ordered logistic models are used when the dependent variable is an ordinal variable which measures ranks such as ratings. It assumes that the ordered logistic model is well adapted for modeling sovereign ratings, which are clearly ordinal variables. The goal of this model is to express the probability of a rating score assigned to a country as a function of the economic and political determinants of the said country. The probability obtained by applying a logistic function to a score obtained by a linear combination of independent variables. Only the most statistically significant variables are observed. Therefore, the model helps identify which independent variables have the largest influence over the rating agencys choices. In ordered dependent variable models, the observed dependent variable Y denotes outcomes representing ordered or ranked categories. We can model the observed response by considering a latent variable Y* that depends linearly on the explanatory variables Xs: Y* =x + where s are independent and identically distributed random variables. The observed Y is determined from Y* using the rule: Y = 0 , if = 1 , if = 2 , if = M , if Y* 1 1 < Y* 2 2 < Y* 3 Y* > M

It is worth noting that the actual values chosen to represent the categories in are completely arbitrary. All the ordered specification requires is for ordering to be preserved so that Yi<Yj implies that Yi*<Yj*. It follows that the probabilities of observing each value of Y are given by Pr(Y=0) = F (1 x) Pr(Y=1) = F (2 x) - F (1 x) Pr(Y=2) = F (3 x) - F (2 x) Pr(Y=M) = 1 - F (M x) where F is the cumulative distribution function of .

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IX. FINDINGS/RESULT HIGHLIGHTS

Descriptive Statistics This study is aimed at determining the economic and political variables that have the most influence on the sovereign credit ratings awarded by ratings agencies, particularly Standard and Poors. The sample of the study includes 61 countries, nine of which are Asian countries namely: China, India, Indonesia, Israel, Japan, Malaysia, Philippines, Thailand and Vietnam. Cross-section data were used covering 2003 independent variables vis--vis the 2004 ratings by S&Ps awarded to respective countries.

Rating A scale of 0-3 (or 4 categories) was used in transforming the alpha ratings of S&P to sample countries: 0 lowest (D to CCC+); 1 (B- to BB+); 2 (BBB- to AA+); and 3 - highest (AAA). Among the sample, three countries obtained the lowest rating of 0, namely Argentina, Dominican Republic and Ecuador. In Asia, the Philippines was awarded a rating of 1 along with India, Indonesia and Vietnam; while China, Israel, Japan, Malaysia and Thailand gained a rating of 2.
Standard and Poor's Sovereign Credit Ratings for the Sam ple of 61 Countries as of Decem ber 31, 2004

Notches (0-lowest; 3-highest)

Argentina Australia Austria Belgium Bolivia Brazil Bulgaria Canada Chile China Colombia Costa Rica Croatia Czech Denmark Dominican Ecuador Egypt El Salvador Estonia Finland France Germany Ghana Greece Hungary India Indonesia Ireland Israel Italy Japan Kazakhstan Latvia Lithuania Malaysia Mali Mexico Mozambique Netherlands New Zealand Norway Panama Peru Philippines Poland Portugal Romania Russia Slovakia South Africa Spain Sweden Thailand Tunisia Turkey United Kingdom United States Uruguay Venezuela Vietnam

14

Of the 61 countries, three fall in the lowest category of 0 rating, 20 in the second higher category of 1, 24 in category 2, and 14 in the highest category of 3 as shown in the one-way tabulation of the dependent variable Rating3. The counties, which were given ratings in the lowest scale of 0 in 2004, include Argentina, Dominican Republic and Ecuador. On the other hand, there were 14 countries which received the highest rating of 3 (or AAA) for the same rating period, namely: Australia, Austria, Canada, Denmark, Finland, France, Germany, Ireland, Netherlands, Norway, Spain, Sweden, United Kingdom, and United States. Tabulation of RATING Number of categories: 4 Value 0 1 2 3 Total Count 3 20 24 14 61 Percent 4.92 32.79 39.34 22.95 100.00 Cumulative Cumulative Count Percent 3 4.92 23 37.70 47 77.05 61 100.00 61 100.00

The average rating received by the sample of 61 countries was 1.8. As expected, since ratings were divided into 4 categories, the minimum rating was 0 and the maximum, 3.
25 Series: RATING Sample 1 61 Observations 61 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability 0.0 0.5 1.0 1.5 2.0 2.5 3.0 1.803279 2.000000 3.000000 0.000000 0.852832 -0.102443 2.203760 1.718108 0.423563

20

15

10

One-way tabulations for each of the variables are shown in Annex D.

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The distribution of the series has a long left tail and is flat (platykurtic) relative to the normal distribution as indicated by the negative value of the skewness statistics and a value of less than 3 for the kurtosis. Although the series Rating is not perfectly symmetric, the Jarque-Bera statistics p-value of 0.423563 leads to the acceptance of the null hypothesis of normal distribution.4

Gross Domestic Savings (% of GDP)

The average gross domestic savings as % of GDP was 21.65574%. This ratio ranged from as low as 0% to as high as 47%. China had the highest savings relative to its GDP and El Salvador, the lowest for the sample of 61 countries. On the other hand, Bolivia, Bulgaria, Ghana, Israel and Mozambique had savings that ranged from 9% to 12% of their respective GDPs in 2003.

Summary of descriptive statistics for all the variables included in the study is presented in Annex E.

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16 14 12 10 8 6 4 2 0 0 10 20 30 40 Series: SAVINGS Sample 1 61 Observations 61 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability 21.65574 22.00000 47.00000 0.000000 7.852569 0.576137 4.880762 12.36520 0.002065

The series Savings was automatically divided by the software Eviews into 25 categories. The highest number of countries with the same percentage of gross domestic savings is 7 (22% savings).

Gross National Income per capita

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The gross national income per capita of the sample countries, on the average, was USD10,608.52. We can also see that our sample includes a diverse group of countries with different income per capita levels. Although the mean income was USD10,608.52, note that the lowest per capita income was registered at USD210 while the highest was USD43,400. The country with the highest income per capita was Norway, followed by the United States, Japan and Denmark. On the other hand, Bolivia, Ghana, India,

Indonesia, Mali, Mozambique and Vietnam had per capita income of less than USD1,000.
24 20 16 12 8 4 0 0 10000 20000 30000 40000 Jarque-Bera Probability 11.74149 0.002821 Series: GNI Sample 1 61 Observations 61 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis 10608.52 4360.000 43400.00 210.0000 11757.04 1.070738 2.816475

As shown in the following table, 65.57% of the sample or 40 out of the 61 countries included in the study registered a GNI per capita within the interval of [USD0, USD10,000). On the other hand, only 1 country posted a GNI above 40,000.

Tabulation of GNI Number of categories: 5 Value [0, 10000) [10000, 20000) [20000, 30000) [30000, 40000) [40000, 50000) Total Count 40 5 12 3 1 61 Percent 65.57 8.20 19.67 4.92 1.64 100.00 Cumulative Cumulative Count Percent 40 65.57 45 73.77 57 93.44 60 98.36 61 100.00 61 100.00

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Consumer Price Index (% change) - Inflation Rate

The movements in the consumer prices (inflation) indicate the sustainability of monetary and exchange rate policies of a country, or it can be a proxy for economic development. Venezuela emerged to have the highest inflation rate in 2003 at 31.06%, while China showed a deflation in the same year at -1.56%. On the other hand, Indonesia has the highest in Asia at 5.9%. The average change in the CPI of the countries included was 5.64%.
24 20 16 12 8 4 0 0 10 20 30 Jarque-Bera Probability 71.28563 0.000000 Series: CPI Sample 1 61 Observations 61 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis 5.643279 2.830000 31.06000 -1.560000 7.280578 2.023545 6.415826

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Out of the 61 countries, 48 (78.7%) had inflation rates that are greater than and equal to 0% but less than 10%; three countries (which constitute 4.9% of the sample) had 2003 consumer price indices that are lower than the 2002 level. The remaining ten countries had inflation rates of at least 10% in year 2003.

Tabulation of CPI Number of categories: 5 Value [-10, 0) [0, 10) [10, 20) [20, 30) [30, 40) Total Trade Openness
14 12 10 8 6 4 2 0 20 40 60 80 100 120 140 160 180 200 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability 79.88148 68.59000 207.6400 22.81000 37.88177 0.946551 3.779534 10.65342 0.004860 Series: TRADE Sample 1 61 Observations 61

Count 3 48 6 3 1 61

Percent 4.92 78.69 9.84 4.92 1.64 100.00

Cumulative Cumulative Count Percent 3 4.92 51 83.61 57 93.44 60 98.36 61 100.00 61 100.00

The average value for trade openness indicator was 79.88%. The percentage of the sum of exports and imports with respect to GDP ranged from as low as 22.81% to 207.64%. Countries with percentages above 150% included Malaysia (which posted the highest trade openness indicator value of 207.64%), Estonia, Slovakia and Ireland.

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In contrast, note that United States and Japan were the two countries with the lowest trade openness values of 23.18% and 22.81%, respectively. Although one may argue that these two countries should have the highest values for trade openness, recall that the indicator is the sum of the exports and imports of a given country as percentage of GDP. Hence, these low values may be due to the fact that these two countries do not rely heavily on imported goods and services, thus, a lower numerator value over the denominator GDP. As indicated in the table below, more than fifty percent of the sample sovereigns recorded trade openness from 50 to 100 percent. This indicates how integrated the countries in the world economy as measured by their respective total exports and imports as a share of GDP. Tabulation of TRADE Number of categories: 5 Value [0, 50) [50, 100) [100, 150) [150, 200) [200, 250) Total Count 12 33 12 3 1 61 Percent 19.67 54.10 19.67 4.92 1.64 100.00 Cumulative Cumulative Count Percent 12 19.67 45 73.77 57 93.44 60 98.36 61 100.00 61 100.00 21

Corruption Perceptions Index

Based on Transparency International 2003, Indonesia was perceived to be the most corrupt country garnering a rating of 1.9 using a scale from 0 (highly corrupt) to 10 (highly uncorrupt), while Finland appeared to be the least corrupt country having a grade of 9.7. Aside from Finland, only Denmark, New Zealand and Sweden received indices above 9. On the other hand, Argentina, Bolivia, Ecuador, Kazakhstan, Philippines, Venezuela and Vietnam got corruption perception indices ranging from 2.2 to 2.5. Of the Asian countries included, the Philippines ranked third as highly corrupt sovereign at 2.5, while Japan and Israel were seen to be the least corrupt Asian countries at 7.0.

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12 10 8 6 4 2 0 2 4 6 8 10 Jarque-Bera Probability 6.393099 0.040903 Series: CORRUPTION Sample 1 61 Observations 61 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis 5.045902 3.900000 9.700000 1.900000 2.356309 0.599399 1.961636

The maximum corruption index given in 2003 to a country included in the sample was 9.7 (0.3 units away from the highest value of 10) and was, therefore, considered highly clean/uncorrupt while the minimum index was 1.9 (which is close to the index of 0 for the most corrupt country. The average rating in this index was 5.05. Based on the tabulation below, 50.82% or 31 countries had corruption perception indices which ranged from 0 to 4, 0 being the most corrupt country while only 16.39% (ten countries) had indices of at least 8.

Tabulation of CORRUPTION Number of categories: 5 Value [0, 2) [2, 4) [4, 6) [6, 8) [8, 10) Total Default History Focusing on the countrys default or rescheduling of debt history, it may be noted that 20 countries have defaulted or rescheduled on their debt, the Philippines included. Count 1 30 10 10 10 61 Percent 1.64 49.18 16.39 16.39 16.39 100.00 Cumulative Cumulative Count Percent 1 1.64 31 50.82 41 67.21 51 83.61 61 100.00 61 100.00

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The remaining 41 sovereigns, or 67.24 percent of the sample, do not have this history as shown in the table below.

Without Default/Rescheduling History Australia Austria Belgium Canada China Colombia Croatia Czech Republic Denmark Dominican Republic Egypt El Salvador Estonia Finland France Germany Ghana Greece Hungary India Ireland Israel Italy Japan Kazakhstan Latvia Lithuania Malaysia Mali Mexico Netherlands New Zealand Norway Portugal Slovakia Spain Sweden Thailand Tunisia United Kingdom United States

With Default/Rescheduling History Argentina Bolivia Brazil Bulgaria Chile Costa Rica Ecuador Indonesia Mozambique Panama Peru Philippines Poland Romania Russia South Africa Turkey Uruguay Venezuela Vietnam

50 Series: DEFAULT Sample 1 61 Observations 61 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability 0.0 0.2 0.4 0.6 0.8 1.0 0.327869 0.000000 1.000000 0.000000 0.473333 0.733352 1.537805 10.90180 0.004292

40

30

20

10

The mean default value for the sample was 0.327869. As expected, since the variable default is a dummy, it will only take values of either 1 if a country has defaulted on its debts or even rescheduled its loans or 0, otherwise.

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The set of independent variables are all positively skewed. Only Savings, CPI and Trade are leptokurtic. The rest of the explanatory variables are platykurtic relative to the normal. Further, the Jarque-Bera statistics p-values of all these variables lead to the rejection of the null hypothesis of a normally distributed series.

Ordered Logistic Model The ordered logistic regression was performed to determine which among the chosen independent variables have an effect on the sovereign credit rating assigned to a given country. The following table shows the results of the initial run of the model: Dependent Variable: RATING Method: ML - Ordered Logit (Quadratic hill climbing) Sample: 1 61 Included observations: 61 Number of ordered indicator values: 4 Convergence achieved after 16 iterations Covariance matrix computed using second derivatives Coefficient Std. Error z-Statistic SAVINGS 0.05289 0.047918 1.10377 GNI 0.000193 9.13E-05 2.114292 CPI -0.128559 0.056463 -2.27687 TRADE 0.013382 0.011081 1.207639 CORRUPTION 1.157246 4.35E-01 2.661828 DEFAULT -1.145463 0.834437 -1.37274 LIMIT_1:C(7) LIMIT_2:C(8) LIMIT_3:C(9) Akaike info criterion Log likelihood Restr. log likelihood LR statistic (6 df) Probability(LR stat) Limit Points 0.955754 2.040921 0.468295 5.876975 2.141553 2.744259 14.78338 4.075983 3.626948 1.241632 Schwarz criterion -28.86976 Hannan-Quinn criteria. -74.33273 Avg. log likelihood 90.92593 LR index (Pseudo-R2) 0.000000

Prob. 0.2697 0.0345 0.0228 0.2272 0.0078 0.1698 0.6396 0.0061 0.0003 1.553072 1.363688 -0.47328 0.611614

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Based on the results of the ordered logit analysis, our model for the latent variable Rating* is: Rating* = 0.05289*Savings + 0.000193*GNI 0.128559*CPI + 0.013382*Trade + 1.157246*Corruption 1.145463*Default

As evidenced by the p-value of the LR statistic, the joint null hypothesis of significant slope coefficients is rejected at 5% level of significance. This means that at least one of the slope coefficients is not equal to zero. However, note that only the variables GNI, CPI and Corruption are significant at 95% confidence level while the dummy variable Default is only significant at 10% level of significance based on the p-values of the Z-statistic. This means that S&Ps credit assessment of a country depends only on the gross national income per capita of each of the individual countries, on the rate of increase in consumer prices, the corruption perceptions index of businessmen on the country and the default risk of a country. Based on the estimated equation, for every one-percentage point increase in the variable Savings (as % of GDP), the estimated logit will increase by 0.05289, ceteris paribus. For every USD1 increase in the GNI per capita, the estimated logit will increase by 0.000193, holding all other variables constant. For every one-percentage point

increase in inflation rate and trade openness, the estimated logit will decrease by 0.128559 and increase by 0.013382, respectively. For every one-unit increase in the corruption perceptions index, the estimated logit will increase by 1.157246, ceteris paribus. The estimated logit will decrease by 1.145463 if a country has defaulted or rescheduled its loans, ceteris paribus. However, these changes dont make any sense because these are just the effects on the estimated logits for every one-unit change in the independent variables. A more meaningful interpretation is in terms of the odds ratios.

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Before moving any further, we verified first whether or not the proportional odds assumption holds. According to this assumption, the independent variables effect on the cumulative odds does not change from one cumulative odds to the next. This means that the slopes remain the same for each category. The only thing that changes is the constant term. The Score test was carried out using the software SAS to validate the assumption: Score Test for the Proportional Odds Assumption Chi-Square DF Pr > ChiSq 19.1761 12 0.0844 Since the Chi-square statistic is insignificant, this means that the proportional odds assumption holds. This provides evidence that treating the dependent variable Rating as ordered is consistent with the data used in the model specification. To get the odds ratios, we have to take the antilog of the negative of the slope coefficients [i.e., exp(-j)]5. This is in contrast to the binary logit model wherein the odds ratios are computed just by taking the antilog of the estimated slope coefficients [i.e., exp(j)] since such model already includes the intercept in the estimated equation. The odds ratios for the set of the independent variables are as follows: Variable Savings GNI CPI Trade Corruption Default Odds Ratio 0.9485 0.9998 1.1372 0.9867 0.3144 3.1439

Hence, the odds of rating being equal to 0 versus all other ratings increases by 1.1372 (13.72%) for every one percentage point increase in the inflation rate. The odds of rating being equal to 0 versus all other rating decreases by 0.3144 for every one5

This computation of the odds ratios only applies when we use the software Eviews wherein the intercepts are separately estimated from the equation. However, if we use SAS wherein the intercepts are included in the estimated equation, the same formula used in the binary logit model applies.

27

percentage point increase in the corruption perceptions index. The odds of rating being equal to 0 versus all other ratings increases by 3.1439 (214.39%) for countries with default histories Since the proportional odds assumption holds, we will get the same odds ratios of rating being equal to 0 or 1 versus ratings above it; or a rating being equal to 0 or 1 or 2 versus a rating of 3. For example, the odds in favor of rating being equal to 0 or 1 (against that of being equal to 2 or 3) increases by 3.1439 for countries which have defaulted on its debts or have rescheduled/restructured its loans at least once in history.

Limit Points

As discussed previously, limit points are the threshold parameters from which we can determine the values of Rating. Shown below are the estimated limit points estimated using the ordered logistic analysis:

LIMIT_1:C(7) LIMIT_2:C(8) LIMIT_3:C(9)

0.95575 5.87698 14.7834

Hence, this means that we can determine the observed value of the dependent variable Rating by just examining within which interval the estimated latent variable Rating* falls. Rating =0, =1, =2, =3, if Rating* 0.955754 if 0.955754 < Rating* 5.876975 if 5.876975 < Rating* 14.78338 if Rating* > 14.78338

For instance, given a countrys statistics/figures for the independent variables, if the estimated Rating* is 5.95, then that country will receive a rating of 2 since 5.95 is within the interval (5.876975, 14.78338].

28

Using this concept, among the 61 countries included in the sample, 47 have equal actual and predicted ratings while the remaining 14 countries shown below were incorrectly classified as having different ratings from the actual rating they received. 6

Incorrectly classified countries Argentina Kazakhstan Belgium New Zealand Bulgaria Panama Dominican Republic Poland Ecuador South Africa France Spain Japan Venezuela In terms of probabilities, we can determine the value of Rating by getting the probabilities associated with each of the four ordered categories from 0 to 3. The rank with the highest probability will be the category to which an observation/country belongs. For example, in the case of the Philippines, the category with the highest probability is at Rating=1. This means that, based on the model, the predicted rating that Philippines will receive is 1. Comparison between actual and predicted ratings shows that this country is correctly rated by the estimated model. In the case of the United States, it has the highest computed probability of 0.876735 at Rating=3, while its lowest probability is at Rating=0. Therefore, based on these probabilities, the United States is least likely to receive a rating of 0 (but will most probably get a rating of 3) in the current year given its values for its economic and political indicators in the previous year. However, as in any other models, there are also errors in the estimation. There are countries, which received the maximum probability at a certain category that is not the same as its actual rating. As expected, these are the same countries incorrectly

Table on the actual ratings, estimated values for the latent variable Rating* and the predicted ratings are shown in Annex F.

29

classified using the limit points technique discussed previously.

The one-notch

inconsistencies in the actual and predicted Rating for said 14 countries are as follows7:

Country Argentina Belgium Bulgaria Dominican Republic Ecuador France Japan Kazakhstan New Zealand Panama Poland South Africa Spain Venezuela

Actual 0 2 2 0 0 3 2 2 2 1 2 2 3 1

Predicted 1 3 1 1 1 2 3 1 3 2 1 1 2 0

The following expectation-prediction table classifies observations on the basis of the predicted response. There are two columns labeled "Error". The first measures the difference between the observed count and the number of observations where the probability of that response is highest. For example, 24 countries were rated 2, while only 20 had predicted probability that was highest for this value. The actual count minus the predicted is 4; hence, an underestimation. The second error column measures the difference between the actual number of countries rated 2 and the sum of the individual probabilities for that value.

Value 0 1 2 3

Prediction table for ordered dependent variable Count of obs Sum of all Count Error with Max Prob Probabilities 3 1 2 2.908 20 25 -5 20.09 24 20 4 24.005 14 15 -1 13.998

Error 0.092 -0.09 -0.005 0.002

The probabilities associated with each of the ordered categories for all the 61 countries are presented in Annex G. Since these are probabilities, their sum for each country would all be equal to one.

30

Correlation Matrix

The correlation matrix was also obtained to determine if there are independent variables that are highly correlated. Since there are no correlation coefficients greater than the benchmark of 0.90, then we can say that there is no possible problem of multicollinearity.

Correlation Rating Savings GNI CPI Trade Corruption Default

Rating 1.00000 0.24854 0.77465 -0.54842 0.14201 0.81321 -0.58073

Savings 0.24854 1.00000 0.15808 -0.15352 0.34421 0.14364 -0.15297

GNI 0.77465 0.15808 1.00000 -0.34844 -0.10404 0.86674 -0.48018

CPI -0.54842 -0.15352 -0.34844 1.00000 -0.14048 -0.38540 0.39123

Trade 0.14201 0.34421 -0.10404 -0.14048 1.00000 0.00092 -0.19684

Corruption 0.81321 0.14364 0.86674 -0.38540 0.00092 1.00000 -0.49789

Default -0.58073 -0.15297 -0.48018 0.39123 -0.19684 -0.49789 1.00000

Redundant variables test

The redundant variables test allows us to test for the statistical significance of a subset of the included variables. More formally, the test is for whether a subset of variables in an equation all have zero coefficients and might thus be deleted from the equation. Since the estimated coefficients of the variables Savings and Trade are not significant, this test was performed to know if we incorrectly included these variables in the model. Redundant Variables: SAVINGS TRADE Log likelihood ratio 3.853068 Probability Test Equation: Dependent Variable: RATING Method: ML - Ordered Logit (Quadratic hill climbing) Number of ordered indicator values: 4 Convergence achieved after 12 iterations Covariance matrix computed using second derivatives Coefficient Std. Error GNI 0.000205 0.000106 CPI -0.13489 0.054498 0.145652

z-Statistic 1.934498 -2.47516

Prob. 0.0531 0.0133

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CORRUPTION DEFAULT LIMIT_1:C(5) LIMIT_2:C(6) LIMIT_3:C(7) Akaike info criterion Log likelihood Restr. log likelihood LR statistic (4 df) Probability(LR stat)

1.085787 0.41485 2.617297 -1.31003 0.7986 -1.6404 Limit Points -1.37174 1.564079 -0.87703 3.424061 1.553747 2.203745 12.32897 3.717755 3.31624 1.239223 Schwarz criterion -30.7963 Hannan-Quinn criteria. -74.3327 Avg. log likelihood 87.072860 LR index (Pseudo-R2) 0.000000

0.0089 0.1009 0.3805 0.0275 0.0009 1.481454 1.334156 -0.50486 0.585697

Based on this test, the independent variables Savings and Trade may be deleted from the model. The p-value of the Log likelihood ratio statistic leads to the acceptance of the null hypothesis that these variables have zero coefficients (insignificant).

However, since we are only interested in determining whether or not each of the explanatory variables influences the rating score of a given country, the two variables will be retained in the model.

Test for Normality of Standardized Residuals

14 12 10 8 6 4 2 0 -0.5 0.0 0.5 1.0 Series: Standardized Residuals Sample 1 61 Observations 61 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability -2.52E-11 -0.038416 0.910229 -0.864951 0.389805 0.535422 3.448022 3.424718 0.180440

Based on the Jarque-Bera statistic with p-value of 0.18044, the standardized residuals are normally distributed since the p-value leads to the acceptance of the null hypothesis of normally distributed error terms.

32

Graph of Standardized Residuals, Actual and Fitted Observations

4 3 2 1 0 1.0 0.5 0.0 -0.5 -1.0 10 20 30 40 50 60 -1

Standardized Residuals Actual Fitted

As can be seen in the graph above, the estimated ordered logit model was able to capture the actual values of the sovereign credit ratings assigned to given countries. Hence, we can say that, except for minor deviations from the actual values of Rating, the estimated model perfectly mimics the behavior of the credit ratings of the sample of 61 countries.

33

X. CONCLUSION
Based on the results of the analysis, only the GNI per capita, percentage change in CPI and corruption perceptions index are significant at 95% confidence level while default history of countries is only significant at 10% level of significance. However, savings and trade openness are insignificant in determining the credit rating of a country.

Countries with higher GNI per capita and are considered to be uncorrupt tend to receive higher ratings while those with higher inflation rates and have defaulted or rescheduled their foreign loans get lower sovereign debt credit ratings.

In contrast, savings and the trade openness level of countries do not have much bearing on the S&Ps assessment of a given country. Factors that have the highest influence on a countrys sovereign credit rating is the corruption perceptions index; followed by default history; and the percentage change in the consumer price index or the inflation rate.

Therefore, a country that seeks to receive a high credit rating, particularly the emerging and low-income economies that rely on foreign borrowings to finance their own development, should implement measures to mitigate corruption in government. It also implies that good governance is the bottom line key that S&P essentially looks for in assessing a countrys particular credit rating.

Likewise, countries should avoid defaulting or even rescheduling debts and loans as it contributes to the perceived default risk of a country. Finally, a government should also exert best efforts to maintain price stability in general.

34

ANNEX A

Data on Dependent and Independent Variables

Country Argentina Australia Austria Belgium Bolivia Brazil Bulgaria Canada Chile China Colombia Costa Rica Croatia Czech Republic Denmark Dominican Republic Ecuador Egypt El Salvador Estonia Finland France Germany Ghana Greece Hungary India Indonesia Ireland Israel Italy Japan Kazakhstan Latvia Lithuania Malaysia

Rating Savings 0 26 3 22 3 25 2 22 1 10 1 22 2 12 3 25 2 27 2 47 1 14 1 18 2 21 2 25 3 26 0 21 0 23 1 15 1 0 2 23 3 26 3 21 3 22 1 11 2 18 2 22 1 22 1 22 3 41 2 9 2 20 2 26 2 33 2 21 2 16 2 42

GNI 3810 21950 26810 25760 900 2720 2130 24470 4360 1100 1810 4300 5370 7150 33570 2130 1830 1390 2340 5380 27060 24730 25270 320 13230 6350 540 810 27010 16240 21570 34180 1780 4400 4500 3880

CPI 13.49 2.77 1.36 1.59 3.41 14.67 2.11 2.77 2.83 -1.56 9.11 9.47 0.19 0.09 2.09 27.4 7.88 4.47 2.08 1.37 0.86 2.1 1.05 26.67 3.53 4.61 3.88 5.09 3.48 0.72 2.67 -0.25 6.45 2.87 1.2 0.97

Trade 40.28 38.1 103.72 138.1 48.91 29.94 116.29 72.81 68.29 65.91 40.96 95.46 111.56 128.28 84.62 108.66 54.97 48.19 70 158.59 68.34 51.62 68.7 96.69 50.12 128.09 31.16 60.11 150.7 78.61 49.16 22.81 94.83 97.51 110.69 207.64

Corruption Default 2.5 1 8.8 0 8 0 7.6 0 2.3 1 3.9 1 3.9 1 8.7 0 7.4 1 3.4 0 3.7 0 4.3 1 3.7 0 3.9 0 9.5 0 3.3 0 2.2 1 3.3 0 3.7 0 5.5 0 9.7 0 6.9 0 7.7 0 3.3 0 4.3 0 4.8 0 2.8 0 1.9 1 7.5 0 7 0 5.3 0 7 0 2.4 0 3.8 0 4.7 0 5.2 0

35

Country Mali Mexico Mozambique Netherlands New Zealand Norway Panama Peru Philippines Poland Portugal Romania Russia Slovakia South Africa Spain Sweden Thailand Tunisia Turkey United Kingdom United States Uruguay Venezuela Vietnam

Rating Savings 1 19 2 18 1 11 3 26 2 23 3 31 1 27 1 19 1 16 2 14 2 18 1 15 1 31 2 24 2 19 3 24 3 23 2 32 2 21 1 20 3 13 3 14 1 15 1 25 1 27

GNI 290 6230 210 26230 15530 43400 4060 2140 1080 5280 11800 2260 2610 4940 2750 17040 28910 2190 2240 2800 28320 37870 3820 3490 480

CPI -1.36 4.57 13.34 2.11 1.75 2.48 1.38 2.25 3.45 0.74 3.28 15.23 13.66 8.57 5.89 3.03 1.9 1.76 2.67 25.29 2.91 2.27 19.43 31.06 3.09

Trade 50.92 58.53 68.5 119.13 57.99 68.59 116.9 35.54 96.93 71.37 66.72 80.35 58.8 156.49 54.95 57.81 81.12 125.19 91.36 59.94 53.71 23.18 51.49 48.67 128.17

Corruption Default 3 0 3.6 0 2.7 1 8.9 0 9.5 0 8.8 0 3.4 1 3.7 1 2.5 1 3.6 1 6.6 0 2.8 1 2.7 1 3.7 0 4.4 1 6.9 0 9.3 0 3.3 0 4.9 0 3.1 1 8.7 0 7.5 0 5.5 1 2.4 1 2.4 1

36

ANNEX B

Description of Sovereign Long-Term Foreign Currency Denominated Debt Credit Ratings of Standard and Poors

AAA. An obligor rated AAA has EXTREMELY STRONG capacity to meet its financial commitments. AAA is the highest Issuer Credit Rating assigned by Standard & Poors. AA. An obligor rated AA has VERY STRONG capacity to meet its financial commitments. It differs from the highest rated obligors only in small degree. A. An obligor rated A has STRONG capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories. BBB. An obligor rated BBB has ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments. BB. An obligor rated BB is LESS VULNERABLE in the near term than other lowerrated obligors. However, it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions, which could lead to the obligors inadequate capacity to meet its financial commitments. B An obligor rated B is MORE VULNERABLE than the obligors rated BB, but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligors capacity or willingness to meet its financial commitments. B. An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligors capacity or willingness to meet its financial commitment on the obligation. CCC. An obligor rated CCC is CURRENTLY VULNERABLE, and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments. CC. An obligor rated CC is CURRENTLY HIGHLY-VULNERABLE. SD and D. An obligor rated SD (Selective Default) or D has failed to pay one or more of its financial obligations (rated or unrated) when it came due. A D rating is assigned when Standard & Poors believes that the default will be a general default and that the obligor will fail to pay all or substantially all of its obligations as they come due. An SD rating is assigned when Standard & Poors believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. Please see Standard & Poors issue credit ratings for a more detailed description of the effects of a default on specific issues or classes of obligations.

37

ANNEX C

Linear Transformation of Credit Ratings of Standard and Poors

Rating -D SD C CC CCCCCC CCC+ BB B+ BBBB BB+ BBBBBB BBB+ AA A+ AAAA AA+ AAA

Numerical Equivalent (Notches) 0 0 0 0 0 0 0 0 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 3

38

ANNEX D

One-way Tabulations for the Dependent and Independent Variables Tabulation of RATING Number of categories: 4 Value 0 1 2 3 Total Count 3 20 24 14 61 Percent 4.92 32.79 39.34 22.95 100.00 Cumulative Cumulative Count Percent 3 4.92 23 37.70 47 77.05 61 100.00 61 100.00

Tabulation of SAVINGS Number of categories: 25 Value 0 9 10 11 12 13 14 15 16 18 19 20 21 22 23 24 25 26 27 31 32 33 41 42 47 Total Count 1 1 1 2 1 1 3 3 2 4 3 2 5 7 4 2 4 5 3 2 1 1 1 1 1 61 Percent 1.64 1.64 1.64 3.28 1.64 1.64 4.92 4.92 3.28 6.56 4.92 3.28 8.20 11.48 6.56 3.28 6.56 8.20 4.92 3.28 1.64 1.64 1.64 1.64 1.64 100.00 Cumulative Cumulative Count Percent 1 1.64 2 3.28 3 4.92 5 8.20 6 9.84 7 11.48 10 16.39 13 21.31 15 24.59 19 31.15 22 36.07 24 39.34 29 47.54 36 59.02 40 65.57 42 68.85 46 75.41 51 83.61 54 88.52 56 91.80 57 93.44 58 95.08 59 96.72 60 98.36 61 100.00 61 100.00

39

Tabulation of GNI Number of categories: 5 Value [0, 10000) [10000, 20000) [20000, 30000) [30000, 40000) [40000, 50000) Total Count 40 5 12 3 1 61 Percent 65.57 8.20 19.67 4.92 1.64 100.00 Cumulative Cumulative Count Percent 40 65.57 45 73.77 57 93.44 60 98.36 61 100.00 61 100.00

Tabulation of CPI Number of categories: 5 Value [-10, 0) [0, 10) [10, 20) [20, 30) [30, 40) Total Count 3 48 6 3 1 61 Percent 4.92 78.69 9.84 4.92 1.64 100.00 Cumulative Cumulative Count Percent 3 4.92 51 83.61 57 93.44 60 98.36 61 100.00 61 100.00

Tabulation of TRADE Number of categories: 5 Value [0, 50) [50, 100) [100, 150) [150, 200) [200, 250) Total Count 12 33 12 3 1 61 Percent 19.67 54.10 19.67 4.92 1.64 100.00 Cumulative Cumulative Count Percent 12 19.67 45 73.77 57 93.44 60 98.36 61 100.00 61 100.00

40

Tabulation of CORRUPTION Number of categories: 5 Value [0, 2) [2, 4) [4, 6) [6, 8) [8, 10) Total Count 1 30 10 10 10 61 Percent 1.64 49.18 16.39 16.39 16.39 100.00 Cumulative Cumulative Count Percent 1 1.64 31 50.82 41 67.21 51 83.61 61 100.00 61 100.00

Tabulation of DEFAULT Number of categories: 2 Value 0 1 Total Count 41 20 61 Percent 67.21 32.79 100.00 Cumulative Cumulative Count Percent 41 67.21 61 100.00 61 100.00

41

ANNEX E

Descriptive Statistics

Rating Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis 1.803279 2.000000 3.000000 0.000000 0.852832 -0.102443 2.203760

Savings 21.65574 22.00000 47.00000 0.000000 7.852569 0.576137 4.880762

GNI

CPI

Trade

Corruption 5.045902 3.900000 9.700000 1.900000 2.356309 0.599399 1.961636

Default 0.327869 0.000000 1.000000 0.000000 0.473333 0.733352 1.537805

10608.52 5.643279 79.88148 4360.000 2.830000 68.59000 43400.00 31.06000 207.6400 210.0000 -1.560000 22.81000 11757.04 7.280578 37.88177 1.070738 2.023545 0.946551 2.816475 6.415826 3.779534

Jarque-Bera Probability

1.718108 0.423563

12.36520 0.002065

11.74149 71.28563 10.65342 0.002821 0.000000 0.004860

6.393099 0.040903

10.90180 0.004292

Sum Sum Sq. Dev.

110.0000 43.63934

1321.000 3699.770

647120.0 344.2400 4872.770 8.29E+09 3180.409 86101.70

307.8000 333.1315

20.00000 13.44262

42

ANNEX F

Estimated Sovereign Credit Ratings of the 61 Countries Based on the Threshold Values for the Latent Variable Rating* Estimated Rating Actual Rating* 0 2.662718 3 15.73638 3 16.96641 2 16.57275 1 2.434898 1 3.570914 2 5.69842 3 16.73006 2 10.23751 2 7.715287 1 4.748479 1 5.672421 2 7.897141 2 8.92021 3 19.71007 0 3.272194 0 2.692628 1 4.950696 1 5.402668 2 10.56556 3 18.62567 3 14.28819 3 15.73463 1 2.327714 2 8.69783 2 9.065073 1 4.426246 1 2.523217 3 17.62877 2 12.66967 2 11.66778 2 16.40833 2 5.306046

Country Argentina Australia Austria Belgium Bolivia Brazil Bulgaria Canada Chile China Colombia Costa Rica Croatia Czech Republic Denmark Dominican Republic Ecuador Egypt El Salvador Estonia Finland France Germany Ghana Greece Hungary India Indonesia Ireland Israel Italy Japan Kazakhstan

Predicted 1 3 3 3 1 1 1 3 2 2 1 1 2 2 3 1 1 1 1 2 3 2 3 1 2 2 1 1 3 2 2 3 1

43

Country Latvia Lithuania Malaysia Mali Mexico Mozambique Netherlands New Zealand Norway Panama Peru Philippines Poland Portugal Romania Russia Slovakia South Africa Spain Sweden Thailand Tunisia Turkey United Kingdom United States Uruguay Venezuela Vietnam

Estimated Rating Actual Rating* 2 7.293146 2 8.480582 2 11.64169 1 5.388866 2 6.515941 1 1.80312 3 18.05871 2 15.7579 3 20.79651 1 6.387555 1 4.740521 1 3.655889 2 5.63982 2 11.33786 1 2.441559 1 3.153059 2 7.496783 2 5.460088 3 12.92634 3 18.39839 2 7.383011 2 8.092753 1 1.590947 3 16.56465 3 16.74525 1 4.940971 1 0.285862 1 4.470525

Predicted 2 2 2 1 2 1 3 3 3 2 1 1 1 2 1 1 2 1 2 3 2 2 1 3 3 1 0 1

44

ANNEX G

Predicted Probabilities Associated with the 4 Ordered Categories of Sovereign Credit Ratings Country Argentina Australia Austria Belgium Bolivia Brazil Bulgaria Canada Chile China Colombia Costa Rica Croatia Czech Republic Denmark Dominican Republic Ecuador Egypt El Salvador Estonia Finland France Germany Ghana Greece Hungary India Indonesia Ireland Israel Italy Japan Kazakhstan Latvia Lithuania Malaysia Rating 0 3 3 2 1 1 2 3 2 2 1 1 2 2 3 0 0 1 1 2 3 3 3 1 2 2 1 1 3 2 2 2 2 2 2 2 Rating=0 0.153558 3.81E-07 1.11E-07 1.65E-07 0.185557 0.068169 0.00864 1.41E-07 9.31E-05 0.001158 0.022038 0.008866 0.000966 0.000347 0 0.089771 0.14971 0.018076 0.011579 6.71E-05 0 1.62E-06 3.82E-07 0.202303 0.000434 0.000301 0.030164 0.172578 0 8.18E-06 2.23E-05 1.95E-07 0.012739 0.001766 0.000539 2.29E-05 Rating=1 0.807809 5.19E-05 1.52E-05 2.25E-05 0.783437 0.841209 0.535881 1.92E-05 0.012518 0.136093 0.733524 0.542095 0.116136 0.045163 9.75E-07 0.841398 0.810531 0.698244 0.604824 0.009049 2.88E-06 0.000221 5.20E-05 0.769754 0.055774 0.039316 0.779947 0.793649 7.82E-06 0.001112 0.003024 2.65E-05 0.626239 0.193497 0.068367 0.003104 Rating=2 0.038627 0.278228 0.101269 0.143127 0.031002 0.090609 0.455366 0.124896 0.97689 0.861898 0.244395 0.448929 0.881877 0.951655 0.007197 0.068821 0.039753 0.283627 0.383513 0.976367 0.020991 0.621105 0.278581 0.027939 0.941522 0.957109 0.189858 0.033768 0.054912 0.891107 0.954485 0.164496 0.360946 0.804179 0.929265 0.955453 Rating=3 5.45E-06 0.721719 0.898715 0.85685 4.34E-06 1.35E-05 0.000113 0.875085 0.0105 0.000851 4.38E-05 0.00011 0.001021 0.002834 0.992802 1.00E-05 5.61E-06 5.37E-05 8.43E-05 0.014517 0.979006 0.378673 0.721366 3.90E-06 0.00227 0.003275 3.18E-05 4.74E-06 0.94508 0.107772 0.042469 0.835477 7.66E-05 0.000558 0.001828 0.04142 Sum 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

45

Country Mali Mexico Mozambique Netherlands New Zealand Norway Panama Peru Philippines Poland Portugal Romania Russia Slovakia South Africa Spain Sweden Thailand Tunisia Turkey United Kingdom United States Uruguay Venezuela Vietnam

Rating 1 2 1 3 2 3 1 1 1 2 2 1 1 2 2 3 3 2 2 1 3 3 1 1 1

Rating=0 0.011738 0.003833 0.299986 0 3.73E-07 0 0.004356 0.02221 0.062965 0.009157 3.10E-05 0.184552 0.099993 0.001441 0.01094 6.33E-06 0 0.001614 0.000795 0.346334 1.66E-07 1.39E-07 0.018249 0.661479 0.028895

Rating=1 0.607923 0.341647 0.683287 5.09E-06 5.08E-05 3.29E-07 0.370702 0.734819 0.839162 0.549856 0.004201 0.784241 0.83843 0.16379 0.591798 0.000861 3.62E-06 0.179913 0.097548 0.640093 2.27E-05 1.89E-05 0.700043 0.334804 0.774311

Rating=2 0.380256 0.654263 0.016725 0.036422 0.273929 0.00244 0.624717 0.242928 0.097858 0.440881 0.964865 0.031202 0.061568 0.834085 0.397172 0.864084 0.026208 0.817862 0.900416 0.013571 0.144124 0.123246 0.281655 0.003717 0.196761

Rating=3 8.32E-05 0.000257 2.31E-06 0.963573 0.72602 0.99756 0.000226 4.35E-05 1.47E-05 0.000107 0.030903 4.37E-06 8.89E-06 0.000684 8.93E-05 0.135049 0.973789 0.000611 0.001241 1.86E-06 0.855854 0.876735 5.31E-05 5.06E-07 3.32E-05

Sum 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

46

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