Page 119 - ES 2020-21_Volume-1-2 [28-01-21]

102 Economic Survey 2020-21 Volume 1

EFFECT OF SOVEREIGN CREDIT RATING CHANGES ON SELECT
INDICATORS

3.35 Changes in sovereign credit ratings can affect economies (see Box 5 for a select review of
literature). From 1998 till date, India has witnessed four instances of a sovereign credit ratings
downgrade and seven instances of a sovereign credit ratings upgrade. As ratings do not capture
India’s fundamentals, it comes as no surprise that past episodes of sovereign credit rating changes
for India have not had major adverse impact on select indicators such as Sensex return, foreign
exchange rate and yield on government securities.

Box 5: Select Review of Literature on Effect of Sovereign Credit Ratings

Jaramillo and Tejada (2011) used a panel of 35 emerging market economies for the period 1997-2010
and observed that investment grade status reduced spreads by 36 per cent over and above that implied
by macroeconomic fundamentals. They found that upgrades within the investment grade reduced
spreads by five-ten per cent while there was no impact of changes within the speculative grade.

Kaminsky and Schmukler (2002), through their study of 16 emerging market economies during 1990-
2000, found that changes in sovereign credit ratings significantly affect bond and stock markets, with
average yield spreads increasing two percentage points and average stock returns decreasing one
percentage point after downgrade. They observed that rating changes had stronger effects during
crises in both domestic and foreign financial markets.
Afonso, Furceri and Gomes (2011) observed significant changes in government bond yields to
changes in ratings and outlook, especially negative announcements. They found evidence of spill
over of rating announcement from lower rated countries to higher rated countries.

Norden and Webber (2004) examined the response of stock markets to rating announcements made
by credit agencies during 2000-02, and found that markets anticipate ratings downgrades and reviews
for ratings downgrades. Li, Jeon, Cho and Chiang (2008) found sovereign rating changes to affect
both, domestic as well as cross-country stock market returns, in five Asian countries during January
1990 to March 2003. Martell (2005) examined the effect of sovereign credit rating changes on
emerging stock markets and found that local stock markets react to news of credit rating downgrades.
They observed that in more developed emerging economies, firms experienced smaller stock price
declines post a sovereign credit rating downgrade.

Cai, Gan and Kim (2018) examined foreign direct investment (FDI) from 31 OECD donors to 72
recipient economies during 1985-2012, and found that donors’ as well as recipients’ credit ratings
impact FDI flows. They observed that countries in high rated regions receive more FDI and that
lower rated non-OECD and higher rated OECD recipients received more FDI. De, Mohapatra and
Ratha (2020) studied sovereign credit ratings and private capital flows to emerging market economies
during 1998-2017, and found that post the 2008 global financial crisis, relative ratings affect portfolio
flows.

Alsakka and ap Gwilym (2012) studied the impact of sovereign credit ratings on foreign exchange
spot markets during 1994-2010 and found that ratings affect own-country exchange rates as well as
have strong regional spill over effect on exchange rates.