Public debt and sovereign credit ratings in the eurozone: a fixed-effects panel threshold approach

Abstract

The current research on sovereign credit ratings has been expanded in the last decade, especially in the years following the Global Financial Crisis and the subsequent European Debt Crisis. While the role of debt-to-GDP ratio was always taken into account, there is no previous empirical work to the best of my knowledge that hypothesized that should a certain threshold is surpassed, then its impact on sovereign credit ratings is more severe. Using data from Moody’s and Fitch, this thesis employs a Panel Threshold Fixed-Effects methodology to assess the varying effect of debt-to-GDP ratio to the attributed sovereign Credit Ratings for member states of the Eurozone. Based on empirical evidence, the two rating agencies share a similar approach toward public debt but they have different levels of tolerance. Two different thresholds are identified; those are 95.782 and 120.038 for Fitch and Moody’s, respectively, resulting in two distinct regimes of ’low’ and ’high’ implications for the attributed sovereign credit rating. The regime-dependant coefficients in the ’low regime’ for Fitch are not statistically significant, implying that public debt does not have harmful consequences at low levels. Overall, the debt-to-GDP ratio erodes more drastically the solvent ability of a sovereign when the estimated threshold is exceeded.