Is it (Still) Mostly Fiscal? Determinants of Sovereign Spreads in Emerging Markets

IMF Working Papers, November 1, 2008

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Study uses a panel of 30 emerging market economies from 1997 to 2007.
Both fiscal and political factors matter for country credit risk as measured by sovereign bond spreads.
Lower levels of political risk are associated with tighter spreads.
Efforts at fiscal consolidation narrow credit spreads, especially in countries that experienced prior defaults.
The composition of fiscal policy matters: spending on public investment contributes to lower spreads as long as the fiscal position remains sustainable and the fiscal deficit does not worsen.

Panel dataset covering 30 emerging market economies.
Time period: 1997 to 2007.
Sovereign bond spreads used as the measure of country risk premiums.
Analysis contrasts with previous studies by explicitly accounting for political factors alongside fiscal variables.

Fiscal consolidation can reduce sovereign spreads, with stronger effects in countries with prior defaults.
Emphasize the quality and composition of fiscal policy: maintain sustainability while allocating spending to public investment to help lower spreads.
Political risk reduction (improvements in political stability/credibility) can tighten sovereign spreads and complement fiscal measures.

IMF Working Paper by Sanjeev Gupta, Amine Mati, and Emanuele Baldacci (November 1, 2008).

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