The Price of Democracy: Sovereign Risk Ratings, Bond Spreads and Political Business Cycles in Developing Countries

Abstract

In developing countries, political business cycles may have implications not only for incumbent governments and their electorates but also for foreign actors involved in allocating credit and pricing it appropriately for investment. We examine this proposition with data on major credit rating agency sovereign risk ratings and market-determined credit spreads on bond yields for developing countries holding presidential elections in the 1980s and 1990s. We find that agency sovereign risk ratings decrease and bond spreads increase for developing countries during election periods. Both agencies and bondholders appear to view elections in developing countries negatively, and impose additional credit costs.