Does Financial Fragility Shape Sovereign Credit Ratings? Evidence From a Multi-Country Study

This study investigates the relationship between financial fragility and sovereign credit rating scores using a multi-country dataset covering advanced, emerging, and low-income economies. Drawing on Minsky’s financial instability hypothesis and the macroeconomic vulnerability framework, the paper constructs a multidimensional fragility index encompassing fiscal, external, macroeconomic, and institutional indicators. Using an ordered probit model and dynamic panel estimations, the analysis reveals that higher financial fragility is systematically associated with lower credit ratings. Fiscal fragility—measured by debt-to-GDP ratios, deficits, and interest burdens—emerges as the dominant driver for advanced economies, while external fragility, foreign reserves, and governance quality are more critical for emerging and low-income markets. The findings further indicate that sovereign ratings function as lagging indicators: market-based measures such as bond spreads and credit default swap premiums adjust more rapidly to shifts in fragility than do rating agencies. Robustness checks—including sensitivity analyses of rating conversion assumptions and the use of geopolitical risk indices as instruments—confirm the consistency of these results. The study contributes to the literature by demonstrating that ratings provide a partial but incomplete reflection of fragility, with significant implications for policymakers, investors, and international institutions. Strengthening fiscal discipline, institutional quality, and external buffers can reduce fragility and enhance creditworthiness, while investors and regulators should complement ratings with real-time fragility assessments to improve financial stability.