Mind the gap: domestic versus foreign currency sovereign ratings

Over the past decade, it has become common practice for rating agencies to assign a domestic currency rating to the debt of sovereign nationals in addition to a foreign currency one. Often the domestic rating is higher, reflecting the presumed greater ability and willingness of sovereigns to service debt denominated in their own currency. However, the gap between the two ratings is neither omnipresent nor uniform. These rating differences are likely to have increasingly important implications for the development of global capital markets. Many governments have embraced the goal of developing local currency bond markets as an alternative to inflows of foreign capital,2 and differential rating policies for foreign and domestic currency debt are likely to reinforce this policy intention through their effect on investor acceptance and market pricing. Rating differences may also be relevant in the light of the expanding use of ratings for regulatory purposes. This feature begins by reviewing the development of the two types of sovereign ratings. Local currency bond ratings tend to be of newer vintage, in line with the more recent emergence of local currency bond markets. We then examine the frequency and size of the markup of local over foreign currency ratings. Our investigation reveals not only differences among borrowers, but also surprising differences across the agencies themselves, suggestive of greater disagreement among the agencies over the risk assessment of domestic currency denominated obligations.