rating process can be complex and not readily available in many countries.<sup>5</sup> The institutional and legal environment governing property rights and sale of securities may be absent or weak, prompting reluctance on the part of politicians to get publicly “judged” by the rating analysts. The fact that the country has to request a rating, and has to pay a fee for that, but has no say over the final rating outcome can also be discouraging.<sup>6</sup> Also Basel capital adequacy regulations that assign a lower risk weight (100 percent) to unrated entities than to those rated below BB- (150 percent) may discourage borrowing entities from getting rated.

Having no rating, however, may have worse consequences than having a low rating. Unrated countries are often perceived by creditors as riskier than they are, than even very high default risk countries. In 2002, the US Department of State, Bureau of African Affairs decided to fund a project to help African nations get an initial sovereign credit rating (US Department of State 2006). The United Nations Development Program (UNDP) recently partnered with Standard and Poor’s to rate 8 African countries during 2003-2006 (Standard and Poor’s 2006a and UNDP 2006). Interestingly, the newly established ratings under these two initiatives did not fall at the bottom of the rating spectrum. Of the 10 newly rated African countries, 1 was rated BB-, and the rest rated in ‘B’ categories, and none was rated ‘C’.

In this paper, we hope to make a modest contribution to these efforts by estimating a model of sovereign ratings for rated developing countries using readily available variables, and then attempting to “predict” sovereign ratings for the unrated developing countries.

The plan of the paper as follows. In the next section, we present some stylized facts about sovereign ratings. We show that ratings by different agencies are highly correlated with a correlation coefficient of 0.97 or higher! We also find that ratings for individual countries tend to be sticky over time, a fact that brought criticism to the rating industry in the aftermath of the Asian crisis (Ferri, Liu and Stiglitz 1999). In section 3, we develop the rating prediction model, drawing on the existing literature. We also discuss the results on predicted or shadow sovereign ratings for the unrated countries in this section. The concluding section summarizes the results, and discusses how poor country entities could improve their borrowing terms through financial structuring or leveraging official aid.

5 For example, Fitch’s questionnaire for government officials includes 128 questions in 14 categories (ranging from demographic and educational factors to trade and foreign investment policy), all of which require supporting documentation, past data for 5 years and 2-year ahead forecasts (FitchRatings 1998).

6 The rating process is initiated by a sovereign (or sub-sovereign) entity. After the signing of the initial contract with a rating agency, which also involves a fee, the rating agency sends out a detailed questionnaire to the entity. Analysts from the rating agency visit the entity and collect information about institutional, economic and political environment. The rating committee comprising these and other analysts compare the entity being rated against other entities, and decide a rating. If the borrowing entity does not agree with the rating, it could request reconsideration, but the rating committee may or may not alter its rating decision. At the final stage, the borrowing entity may request that the rating not be published. Otherwise, the rating is made available publicly to potential investors.

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