numerical scale that ranges from 1 to 21, with 1 corresponding to the highest rating (“Aaa” for Moody’s and “AAA” for S&P and Fitch) and 21 to the lowest rating. A higher value of the numerical index is thus associated with a worse rating.

An important threshold is that separating investment grade (“BBB-” or higher for Fitch and S&P, and “Baa3” or higher for Moody’s) and sub-investment grade countries. In our numerical scale, investment grade countries have a rating of 10 and below. As not all agencies rate all countries, we maximize the number of observations by averaging the ratings of the three agencies for each country-year and only use one or two agencies for countries that are not rated by all three agencies.<sup>22</sup> Table 3.1 reports the correspondence between the alpha-numeric ratings, their numerical counterparts, and our combined numeric sovereign rating.

The data on 5-year CDS spreads are sourced from the World Bank’s Fiscal Space database (Kose et al. 2017). Higher spreads convey higher premium demanded by investors, i.e., higher sovereign risk. Out two sovereign risk measures are highly correlated: the correlation between sovereign ratings and the CDS spreads is 0.7 and is statistically significant at the 1-percent level.

Other variables are sourced from various publicly accessible databases. Data on the share of government debt in foreign currency in total government debt is from the World Bank’s Fiscal Space database. Data on public investment are from the IMF Investment and Capital Stock Dataset. The measures of institutional development are from the International Country Risk Guide (ICRG), World Bank’s Worldwide Governance Indicators (WGI), Country Policy and Institutional Assessment (CPIA), and World Economic Forum (WEF). Most macroeconomic data (general government debt-to-GDP ratio, exchange rate, inflation, foreign reserves as a share of GDP, real GDP growth, per capita GDP, net real ODA received, age dependency ratio, net FDI inflows, foreign trade-to-GDP ratio, current account balance, and total natural resource rents as a share of GDP) are from the World Bank’s World Development Indicators (WDI). Data on financial crises are from Laeven and Valencia (2020). Capital account openness data are sourced from the most recent update of Chinn and Ito (2006). Summary statistics for the variables used in the estimations are reported in Annex Table A2.

On average, EMDEs exhibit higher sovereign risk compared to advanced economies. However, there is significant heterogeneity within both country groups (Figure 3.1). Sovereign risk in lowincome countries is significantly higher than in middle-income and high-income countries. Among EMDEs, except for the majority of high-income ones, sovereign ratings generally fall within the speculative rating range (10-21 on our combined scale). If we exclude the Middle East and North Africa (MNA), all EMDE regions have average sovereign ratings above 10, indicating elevated risk (Figure 3.2). In recent years, sovereign risk has increased in all EMDE groups.<sup>23</sup>

> 22 This averaging procedure does not generate any source of bias because the correlation between the ratings of the three agencies is well above 90 percent.

> 23 We measure sovereign risk with yearly average. Note that we follow Combes et al. (2021) and use the log of CDS spreads. Taking logs helps in downplaying the role of outliers in the heavily skewed distribution of spreads and in addressing heteroscedasticity issues in the CDS spreads data.

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