Sustainability and Sovereign Credit Ratings in Emerging Markets: Nigeria as a Case Study

Abstract

In their recent provocative book Why Nations Fail, political scientist Daron Acemoglu and economist James A. Robinson contend that nations fail when they become “extractive” in their exercise of political power. According to the authors, the neoliberal system of market-centred competition that is a feature of modern democracies offers the best platform for innovation. Since economic growth flows from new technologies and processes, political arrangements which allow for profit seeking on the part of smart people tend to be associated with successful economic development at the national level. The bulk of the extraction that Acemoglu and Robinson chronicle takes the form of expropriated commodities and land, as well as exploited human labour. Whereas democratic governments encourage regulation so that economic activity will be sustained, despotic governments usually leave environmental and human wastelands in their wake. There is a considerable political science literature around the topic of state failure, and in recent years finance and economics researchers have begun to pay more attention to the financial markets and banking systems of so-called “frontier” economies such as Iraq, Pakistan and Egypt, all of which would be classified as having had extractive governments in the past. One area of interest is the raising of funds by frontier countries through the international issuance of sovereign bonds (“Eurobonds”). A central question surrounds the assigning of an interest rate to sovereign Eurobonds and whether that rate appropriately compensates investors for associated political and country-specific risks. There is, then, a link between political arrangements, credit ratings, and sustainability. Is that relationship being accurately reflected in the interest rates that are assigned to frontier market Eurobonds? To what degree do bond markets consider issues related to sustainability when pricing Eurobonds? What is the role of the global credit ratings agencies in this process? This paper will explore the link between sustainability, political risk and sovereign credit ratings. After an initial qualitative discussion of the issue at hand, Nigeria will be examined as a case study.

Keywords: sovereign debt, credit ratings, Eurobonds, Nigeria, sustainability

JEL Classification: F34, G12, G15, G24, O16, Q56