The Impact of Transparency on the Cost of Sovereign Debt in Times of Economic Crisis

• Author: Bernardino Benito,Francisco Bastida,María‐Dolores Guillamón
• DOI: http://doi.org/10.1111/faam.12090
• Date: 01 August 2016
• Published date: 01 August 2016

Financial Accountability & Management, 32(3), August 2016, 0267-4424

TheImpactofTransparency

on the Cost of Sovereign Debt

in Times of Economic Crisis

BERNARDINO BENITO,MAR

´

IA-DOLORES GUILLAM´

ON

AND FRANCISCO BASTIDA∗

Abstract: This paper analyses which factors determine the cost of debt, specifically

in the light of the deep economic crisis the world is facing today. We evaluate

the impact of transparency, financial indicators and sovereign ratings on public

debt interest. We consider several measures related to transparency: transparency

index, corruption index and public trust in politicians’ financial honesty index. We

work with 2008 (the beginning of the economic crisis) and 2012 data for OECD

and BRICS countries. Our results show that all measures connected with fiscal

transparency negatively impact the cost of sovereign debt, increasing therefore the

financing costs of the government in 2008. A comparison of 2008 with 2012 reveals

a substitution effect. On the one hand, transparency, corruption and public trust

indexes explain interest rates in the first year considered. On the other, in 2012,

when the crisis started to be overcome, the fiscal situation, rather than transparency

indexes, explains interest rates. In the whole time window, sovereign rating holds its

explanatory power.

Keywords: fiscal transparency, economic crisis, sovereign debt, corruption, public

trust

INTRODUCTION

In the past two decades, an increasing number of countries have gone to financial

markets to finance their deficits. This trend has enhanced the transparency

∗The authors are respectively, Full Professor of Accounting, Lecturer of Accounting and

Professor of Accounting in the Department of Accounting and Finance, University of Murcia,

Spain.

Address for correspondence: Bernardino Benito, Professor of Accounting, Department of

Accounting and Finance, Faculty of Economics and Business, Regional Campus of Interna-

tional Excellence ‘Campus Mare Nostrum’, University of Murcia, 30100 (Murcia), Spain.

e-mail: benitobl@um.es

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310 BENITO, GUILLAM ´

ON AND BASTIDA

of these countries’ financial situation. Indeed, they are required to provide

rating agencies, underwriters, and security market supervisory agencies with

considerable data on their debt stock (Kopits and Craig, 1998). Sovereign rating

changes may reveal new information about a country and thus may encourage

financial market rallies or downturns.

Sovereign credit ratings assess governments’ ability to repay their debt.

Countries with a better credit rating are more likely to convince the markets

about their ability to meet their financial commitments. This should then be

reflected in lower interest rates (Hameed, 2005). Butler and Fauver (2006)

show that sovereign ratings take into account, among other factors, the balance

of payments, banking and financial system stability, debt profile, governmental

fiscal policy, the country’s regulatory regime, rule of law and transparency.

Furthermore, there are many risk factors simultaneously influencing a country’s

credit rating, including, among others, political and other expropriation risk,

inflation, exchange rate volatility and the country’s industry composition.

Accordingly, sovereign credit ratings are considered as a good proxy for the

degree of transparency and future country risk (Kim and Wu, 2008).

The potential role of transparency in promoting good governance has been

widely recognized. In general, better-performing countries generally follow more

transparent fiscal practices (Benito and Bastida, 2009). Transparency is also

increasingly viewed as central to curbing corruption and to increasing public

trust in politicians (Kolstad and Wiig, 2009). In an untransparent environment,

there are few trustworthy signals of honesty through which honest agents can

signal their integrity. Thus, transparency can help maintain norms of integrity

and trust.

There are good reasons to believe that fiscal transparency contributes

to macroeconomic stability, allocative efficiency and fairness. In fact, fiscal

transparency leads to increased credibility, which, in turn, helps reduce risk

premiums in financial markets (Kopits and Craig, 1998). Earlier papers on

market effects of transparency have also considered sovereign spreads as a

measure of risk (Hameed, 2005). According to Heald (2003), when governments

enhance fiscal transparency, a lower cost of capital can be expected, as credit

rating improves.

Within this background, this paper analyses the factors that seem to play an

important role in determining the cost of debt. Specifically, we examine the

impact on interest rates of fiscal policy, sovereign ratings and three different

measures related to transparency (transparency index, corruption index and

public trust in politicians’ financial honesty index). Furthermore, we want to

check if this impact is the same before and during the current global economic

crisis. We collected information from years 2008 (the beginning of the crisis)

and 2012 for OECD and BRICS countries.

We think the interest of this paper is twofold. On the one hand, the

opportunity to revisit the theme of world interest rates is particularly welcome

because it has been over a decade since the last extensive discussion of the

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