Sovereign debt and the cost of migration: India 1990–1992

Abstract

In this paper we look at the Indian financial crisis of 1990–1992 that included three credit rating downgrades of two notches each in the short space of 9 months. We measure to what extent India’s financial difficulties were the result of conditions prevailing on the international capital markets at the time, reflected in changes in the risk-free international term structure of interest rates, and to what extent they were linked to credit risk specific to the country’s political environment and its economic and financial management as reflected in the three ranking migrations. (In the credit risk literature, migrations refer to changes in credit rating in the sense that a country “migrates” from a rating of A2, for example, to a rating of Baa3.) We find that most of the changes in Indian Eurobond prices over the period were due to conditions on the international capital markets. Migration effects were surprisingly small. Interestingly, our results show that there are no maturity, currency or bond specific effects of migration on percentage changes in the bond prices. However, when we measure the cost of migration in terms of basis points on the yield to maturity, we find that migration is relatively more costly for shorter maturities. Averaging over all bonds, the first migration added about 106 basis points to the bonds’ yields to maturity while the third migration added about 42. The second migration was very small and not statistically significant, indicating that it was anticipated by the markets and priced in the first downgrade