Ethnic politics and sovereign credit risk

Abstract

How does domestic politics affect sovereign credit risk? To date, scholars have largely focused on how economic interests along class-cleavages influence sovereign default risk and borrowing costs. Ethnic dynamics are another important political factor that explains governments’ creditworthiness, yet are understudied. We investigate how ethnic politics shape governments’ credit access and argue that the fiscal incentives generated by ethnic coalitions influence credit risk differently than those created by class cleavages. Because ethnic coalitions are usually smaller than class coalitions, left governments with ethnic support can commit to lower spending and receive more favorable risk assessments. Right governments that rely on ethnic support, however, will have greater spending demands because of their need to satisfy ethnic groups. We test our argument using a new indicator of government ethnic support and four indicators of sovereign credit risk. We find that, in emerging markets, the borrowing costs of right governments increase as they become more dependent on ethnic groups for political support. Our findings suggest that financial markets are attuned to multiple dimensions of domestic politics and demonstrate that ethnic divisions can have strong implications for governments’ access to credit.

Keywords:

• Sovereign debt
• ethnic politics
• partisanship
• emerging markets

Acknowledgements

The authors would like to thank Alexandre Afonso, Natascha van der Zwan, Sebastian Diessner, Fabio Bulfone, Alessia Aspide, Carl Muller-Crepon, and William Grimes for their feedback on earlier drafts.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 https://www.bloomberg.com/news/articles/2022-07-07/why-developing-countries-are-facing-a-debt-default-crisis; https://www.bloomberg.com/news/articles/2022-07-12/imf-chief-warns-of-debt-crisis-as-higher-rates-follow-covid-war

2 There is more consensus that partisanship influences fiscal outcomes and borrowing decisions (Alt & Lassen, 2006; Ballard-Rosa et al., 2022; Cormier, 2023; Eslava, 2011).

3 See Dubois (2016) for a review.

4 Other scholars note that the assumption of perfect substitution between class and ethnicity is theoretically limiting (Auerbach et al., 2022).

5 As Huber (2017) notes, when ethnic groups do not allow governments to create a smaller winning coalitions, governments will retain class-based parties.

6 V-Party codes parties that received at least 5% of the national vote share.

7 We offer more detail on the distribution of $\mathit{\text{EthnicSupport}}$ and LR in the Appendix.

8 The long-run multiplier is calculated by: $\beta /(1-\rho )$.

Additional information

Funding

This work was supported by the HORIZON EUROPE European Research Council under grant #852334.

Notes on contributors

Kathleen J. Brown

Kathleen J. Brown is a PhD Candidate at the Institute of Political Science at Leiden University. Her research focuses on the international political economy of sovereign debt and transparency in global finance.

Matthew DiGiuseppe

Matthew DiGiuseppe is an Associate Professor of International Relations at the Institute of Political Science at Leiden University. His research focuses on the politics of sovereign debt, public opinion on fiscal policy, conflict, and interstate alliances.

Patrick E. Shea

Patrick E. Shea is a Senior Lecturer in International Relations at the University of Glasgow’s School of Social and Political Sciences. His research focuses on the political economy of conflict and the politics of debt.