Relationship between creditworthiness, financial market development and institutional arrangements: A cross -country analysis

The dissertation postulates that there is simultaneity between creditworthiness in developing countries and financial development. Well-functioning financial markets might improve a country's credit ratings, and higher credit ratings might induce greater financial development. Two existing models are modified to test for the possible directions of the causality. The first model is a model of country risk analysis. This model is modified to include financial development as an additional explanatory variable. The second model includes a set of variables as explanatory factors of financial development. This model is modified by incorporating a country's creditworthiness as a plausible factor affecting financial development. To correct for the co-determination between the creditworthiness of the government and financial development, the Generalized Method of Moments with Instrumental Variables (GMM) is used to estimate the models. Findings based on a sample of 31 developing countries for the period 1990--97 show that there is no clear-cut impact that financial market development has on the creditworthiness of developing countries' governments. Furthermore, findings based on a sample of 17 developing countries for the period 1990--97 show that a one unit rise in a country's creditworthiness is estimated to improve financial development by a magnitude which varies between 0.045 and 0.32, depending on the proxy for financial development. Sustained and successful privatization could be a vehicle for financial development through four main channels: (i) the direct sales of State-Owned Enterprises; (ii) the listing of newly privatized companies on the stock exchange; (iii) the issuance of new stock shares; and (iv) the creation of a business-friendly environment by offering law enforcement, ensuring property rights and building reliable institutions.