MARKET EFFICIENCY, SOVEREIGN DEBT ...

Applied Econometrics and International Development

Vol. 17-1 (2017)

MARKET EFFICIENCY, SOVEREIGN DEBT RESTRUCTURING AND CREDIT RATINGS IN DEVELOPING COUNTRIES C. Justin ROBINSON* Prosper F. BANGWAYO-SKEETE Abstract The paper investigates the investor’s sensitivity to the announcements of nine sovereign debt restructurings and 50 credit rating reviews on six stock markets across the Caribbean. Using event study methodology, while controlling for thin-trading, the study found no stock price reaction to the credit rating announcements that occurred over 2000-2015. Prices on the Jamaica Stock Exchange, however, reacted to the announcement of two sovereign debt restructurings. In one case, the stock price reaction was delayed and protracted, which is inconsistent with semi-strong form market efficiency. This requires policymakers and practitioners to exercise caution in utilizing stock markets information for policymaking. Key words: debt restructuring; credit ratings; thin trading; stock market efficiency; developing countries JEL Classification: G 1. Introduction The significance of stock market efficiency is often under-appreciated in developing countries, particularly those in the Commonwealth Caribbean1. Consider the take-over of Banks Holding Limited in Barbados. In December 2015, Companhia de Bebidas Das Américas – AmBev, completed the takeover of Banks Holding Limited at a price of Barbados $7.10 per share. At the start of the takeover battle, AmBev offered a price of Barbados $4.00 per share, which represented a substantial premium on the market price of $2.49 per share, but was a discount from the balance sheet value (or book value) of $4.81. The entry of Ansa Mcal of Trinidad and Tobago as a rival bidder saw the offer price rise from $4.00 and eventually closing at $7.10 per share. The final sale price of $7.10 per share meant that while the stock market was valuing the assets of Banks Holdings Limited, net of long term liabilities at Barbados $161,485million ($2.49 per share), AmBev valued them at $460,461million and the balance sheet valued them at $311,944 million. The public battle for ownership of the iconic “Banks” brand (the most popular brand of beer in Barbados) leads many to question why the stock market price was so *

C. Justin Robinson, Dean of the Faculty of Social Sciences and Senior Lecturer in Management, Faculty of Social Sciences, University of the West Indies, Cave Hill Campus, Bridgetown, Barbados. Prosper F. Bangwayo-Skeete, Lecturer in Economics Department of Economics, University of the West Indies, Cave Hill Campus, Bridgetown, Barbados. 1

The countries that make up the Commonwealth Caribbean are: Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Montserrat, St. Kitts and Nevis, Saint Lucia, St. Vincent and The Grenadines, and Trinidad and Tobago.


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much lower than the book value, or any of the subsequent offer prices. A differential of this magnitude between the stock market price, book value of a company and the price offered in a takeover bid can be attributed to various factors including investor irrationality. One other factor influencing the market price of a stock is the manner in which marginal investors acquire and react to new information on an economy and a company, trade on that information, and thereby set market prices, i.e. the efficiency of the market. Market efficiency deals with the precision with which a market prices securities. Put in stock market context, how quickly do market participants discover, learn and react to new information about a country or company. How accurately and quickly do stock prices adjust to reflect the new information? If stock prices react accurately in a rapid manner, the market is considered relatively efficient, and market prices can serve as useful guides for decision-making. An inefficient market is characterized by slow dissemination of information such that investors take time in analyzing it and stock prices deviate significantly from the fundamental value of the firm. Questions then arise as to the usefulness of such market prices in decisionmaking. If there are structural features of a market that make a stock market relatively inefficient, then stock prices can deviate significantly from fundamental values, and the usefulness and “accuracy” of such prices is highly questionable. Sovereign debt restructurings and credit ratings reviews are prominent economic events with likely consequences for corporate profitability and rates of return across the economy. Their importance have intensified since the onset of the 2007-2009 global financial crisis. Both governments and market participants have paid increased attention to their announcements. As such, these events provide a useful context for investigating the issue of semi-strong form market efficiency, i.e. how quickly and accurately do market prices react to new information. Hence, we uniquely investigate whether six Caribbean stock exchanges respond to sovereign defaults and credit rating reviews. In so doing, the paper adds another dimension to the financial literature (that includes Succurro and Mannarino, 2014) on the impact of sovereign debt restructurings and sovereign credit ratings on the financial market in developing countries. Apart from largely focusing on developed countries and the larger emerging markets, the extant literature is mainly concerned about the desirability of debt restructuring, debt sustainability, the accuracy and fairness of credit ratings and issues of equity and fairness surrounding fiscal adjustment programs. Our paper is the first to undertake such a study in the Caribbean. The stock markets in the Caribbean have great economic significance given their high market capitalization to GDP ratios in 2014: Guyana 21%, Jamaica 43%, Trinidad and Tobago 64%, Bahamas 89%, OECS 93% and Barbados 106%. We, therefore, investigate the stock markets effect of nine sovereign debt restructurings and 50 credit rating changes by two international credit rating agencies: Moody’s and Standard & Poor’s. The data span from 2000-2015. The study proceeds as follows: section 2 provides a review of prior research on the economic and financial impact of sovereign debt restructurings and stock price reactions to sovereign credit rating reviews. Section 3 presents the empirical framework and the data, while section 4 presents and discusses the results. Lastly, section 5 concludes.

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Robinson,C.J.,Bangwayo-Skeete,P.F. Market Efficiency, Sovereign Debt And Credit Ratings

2. Literature Review The reaction of stock prices to the announcement of sovereign debt restructurings and sovereign credit ratings will likely depend on three factors. Firstly, what are the likely consequences of sovereign debt restructurings for corporate profitability and expected returns on equity investments? Secondly, do investors view sovereign credit rating reviews viewed as credible signals for sovereign debt restructurings? Thirdly, are sovereign debt restructurings and credit rating changes widely anticipated, or does the announcement of the events convey new information that can inform the portfolio allocation and asset pricing decisions of equity investors? Previous literature suggest that sovereign debt restructurings are associated with a range of negative macroeconomic consequences likely to have undesirable spillover effects on corporate profitability and expected returns on equity investments. The adverse macroeconomic consequences: reduced access to credit markets for affected governments, declines in gross domestic product, lesser foreign trade, dwindled foreign direct investment, and reduced private sector access to external financing. Eaton and Gersovitz (1981), Aguiar and Gopinath (2006), Amador (2009), Arellano (2008), Asonuma (2010), Mendoza and Yue (2008), Tomz and Wright (2007) and Yue (2010) all present theoretical arguments that sovereign debt restructurings have negative consequences for governments in credit markets. Other studies, Sturgenzer (2002) and De Paoli, Hoggarth and Saporta (2009), provide evidence suggesting that output losses in times of sovereign debt restructuring can range between two and five percent a year, and last up to ten years. Declines in trade flows were found to reach seven percent and lasting between five to fifteen years after a debt restructuring episode [see e.g. Rose, 2005 and Martinez and Sandleris, 2011]. Countries that underwent through debt restructuring also experienced reduced foreign direct investment flows of up to two percent of gross domestic product per year (Fuentes and Saravia, 2010). Arteta and Hale (2008) document a drop of more than twenty percent in foreign loans and bond issuance by domestic firms. Further evidence exist of a forty percent drop in private sector external borrowing (Das, Papaioannou and Tresbech, 2010; 2011). More importantly, Cruces (2007) found sizeable sovereign risk related to equity risk premia. He found that corporations in countries with credit ratings in the default range are forced to offer much higher expected rates of return compared to companies in countries with non-default range ratings (higher equity risk premia imply lower stock prices). Interestingly, despite the large body of evidence demonstrating the detrimental effect of sovereign debt restructuring, early empirical studies suggested that capital markets have short memories and the impact on borrowing costs and exclusion from capital markets is negligible. Borensstein and Panizza (2009) found that sovereign debt restructurings affect risk spreads only in the first and second year after the restructuring, while Gelos et al. (2004) and Richmond and Dias (2009) found that most defaulters regain access to new credit within one or two years after a crisis. This view, however, has been persuasively contradicted by Cruces and Trebesch (2011), who showed that the impact of a sovereign debt restructuring on capital market access depends primarily on the size of the haircut or creditor losses. The study further show that sovereign debt restructurings involving haircuts and significant creditor losses have large and long lasting impacts on sovereign’s access to credit markets. 7


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In summary, the current consensus in the academic literature suggests that sovereign debt restructurings, especially those involving haircuts, tend to have large and long lasting adverse effect on a sovereign’s borrowing costs and access to international capital markets, negative impacts on output, trade, foreign direct investment, private sector access to external credit, and leads to increases in equity risk premia. As such, sovereign debt restructurings can have detrimental effect on the profitability of firms operating in that economy, returns on equity investments and can be expected to trigger declines in stock prices. However, the literature has not separated the economic consequences of a build up to a sovereign debt restructuring from the aftermath of the exercise. In theory, a successful debt restructuring may signal the resolution of a period of economic instability, reduce debt overhang, improve public finances and create fiscal space for growth enhancing policies. Thus, a sovereign debt restructuring can create the potential for greater economic and financial stability in the future which can enhance corporate profitability and lower equity risk premia, which in turn can enhance returns on equity investments and can trigger increases in stock prices. No studies, however, evaluated the stock market reaction to the announcement of sovereign debt restructurings. Studies have instead focused on stock market reaction to the announcement of credit rating changes as proxies for stock market reaction to sovereign debt related issues. Hence, this study fills this gap. Sovereign credit ratings are commonly used as indicators of the likelihood of sovereign default, and changes in these credit ratings are of major interest in the investment community. Given that sovereign credit ratings typically serve as ceilings for credit ratings of private entities in an economy, their change have implications on the cost of financing of firms and projects within that economy. Thus, the reaction of stock prices to credit rating changes will depend on whether or not equity investors view credit rating reviews as credible signals for the likelihood of a sovereign debt restructuring, whether or not ratings changes are widely anticipated or investors have other credible signals for the likelihood of a sovereign debt restructuring. Several event studies examined the impact of the announcement of changes in sovereign credit ratings on corporate stock and bond markets. Cantor & Packer (1996), Kaminsky & Schmukler (2002), Reinhart & Rogoff (2004), Bissoondyal-Bheenick (2004), Brooks et al (2004), Pukthuanthong-Le et al (2007), Hooper et al (2008), Norden, & Weber (2009), Brooks, Faff, Treepongkaruna & Wu (2011), Klimaviciene (2011) and Ftanassi, Ftiti and Hasnaoui (2014) all provide evidence that asset prices are affected by the announcement of changes in sovereign credit ratings. The abovementioned literature normally finds that the announcement of sovereign credit ratings changes affects both bond and stock markets. However, as can be expected, the impact is greater on bond prices. Furthermore, there is general consensus that the impact is asymmetric, in that stock and bond markets react significantly to downgrades but not upgrades. In summary, the literature suggests that episodes of sovereign debt restructurings have negative consequences for a broad range of economic activity and can adversely impact corporate profits and equity returns. However, a successful debt restructuring exercise may signal a new economic dawn which can enhance the prospects for corporate profits and equity returns. Hence the stock market reaction to a sovereign debt restructuring can be either negative or positive depending on the context. The literature also provides a clear indication that equity investors view credit rating 8


reviews as credible signals for the likelihood of a sovereign debt restructuring, and react to the actual announcement of ratings changes. This suggests that the actual announcement of ratings reviews constitutes news for investors. In particular, stock markets react negatively to sovereign credit downgrades, but do not react to upgrades or others ratings reviews generally. The aforementioned studies have all focused on developed and the larger emerging markets. Hence, we pay attention to the Caribbean stock market which are missing in the literature. The next section discusses the data and methodology utilized. 3. Data and Methodology 3.1 Data and Events Description As alluded earlier, this study explores stock price reaction to the announcement of sovereign debt restructurings and credit rating reviews on the six stock exchanges in the Commonwealth Caribbean over the period January 1 2000 to August 31 2015. The six stock exchanges in the Commonwealth Caribbean considered are: the Bahamas International Securities Exchange (BISX), the Barbados Stock Exchange (BSE), the Eastern Caribbean Securities Exchange (ECSE), the Guyana Stock Exchange (GASCI), the Jamaica Stock Exchange (JSE) and the Trinidad and Tobago Stock Exchange (TTSE). Over the sample period, the following debt restructurings occurred: Antigua & Barbuda (2010), Belize (2006, 2012), Dominica (2004), Grenada (2005, 2013), Jamaica (2010, 2012, 2013) and St. Kitts & Nevis (2010, 2011, 2013). The sovereign debt restructurings in Antigua & Barbuda 2010, Dominica 2004, Grenada 2005 & 2013, and St. Kitts & Nevis 2013 involved the exchange of official debt under the auspices of the Paris Club, as well as commercial debt exchanges of both bonds and bank debt, but the bank debt was not restructured under the auspices of the London Club. On the other hand, the Belize (2006 & 2013) and Jamaica (2010 & 2013) debt exchanges involved only commercial debt in the form of bonds. Table 1A shows that Jamaica has limited its debt exchanges to domestic bonds, Belize to external bonds, whilst the other Commonwealth Caribbean nations undertaking debt restructurings over the sample period have restructured either domestic and external bonds or bank debt. Moreover, the sovereign debt restructurings have primarily been preemptive (i.e., launched prior to a default) in nature except for those in Dominica 2004, and Grenada’s 2005. However, the debt restructurings have all been forced as opposed to voluntary debt exchanges and they have not involved cash payments. Dominica’s debt restructuring took the longest, lasting over 98 months (see table 2A). It is the only one involving creditor litigation. A typical Caribbean debt restructuring usually lasts less than a year and achieves participation rates in excess of 90% (refer to table 2A and 3A). The duration is in line with recent trends (refer to Das, Papaioannou, and Trebesch, 2012). The debt exchanges in Belize (2006), Grenada (2005) and Jamaica (2010 & 2013) did not involve haircuts and were limited to the extension of maturities and reduction in coupon rates. The level of debt relief achieved as a result of the sovereign debt restructurings in the Caribbean has been mixed (see table 3A), with Jamaica’s 2010 and 2013, being the most successful in terms of total debt relief in terms of GDP. Severe creditor losses 9


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have been recorded in Grenada 2005, 2013 and St Kitts and Nevis 2011. The debt relief in Belize and Jamaica has primarily been in the form of liquidity relief in terms of the amount and timing of payments, with the actual stock of debt left largely unchanged. The other cases of sovereign debt restructuring in the Commonwealth Caribbean over the sample period have resulted in some modest reduction in the stock of debt, but the major relief has been in the form of liquidity relief in terms of the amount and timing of payments. Turning to credit rating reviews, Barbados, Bahamas, Jamaica, Belize and Trinidad and Tobago were the only Commonwealth Caribbean countries rated by the international credit rating agencies: Standard & Poors and Moodys. Fifty credit rating reviews occurred over the sample period. See table 5A and 6A for a listing, timing and the status of the credit rating reviews over the study period. In the case of sovereign debt restructurings we are interested in two (event) dates, the announcement date and the completion date, while for the sovereign credit rating reviews the actual publication of the rating action is used as the event date. Therefore, there are 18 events related to sovereign debt restructurings and 50 credit rating review events. The dates of these events, the daily closing prices for the 159 securities listed on the six stock exchanges and the six stock market indices, constitute the basic dataset for the event studies conducted. 3.2 Methodology The Efficient Market Hypothesis (EMH) identifies three categories or levels of market efficiency: weak form, semi-strong form and strong form market efficiency (Fama 1969, Fama et al, 1998). Weak form efficiency emphasizes the efficiency with which the market prices historical information, semi-strong form focuses on the efficiency with which publicly available information is priced, and strong form deals with the efficiency with which all relevant information, including private information, is priced. Studies treat the EMH as an ideal type or benchmark for evaluating the price discovery process in a market. Event studies which examine abnormal returns surrounding a particular event, have been the major research tool used to study semistrong form market efficiency. This study also uses the event study methodology in order to investigate the Caribbean stock market impact of the events involving the announcement of sovereign debt restructurings and credit rating reviews. The event study methodology documented in several studies including: Hillier and Marshall (2002), Gunasekarage and Power (2006, 2002), Dennis and McConnel (1986), Al-Yahyaee, Pham and Walter (2011), Gurgul, Mestel and Schleicher (2003), Harada and Nguyen (2005) and Benartzi, Michaely and Thaler (1997). The event study methodology is now standard and widely utilized. Due to the fact that most studies are done on developed countries, the standard methodology overlooks the problem of low trading volumes on markets termed “thin trading”. Thin-trading describes situations where stocks do not trade for a prolonged period of time, and tends to be a feature of stock markets in developing countries (see Robinson, 2006), and is especially true of those in the Caribbean. Geyt, Cauwenberge & Bauwhede (2013) developed an approach to adjust the standard methodology for thin trading, and this study adopts this approach which improves the robustness of the results.

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The method tracks the impact of an event on stock prices around the occurrence of the event. Each event is presumed to occur on date zero denoted . The first step is to estimates the “expected normal return” using a regression model in the absence of the event. To that effect, we utilize the adjusted market model, initially introduced by Dimson (1979) but recently familiarized in empirical approaches by Geyt et al. (2013) and Buysschaert et al. (2004). In the adjusted market model, stock returns depend on leads, current and lagged market returns instead of only the contemporaneous market return. Consistent with Geyt et al. (2013) and Buysschaert et al. (2004), we add one leading and three lagged market returns to the model: ……………………………………(1) where represents the daily return on stock on day t, is the adjusted return on the stock market index for day , denotes the error term which also represents the component of returns which is abnormal or unexpected. Equation (1) was estimated over a sample of 120 days ranging from day 31 until day 150 preceding the event. With the estimates of the coefficients: and , one can predict each day’s normal return during the event window. The difference between actual return and normal return during the event window, , the prediction error is also referred to as the abnormal or unexpected return for a single security at a given day . This daily abnormal returns, i.e. the predicted error, during the event window are computed as: ………………………..………..(2) It is a direct measure of the (unexpected) change in stockholder wealth associated with the event. The event window is the period of interest, reflecting days around the event date which could have spill-over effects from the event. The objective is to analyze the stock return’s behavior during the event window. Five various event windows were used with the widest window being 30 days before and 30 days after the event date. The smallest window is 10 days on either side of the event date. Investigating over different window ranges give insights into immediate versus long run effects on returns. For each individual event, abnormal return observations and relevant statistical tests from each day within the event window are calculated. For each day, , in the event window ( ), the sampled average abnormal returns ( ) are aggregated over all firms. We then test for the persistence of the effect during the event window through examining whether the average abnormal returns for the days around the event are equal to zero. Therefore average abnormal returns are summed to obtain the cumulative average abnormal returns ( ) for N firms over the event window.

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……………………………………………….(3) The t-statistic for each day is then computed as:

………………………………………………………....(4) where denotes standard deviation. While the test-statistic is estimated per event day, in order to make an inference over the entire event window, the cumulative average abnormal returns over the event window is used. A robust regression approach is employed to test for the significance of the cumulative average abnormal returns over the event window. While a large number of event studies were undertaken, we only present and discuss the statistically significant results. 4. Results and Discussion of Study The period January 1 2000 to August 31 2015 saw fifty credit rating actions in the Commonwealth Caribbean countries of Barbados, The Bahamas, Jamaica and Trinidad and Tobago, and nine sovereign debt restructurings in Antigua and Barbuda, Belize, Dominica, Grenada, Jamaica and St. Kitts and Nevis respectively. Surprisingly, and in sharp contrast to the stock price reaction on developed and emerging stock markets, stock prices on the Barbados, Bahamas, Jamaica and Trinidad & Tobago stock exchanges did not react to any of the rating actions, including several downgrades. In terms of sovereign debt restructurings, stock prices on the Jamaica Stock Exchange reacted positively to the announcement of the Jamaica 2010 debt restructuring, and negatively to the announcement of the St. Kitts and Nevis 2011debt restructuring. However, stocks prices, on any of the six exchanges, failed to react to the announcement of the Antigua & Barbuda (2009), Belize (2006 & 2012), Dominica (2003), Grenada (2004 and 2013) and Jamaica 2013 debt restructurings. We now proceed to a discussion of these results. 4.1. Stock Price Reaction To Credit Rating Actions The credit rating actions over the sample period included eleven upgrades, eleven outlook changes, nine affirmations of ratings and nineteen downgrades. There was no stock price reaction, on any of the six stock exchanges analyzed, to the fifty credit rating actions over the sample period, especially the nineteen credit rating downgrades. This stands in stark contrast to the results documented in the previous academic literature. As stated earlier, there is a large body of empirical evidence which shows that equity investors view credit rating reviews as credible signals for the likelihood of a sovereign debt restructuring, and stock prices react to the announcement of credit rating actions. In particular, stock prices react negatively to sovereign credit downgrades, but not to upgrades or others ratings reviews.

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In the context of a semi-strong form efficient market, the absence of a stock price reaction to a credit rating action would imply that investors either do not view sovereign debt restructurings as having significant implications for corporate profitability and the expected returns on equity investments, do not view credit ratings as credible signals for sovereign debt default and restructurings, ratings announcements are fully anticipated by investors, hence no reaction to the actual announcement of the rating, or investors have other more credible signals for sovereign debt restructurings. Given the well-documented negative economic consequences associated with sovereign debt defaults and debt restructurings, it appears difficult to argue that there are no significant consequences for corporate profitability and equity returns in the Caribbean. Therefore, unless one can provide evidence as to why credit rating actions are not viewed as credible signals for sovereign debt default and restructurings by equity investors in the Caribbean, why these investors are able to fully anticipate ratings announcements, or what other more credible signals for sovereign debt default and restructurings these investors possess, the absence of any stock price reaction to the nineteen downgrades, including a downgrade of non-investment grade status, appears inconsistent with semi-strong form market efficiency. In the absence of such evidence one is left to consider the likelihood that stock markets in the region do not react accurately and quickly to relevant new information, and as such may not be semistrong form efficient, at least as it relates to credit rating actions. 4.2 Stock Price Reaction to Sovereign Debt Restructurings As mentioned earlier, stock prices on the Bahamas, Barbados, Eastern Caribbean, Guyana and Trinidad and Tobago stock exchanges did not react to the announcement of any of the nine sovereign debt restructurings that occurred over the sample period, while prices on the Jamaica Stock Exchange reacted to the Jamaica 2010 and St. Kitts and Nevis 2012 debt restructurings (see tables 1 and 2). Table 1. Stock Market Reaction To Jamaica’s 2010 Debt Restructuring 1/14/2010 Event window Mean CAR Robust Std. Err. t-value p-value 95% Conf. Interval [-30,30] 0.078 0.033 2.390 0.020 0.013 0.143 [-25,25] 0.088 0.037 2.390 0.021 0.014 0.161 [-20,20] 0.065 0.042 1.530 0.134 -0.021 0.150 [-15,15] 0.064 0.048 1.340 0.189 -0.033 0.162 [-10,10] -0.004 0.051 -0.070 0.945 -0.109 0.102 Table 2. Stock Market Reaction To St Kitts & Nevis Debt Restructuring 3/18/2012 Event window Mean CAR Robust Std. Err. t-value p-value 95% Conf. Interval [-30,30] -0.077 0.034 -2.250 0.028 -0.145 -0.009 [-25,25] -0.082 0.040 -2.040 0.047 -0.162 -0.001 [-20,20] -0.075 0.045 -1.660 0.104 -0.166 0.016 [-15,15] -0.137 0.051 -2.710 0.011 -0.241 -0.034 [-10,10] -0.135 0.053 -2.530 0.020 -0.246 -0.024

The absence of a stock price reaction to the announcement of the Antigua & Barbuda (2010), Belize (2006 & 2012), Dominica (2003), Grenada (2004 and 2013), Jamaica (2010 & 2013) and St. Kitts and Nevis (2012) debt restructurings may be 13


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consistent with semi-strong form market efficiency for the Barbados, Bahamas and Guyana stock exchanges. These three countries did not experience any sovereign debt restructurings over the sample period, and the companies listed on these stock exchanges had little or no exposure to the government debt of other Commonwealth Caribbean countries. In the case of the Eastern Caribbean Securities Exchange, while the absence of a stock price reaction to the announcement of the Belize (2006 & 2012), and the Jamaica (2010 & 2013) debt restructurings may be consistent with semi-strong form market efficiency, for the above mentioned reasons, no stock price reaction to the announcement of the Antigua & Barbuda (2009), Dominica (2003), Grenada (2004 and 2013) and St. Kitts and Nevis (2012) debt restructurings begs further explanation. The Eastern Caribbean Stock Exchange is the home exchange of Antigua and Barbuda, Dominica, Grenada and St. Kitts and Nevis, countries that actually experienced sovereign debt restructurings over the sample period. These debt restructurings all involved haircuts for investors and given that a number of companies listed on the Eastern Caribbean Stock Exchange had direct exposure to the government debt of these countries, the profitability of these companies and equity returns would have been affected. The finding of Cruces and Trebesch (2011) also suggests that debt restructurings involving haircuts tend to generate negative consequences for a government’s future capital market access, which then impacts negatively on equity risk premia. Therefore, unless one can provide evidence as to why sovereign debt restructurings are fully anticipated by equity investors in the Eastern Caribbean, the failure of stock prices to react to the announcement of the Antigua & Barbuda (2009), Dominica (2003), Grenada (2004 and 2013) and St. Kitts and Nevis (2012) debt restructurings appears inconsistent with semi-strong form market efficiency. One is left to consider that the market is not semi-strong form efficient, at least with respect to the announcement of sovereign debt restructurings. While Trinidad and Tobago did not experience any sovereign debt restructurings over the sample period, a number of financial institutions listed on the Trinidad and Tobago Stock Exchange had direct exposure to the government debt of the Commonwealth Caribbean countries that did experience debt restructurings. Therefore, the debt restructurings would likely have had implications for corporate profitability and equity returns on the Trinidad and Tobago, and one would expect a stock price reaction. Again, unless one can provide evidence as to why sovereign debt restructurings are fully anticipated by equity investors in Trinidad and Tobago, the absence of a stock price reaction to any of the debt restructurings appears inconsistent with semi-strong form market efficiency. Therefore, the available evidence suggests that the Eastern Caribbean and Trinidad and Tobago stock exchanges may not be semi -strong form efficient, at least as it relates to the announcement of sovereign debt restructurings. As for Jamaica the results are more mixed. Stock prices on the Jamaica Stock Exchange reacted positively to the Jamaica 2010 debt restructuring, negatively to the St. Kitts and Nevis 2012 debt restructuring, and did not react to the Antigua & Barbuda (2009), Belize (2006 & 2012), Dominica (2003), Grenada (2004 and 2013) and Jamaica ( 2013). The Jamaica 2010 debt restructuring was a major development in the economic history of Jamaica and attracted a great deal of attention. The exercise 14


did not involve a haircut for investors, was seen as very successful, especially in terms of the investor participation rate (see table 8) and was widely viewed as creating a platform for improved macroeconomic stability in Jamaica. The announcement of the debt restructuring was welcomed by equity investors and the cumulative 7.8% in stock prices added US$ 390 million to the value of stocks listed on the exchange. The positive stock price reaction to the announcement of the Jamaica 2010 debt restructuring on the Jamaica Stock Exchange, is consistent with the finding of Cruces and Trebesch (2011) that the size of haircut is the main determinant of the financial market impact of a debt restructuring. In terms of semi-strong form market efficiency, while there appeared to be an “accurate” stock price reaction, the stock price reaction was delayed, with the reaction only becoming significant over the 25 and 30 day windows. The delayed and protracted stock price response is inconsistent with semistrong form market efficiency. Surprisingly, there was no stock price reaction on the Jamaica Stock Exchange to the Jamaica 2013 debt restructuring exercise but a swift negative reaction to the St. Kitts and Nevis 2012 exercise. The terms and conditions of the Jamaica 2013 debt restructuring were largely similar to those of the Jamaica 2010 debt restructuring, and both enjoyed similar participation rates (see tables 1 to 4), but yet the two events generated very different stock market reactions. It can be argued that having gone through the experience of the Jamaica 2010 debt restructuring the 2013 exercise did not generate the same level of interest among investors. It may also be argued, that the Jamaica 2010 debt restructuring did not provide many of the expected benefits, which may have led to a level of investor indifference to the Jamaica 2013 debt restructuring. For example, table 3A shows that Jamaica’s Debt to GDP ratio was actually higher one year after the 2010 debt restructuring exercise, and table 5A shows that the country’s credit rating was also largely unchanged one year after the exercise. Therefore, investors may have been neutral to another debt restructuring, and the absence of a stock price reaction may be consistent with semi-strong form market efficiency. However, the above argument must be balanced against the fact that prices on the JSE had a swift negative reaction to the announcement St. Kitts and Nevis’s 2012 debt restructuring exercise. The St. Kitts and Nevis exercise involved a sizeable haircut (see table 4A) which would have had a direct negative impact on investors exposed to St. Kitts and Nevis’s government debt. While the exposure to this relatively small debt exchange of US $140ml was limited, equity investors in Jamaica reacted negatively to the announcement of the debt restructuring and the cumulative 7.7% decline in stock prices, took US$ 238ml off the value of stocks listed on the exchange. While, the nature of the stock market reaction was consistent with the finding of Cruces and Trebesch (2011) that the size of haircut is the main determinant of the financial market impact of a debt restructuring, the scale of the stock price reaction was surprising giving the limited exposure. In terms of semi-strong form market efficiency, the stock price reaction not only appeared “accurate”, but was relatively swift as well, being statistically significant within the ten day event window. As such, the stock market reaction on the JSE to the St. Kitts and Nevis’s 2012 debt restructuring is consistent with semi-strong form market efficiency. As mentioned earlier, stock prices on the Jamaica Stock Exchange did not react to the announcement of the Antigua & Barbuda (2009), Belize (2006 & 2012), Dominica 15


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(2003) and Grenada (2004 and 2013) debt restructurings. It can be argued that the absence of a stock price reaction was consistent with semi-strong form market efficiency in that investors on the JSE had little or no exposure to the Belizean, Antiguan or Dominican government debt that was restructured, hence no significant effect on corporate profits or rates of return for equity investments and no need for a stock price reaction. However, the exposure to these debt restructurings would have been no less so than the St. Kitts and Nevis’s 2012 case, which generated a swift reaction on the JSE. Therefore, the results appear inconclusive as to the semi-strong form efficiency of the JSE, at least with respect to sovereign debt restructurings. 5. Conclusion Sovereign debt restructurings and credit ratings reviews rose to prominence post the 2007-2009 financial crisis. Despite the global media attention and supposed economic significance, their announcements have little or no impact on stock market behavior in the Commonwealth Caribbean. Stock prices on the Barbados, Bahamas, Eastern Caribbean, Guyana and Trinidad and Tobago stock exchanges did not react to any of the sovereign debt restructurings or credit rating changes over the sample period. Guyana was not directly impacted by any credit rating changes and sovereign debt restructurings, therefore the absence of any stock price reaction on the Guyana Stock Exchange may be consistent with semi-strong form market efficiency. However, given the exposure of investors on the Barbados, Bahamas, Eastern Caribbean and Trinidad and Tobago stock exchanges, the fact that stock prices did not react to any of the credit rating downgrades and/or sovereign debt restructurings suggests that the respective stock exchanges may not be semi-strong form efficient. In the case of Jamaica, while stock prices on the Jamaica Stock Exchange reacted to two of the nine sovereign debt restructurings over the sample period, they did not respond to any of the credit rating reviews, including a number of downgrades. The fact that stock prices did not react to the announcement of a number of credit rating downgrades on Jamaican government debt, and the fact that the stock price reaction was delayed in one of the two cases where there was a stock price reactions suggests that the Jamaica Stock Exchange may not be semi-strong form efficient. The failure of stock prices to react to the vast majority of economically significant events, the delayed nature of the reaction in one of the two cases where there was a stock price reaction, and the absence of any stock price response to credit rating downgrades, even a downgrade to non-investment grade, seems to suggest weaknesses in the price discovery processes on stock markets in the Commonwealth Caribbean. The indicates that these stock markets may not semi-strong form efficient and as such stock prices may deviate from values based on a careful analysis of all available, relevant information. The findings informs portfolio managers need not worry whenever a Caribbean country experience a downgrade given the stock prices insensitivity. Intuitively, investors’ portfolios are safe in the Caribbean as far as negative events are concerned. However, policymakers, investors and other decision makers may well be advised to question the usefulness of such security prices in guiding their decision making. Further research should seek to isolate the causes of the apparent inefficiency of stock markets in the Commonwealth Caribbean.

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References Arteta, C., & Hale, G. (2008). Sovereign debt crises and credit to the private sector. Journal of international Economics, 74(1), 53-69. Barber, B. M., & Lyon, J. D. (1996). Detecting abnormal operating performance: The empirical power and specification of test statistics. Journal of financial Economics, 41(3), 359-399. Barber, B, and J Lyon, 1997, "Detecting loong-run abnormal stock returns: The Empirical power and specification of test statistics," Journal of Finance Economics 43: 341 -37 Barrett, B.W., Henson, A.J., Kolb, R.W. and Schropp, G.H, 1987, “The Adjustment of Stock Prices to Completely Unanticipated Events,” Financial Review, 22, (4), 345-354 Boehmer, E, J Musumeci, and A Poulsen,1991, "Event Study Methodology Under conditions of Event-induced Variance." Journal of Financial Economics Vol 30: 253 - 272. Brooks, R., Faff, R. W., Hillier, D., & Hillier, J. (2004). The national market impact of sovereign rating changes. Journal of banking & finance, 28(1), 233-250. Borensztein, Eduardo and Ugo Panizza, 2009, “The Costs of Sovereign Default,” IMF Staff Papers, vol. 56(4), 683-741. Cantor, R., & Packer, F. (1996). Determinants and impact of sovereign credit ratings. Economic policy review, 2(2). Cowan, A. R., & Sergeant, A. M. (1996). Trading frequency and event study test specification. Journal of Banking & Finance, 20(10), 1731-1757. Cruces, J. J., & Trebesch, C. (2013). Sovereign defaults: The price of haircuts. American economic Journal: macroeconomics, 5(3), 85-117. Das, M. U. S., Papaioannou, M. M. G., & Trebesch, C. (2010). Sovereign default risk and private sector access to capital in emerging markets (No. 10). International Monetary Fund. Das, U. S., Papaioannou, M. G., & Trebesch, C. (2012). Sovereign debt restructurings 1950-2010: literature survey, data, and stylized facts. International Monetary Fund. IMF Working Papers, Working Paper 12/203. Dimson, E. (1979). Risk measurement when shares are subject to infrequent trading. Journal of Financial Economics, 7(2), 197-226. Eaton, J., & Gersovitz, M. (1981). Debt with potential repudiation: Theoretical and empirical analysis. The Review of Economic Studies, 48(2), 289-309. Fama, E. F., Fisher, L., Jensen, M. C., & Roll, R. (1969). The adjustment of stock prices to new information. International economic review, 10(1), 1-21. Fama, E. F. (1998). Market efficiency, long-term returns, and behavioral finance. Journal of financial economics, 49(3), 283-306. Fuentes, M., & Saravia, D. (2010). Sovereign defaulters: Do international capital markets punish them?. Journal of Development Economics, 91(2), 336-347.

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Gelos, R. G., Sahay, R., & Sandleris, G. (2011). Sovereign borrowing by developing countries: What determines market access?. Journal of international Economics, 83(2), 243-254. Hooper, V., Hume, T., & Kim, S. J. (2008). Sovereign rating changes—Do they provide new information for stock markets?. Economic Systems, 32(2), 142-166. Kaminsky, G., & Schmukler, S. L. (2002). Emerging market instability: do sovereign ratings affect country risk and stock returns?. The World Bank Economic Review, 16(2), 171-195.. Klimaviciene, A., & Pilinkus, D. (2011). the impact of sovereign credit rating changes on the stock markets in central and eastern europe. Transformation in Business & Economics, 10(3). Martinez, J. V., & Sandleris, G. (2011). Is it punishment? Sovereign defaults and the decline in trade. Journal of International Money and Finance, 30(6), 909-930. Norden, L.; Weber, M. (2009). The co-movement of credit default swap, bond and stock markets: An empirical analysis. European Financial Management, 15(3), 529-562. Klimavičienė, A. (2011). Sovereign Credit Rating Announcements And Baltic Stock Markets. Organizations & Markets in Emerging Economies, 2(1), 51-62 Richmond, C., & Dias, D. A. (2009). Duration of capital market exclusion: An empirical investigation. Available at SSRN 1027844. Robinson, J. (2005). Stock price behaviour in emerging markets: Tests for weak form market efficiency on the Jamaica Stock Exchange. Social and Economic Studies, 51-69. Robinson, J. "Stock Price Rose, A. K. (2005). One reason countries pay their debts: renegotiation and international trade. Journal of development economics, 77(1), 189-206. Succurro, M., & Mannarino, L. (2014). The impact of financial structure on firms’probability of bankruptcy: a comparison across western europe convergence regions. Regional and Sectoral Economic Studies, 14(1), 81-94.

Annex on line at the journal Website: http://www.usc.es/economet/eaat.htm

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APPENDIX

Table 1A. Highlights of Sovereign Debt Restructuring Terms In The Commonwealth Caribbean

Belize 2006 Belize 2012 Grenada 2005

Jamaica 2010 Jamaica 2013 St. Kitts & Nevis 2010

PreEmptive Or Post Default Pre

Outstanding Debt Instruments Exchanged

New Instruments

Debt Exchanged

Nominal Cut In Face Value

NPV Losses

7 bonds, 8 loans 1 Bond

1Super Bond

US$3.19bl

0.0%

21%

1 Bond

US$ 550ml

2%

33%

Pre

7 Ext. bonds 9 Dom.bonds 2 Ext. loans 6 Dom loans

1 US$ Bond 1 EC$ Bond

US$210ml

0.0%

Pre

350 US & Jam $ bonds 28 US & Jam $ bonds 11Ext. bonds 2Dom.bonds 4 loans

25 US & Jam $ bonds 26 US & Jam $ bonds 1 US$ Bond 1 EC$ Bond

US$7.8bl

0.0%

US$8.90bl

0.0%

US$ 140ml

31.8%

Pre

Pre Pre

Source: IMF Sovereign Debt Restructuring Database Key: Ext. bonds – external bond Dom. bonds – domestic bonds EC$ - Eastern Caribbean dollar. Note US$1 is equivalent to EC$2.70.

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1520%


Vol. 17-1 (2017)

Table 2A. Highlights of Sovereign Debt Restructuring Process In The Commonwealth Caribbean Announcement Date

Completion Date

Duration (Months)

Creditor Structure

Creditor Committee

June -2010

-

Ongoing

Concentrated

No

Collective Action Clauses No

Aug -06

Feb - 07

6

Concentrated

Yes

Yes

Aug-12

Mar-13

7

Concentrated

Yes

Yes

July -03

July-2012

98

Concentrated

No

No

Oct- 04

Nov - 05

13

Concentrated

No

No

Concentrated

No

No

Antigua & Barbuda Belize 2006 Belize 2012 Dominica 2004 Grenada 2005 Grenada 2013 Jamaica 2010 Jamaica 2013 St. Kitts & Nevis 2011

April-2015 Jan-2010

Feb-2010

1

Dispersed

No

Yes

Feb -13

Feb-13

1

Dispersed

No

Yes

June -11

Apr-12

10

Concentrated

No

No

Source: IMF Sovereign Debt Restructuring Database

Table 3A. Sovereign Debt Restructuring Outcomes in the Commonwealth Caribbean

Belize 2006 Belize 2012 Dominica 2004 Grenada 2005 Grenada 2013 Jamaica 2010 Jamaica 2013 St. Kitts & Nevis 2011

Creditor Losses

Participation Rate

Litigation Cases

Pre-Restr Debt to GDP

None

Quarters To International Bond Issuance Not yet

92%

PostRestr Debt to GDP 90%

(2124%) (2933%) (2030%) (40 – 45) (5075%) 20% 24% (4060%)

98% 100%

None

Not yet

92.5%

87.6%

72%

1 case

Not yet

95.3%

70.7%

91%

None

Not yet

130%

120%

92%

None

Not yet

75.1%

81.6%

99% 99% 94%

None None None

4 3 Not yet

124% 147% 154%

140% 143% 117%

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Table 4A. Debt Relief Achieved From Sovereign Debt Restructurings In The Commonwealth Caribbean Nominal Hair Cut Belize 2006 Belize 2012

Grenada 2005 Jamaica 2010 Jamaica 2012 St. Kitts & Nevis 2011

0.0% 10% (3% after capitalized interest) 0.0% 0.0% 0.0% 31.8%

Maturity Extension 16 years 9 years

Interest Rate Reduction 2.1% 2.%%

3.6 years 3-10 yeras

2.0% to 6.5% 0.75% to 5.0%

NPV Losses 24% 29%

Source: IMF Sovereign Debt Restructuring Database

Table 5A. Sovereign Ratings around the time of Sovereign Debt Restructurings in the Commonwealth Caribbean Restructuring Date Belize 2006

Aug -06

Belize 2012

Aug-12

Grenada 2005 Jamaica 2010 Jamaica 2012

Oct- 04

Rating One Year Before Restructuring. Caa1 CCC-

Rating Just Before Restructuring Caa3 CCC-

Rating One Year After Restructuring

CCCB3 NR

BCa NR

BCaa2 NR

CCC+ Ba2 BB3

CCC Caa2 CCCCaa3

Caa2 BCaa2

Jan-2010 Feb -13

Caa1 B3

Source: Moodys and Standard & Poors Sovereign Ratings Actions Databases

Table 6A: Credit Rating Reviews By International Ratings Agencies in the Caribbean EVENT DATES Barbados credit rating upgraded Barbados credit rating affirmed Barbados credit rating affirmed Barbados credit rating upgraded Barbados credit rating downgraded Barbados credit rating upgraded

Feb 8 2000 July 12 2001 Sept 10 2003 May 24 2006 Oct 13 2009 May 24

21

Belize credit rating upgraded Belize credit rating upgraded Belize credit rating downgraded Belize credit rating affirmed Jamaica credit rating downgraded Jamaica credit rating upgraded

Feb 13 2007 Feb 10, 2009 Feb 16, 2012 Jun 17, 2015 May 27 2003 May 24

Applied Econometrics and International Development Barbados credit rating downgraded to junk Barbados credit rating downgraded to junk Barbados credit rating downgraded Barbados credit rating downgraded Barbados credit rating downgraded Bahamas outlook changed from positive to stable Bahamas outlook changed from stable to positive Bahamas outlook changed from positive to stable Bahamas credit rating downgraded Threat to Downgrade Bahamas credit rating to junk Bahamas credit rating downgraded Jamaica credit rating placed on review Belize credit rating affirmed Belize outlook changed to negative Belize credit rating downgraded Belize credit rating on review for possible downgrade Belize credit rating downgraded Belize credit rating downgraded Belize credit rating downgraded

2006 July 17 2012 December 20 2012 December 20 2013 November 22 2013 June 2 2014 September 6 2001 September 30 2002 June 26 2003 December 14 2012 January 22 2014 September 2 2014 April 17 2003 June 13 2002 August 6, 2002 May 28, 2003 June 18 2004 August 5, 2004 June 7, 2005 June 26, 2005

Vol. 17-1 (2017) Jamaica credit rating placed on review Jamaica credit rating downgraded Jamaica credit rating downgraded Jamaica credit rating upgraded Jamaica credit rating placed on review Jamaica credit rating downgraded Jamaica credit rating downgraded Jamaica credit outlook changed from stable to positive Jamaica credit rating upgraded Trinidad & Tobago credit rating on review for upgrade Trinidad & Tobago credit rating upgraded Trinidad & Tobago credit rating affirmed Trinidad & Tobago credit rating affirmed Trinidad & Tobago credit rating affirmed Trinidad & Tobago credit rating affirmed Trinidad & Tobago credit rating upgraded Trinidad & Tobago credit rating upgraded Trinidad & Tobago credit rating affirmed Trinidad & Tobago credit rating downgraded

Journal published by the EAAEDS: http://www.usc.es/economet/eaat.htm

22

2006 Nov 4 2008 Mar 4 2009 Nov 18 2009 Mar 2 2010 Feb 14 2013 Mar 6 2013 Mar 6 2013 Feb 16 2014 May 28 2015 Jan 11 2000 Apr 6 2000 Aug 28 2001 Apr 16 2002 Sep 9 2003 Nov 10 2004 Aug 9 2005 Jul 13 2006 Jan 16 2013 Apr 30 2105