What determines a country’s creditworthiness?

This article is a part of Poland Unpacked. Weekly intelligence for decision-makers

Why can some countries carry enormous public debt burdens without losing their high credit ratings, while others have far less room for maneuver? New research by Olivier Blanchard and his co-authors shows that debt levels alone do not tell the whole story. The findings are particularly relevant for Poland, where public debt is rising rapidly.

What determines a country’s sovereign credit rating? Is there a level of public debt that can be considered safe regardless of the country? Or can the same debt-to-GDP ratio imply vastly different risks for different economies?

And what matters more to credit rating agencies: the past, in the form of accumulated debt, or the future – projected budget balances, economic growth and borrowing costs? Olivier Blanchard and his co-authors recently examined some of these questions. Blanchard, a French economist and professor at MIT, is a former chief economist of the International Monetary Fund (IMF) and one of the most influential macroeconomists of our time.

A sovereign credit rating assesses a country’s ability and willingness to meet its financial obligations to creditors. These assessments are conducted by specialized firms known as credit rating agencies, the best-known of which are S&P Global Ratings, Fitch Ratings and Moody’s. The latter recently downgraded Poland’s long-term foreign-currency credit rating by one notch, from A2 to A3.

Blanchard and his co-authors developed a simple theoretical model using key fiscal and macroeconomic variables to identify the factors that should determine sovereign credit ratings. They then compared the model’s predictions with actual ratings assigned by S&P, Moody’s and Fitch. What did they find?

Rating agencies put more weight on debt levels than deficit forecasts

A country’s sovereign credit rating is strongly influenced by its public debt. The higher the debt burden, the lower its rating is likely to be, all else being equal. By contrast, projected primary fiscal balances – the difference between government revenue and expenditure, excluding debt-servicing costs – carry considerably less weight. In other words, the expected trajectory of public finances over the coming years matters relatively little.

This marks an important departure from the authors’ theoretical model. According to their framework, the prospect of future fiscal surpluses or deficits should play a much greater role in assessing a country’s ability to service its debt. In practice, rating agencies appear to place more emphasis on debt already accumulated than on the future course of fiscal policy.

Credit ratings give less weight to GDP growth

One of the key determinants of public debt dynamics is r − g: the difference between the interest rate paid on government debt (r) and the economy’s growth rate (g). When r is lower than g, the economy grows faster than the cost of servicing its debt, making it easier to stabilize or reduce the debt-to-GDP ratio.

Conversely, when r exceeds g, the relationship between interest costs and economic growth pushes the debt-to-GDP ratio higher. In such circumstances, stabilizing public debt requires a stronger fiscal position, meaning a higher primary balance. Credit rating agencies do take this mechanism into account in the expected direction, but its impact on sovereign ratings turns out to be considerably smaller than the theoretical model would suggest.

The country itself matters enormously

The third finding is perhaps the most intriguing: sovereign credit ratings cannot be explained by debt levels and projected public finances alone. Even two countries with identical debt burdens and primary balance forecasts can receive vastly different ratings. The authors describe this as strong “country effects.” In practice, it also means that there is no universal level of public debt that can be considered safe for every country. The debt burden consistent with a given credit rating can be extremely high in one economy and much lower in another.

The chart illustrates just how much debt “tolerance” varies across countries, even when the objective is to maintain exactly the same credit rating. The authors calculate the debt level at which each country has a 50% probability of maintaining an S&P rating of 9 on their 11-point scale, assuming a projected primary fiscal balance of zero.

The differences are striking. According to the empirical model, Germany could sustain debt equivalent to 248% of GDP while meeting this rating criterion. The corresponding figure is 161% for the United States, 135% for France and 76% for Spain. The authors also highlight the extreme case of Singapore, where the estimate reaches 272% of GDP. The model assigns particularly low debt “tolerance” to some Central and Eastern European economies: just 17% of GDP for the Czech Republic and 12% for Slovakia, with estimates even turning negative for the Baltic states. Unfortunately, Poland is absent from the comparison. Under the IMF’s classification, it still belongs to the group of emerging and developing economies, whereas these estimates cover advanced economies.

These figures should not, however, be interpreted as safe debt thresholds or recommended borrowing limits. They are estimates derived from a statistical model of sovereign credit ratings, indicating the debt levels consistent with the same rating under identical assumptions about future primary fiscal balances. The key takeaway, therefore, is not the precise height of each bar in the chart, but the enormous variation between countries.

What the model leaves out

The authors identify several possible explanations for these differences between countries, including who holds their government debt, the political environment, the role of the central bank and varying degrees of uncertainty surrounding economic forecasts. Debt levels and fiscal prospects are not the only factors shaping sovereign credit ratings. Economic research also points to the importance of GDP per capita, inflation, external debt, foreign exchange reserves and a country’s history of sovereign default. More recent studies also emphasize institutional quality.

In other words, the large country effects identified by Blanchard and his co-authors may actually reflect important variables omitted from their model. This highlights the complexity of the factors determining sovereign creditworthiness. The authors themselves caution, however, that the differences between countries are so substantial that these additional variables alone may not be enough to explain them fully.

What does this mean for Poland?

The findings of Blanchard and his co-authors are particularly relevant for Poland. On the one hand, public debt is expected to rise rapidly in the coming years. This matters because the study suggests that rating agencies place greater weight on existing debt levels than the theoretical model would imply. Even a commitment to future fiscal consolidation may therefore not fully offset the negative impact of an earlier increase in debt.

On the other hand, the debt-to-GDP ratio alone does not tell the whole story of Poland’s creditworthiness. The structure of its debt and the economy’s external position also matter. The public sector’s relatively limited exposure to foreign-currency debt reduces the risk that a depreciation of the zloty would sharply increase the debt burden. The current account balance is another important consideration: a large, persistent deficit can increase a country’s dependence on foreign financing, particularly when funded through short-term borrowing or volatile capital flows.

Poland’s external position therefore provides some protection against the risks associated with deteriorating public finances, as does its relatively strong economic growth. But neither factor can indefinitely offset rising debt and persistently high fiscal deficits. Indeed, Blanchard’s research suggests that rating agencies may attach greater importance to accumulated debt than the arithmetic of debt sustainability alone would justify.

Although the authors do not provide a comparable estimate for Poland, their findings suggest that its debt “tolerance” may still be lower than that of many Western European countries. The substantial differences between countries, along with relatively low estimates for several Central and Eastern European economies, point in that direction. This means that comparisons between Poland’s public debt and that of France, Italy or Germany should be treated with caution. A similar debt burden would not necessarily be viewed as equally sustainable by credit rating agencies.

Rating agencies place far greater weight on accumulated public debt than on projected primary fiscal balances, according to Blanchard’s research. The theoretical model suggests that future surpluses and deficits should play a major role in determining sovereign creditworthiness, as they directly affect a country’s ability to stabilize its debt. In actual credit ratings, however, the influence of existing debt levels is considerably stronger. Rating agencies therefore appear to focus more on a country’s fiscal legacy than on its projected fiscal trajectory.
The study reveals substantial “country effects” in sovereign credit ratings. The debt-to-GDP ratio consistent with maintaining the same rating can differ by more than 200 percentage points between countries. These differences may reflect factors such as the composition of government debt holders, the political environment, the role of the central bank and uncertainty surrounding economic forecasts. There is therefore no single debt threshold that can be considered universally safe.
Rising public debt could have a greater impact on Poland’s credit rating than deficit projections alone might suggest. At the same time, Poland benefits from relatively strong economic growth, a favorable debt structure and its external economic position. The findings also call for caution when comparing Poland’s debt burden with those of major Western European economies: similar debt levels are not necessarily viewed as equally sustainable by credit rating agencies.