Stigma or cushion? IMF programs and sovereign creditworthiness

Abstract

Policymakers in crisis countries often hesitate to enter IMF programs out of the fear that they trigger adverse reactions on financial markets. We explain why credit ratings and investor assessments are reliable measures of creditworthiness during crises, and examine how IMF programs affect them with three distinct identification strategies. The first strategy exploits the differential effect of changes in IMF liquidity on loan allocation as an instrument, the second uses the exact timing of program agreements, and the third provides text-based evidence from rating agency statements. When accounting for endogenous selection, we find that IMF programs help countries regain their creditworthiness. Even though IMF programs tend to result in economic contractions, the agreement on a program is perceived as a positive signal on financial markets. Our text-based analysis supports this signaling effect and suggests that the content of programs matters for how they are perceived.