The International Budget Partnership’s Open Budget Initiative has just published a series of working papers that explore the causes and consequences of budget transparency. Such research is important because it can show what the best ways are to promote greater budget transparency. It can also motivate governments to become more transparent by pointing out the rewards of budget transparency.

One of these papers provides convincing evidence that high levels of budget transparency can contribute to favorable credit ratings. But the links between budget transparency and credit ratings are sometimes not as straight forward as one might expect.

Financial markets have played an increasingly important role in the ability of both developed and developing countries to finance their budget deficits. Emerging markets in particular have succeeded in accessing credit to support their spending on infrastructure and to restructure existing debt on more favorable terms.

But before financing a country’s debt, lenders will assess the creditworthiness of the particular country so that it can set interest rates that will make the transaction profitable to them. In a recent research paper prepared for the Open Budget Initiative, Farhan Hameed finds that countries with higher levels of budget transparency are rewarded with better credit ratings. And the better the credit worthiness, the more favorable the terms of the debt.

Transparency shields against shocks

Hameed also finds limited evidence that more transparent countries are less likely to have their credit ratings downgraded because of sudden changes in market sentiment. Markets assess the merits of more transparent countries on the basis of known economic data rather than mere ‘market sentiment’.

Transparency can therefore help steady the boat of government finances in turbulent economic times, especially in smaller, outwardly oriented economies like South Africa that are more exposed to global market forces.

Medium transparency countries can benefit the most

But not all countries can access the rewards of budget transparency. Medium transparent countries like Tanzania, the Philippines and Mongolia stand to gain the most. Untransparent countries may not reap these benefits . If transparency brings to light adverse information, such countries may initially be punished by having their credit worthiness downgraded. Over the medium to long-term this effect should however diminish and these countries should also start reaping the rewards available to more transparent countries.

Highly transparent countries may also not reap the market benefits transparency improvements because they may have published enough budget information already for markets not to be impressed by further information.

Don’t jump to easy policy conclusions

Before we get too excited about the implications of this research, Hameed cautions against drawing easy policy conclusions . At this time, he writes, we cannot be completely sure about the nature of the link between transparency and financial markets. While it is likely that credit ratings are dependent on budget transparency, it is also possible that a more capable government may adopt transparent practices in order to benefit from better ratings. This would mean that improved credit ratings are caused by lenders’ perception of the capability of the government, rather than just of its budget transparency practices. In other cases, more transparent practices may be driven by other considerations such as political competition.  Future research should therefore investigate other determinants of transparency to better understand what brings about budget transparency and improved credit ratings.

More budget transparency research

Other themes dealt with in the OBI series of working papers does just this and provides greater insight into the other determinants of transparency such as natural resource dependency and administrative legacy. The OBI has also commissioned a series of case studies that go deeper into the drivers  and consequences of budget transparency in specific countries. The results of this research will be published in an edited volume by mid-2012. Watch this blog for further news!

PS Farhan Hameed was previously a researcher at the IMF and taught economics at Lahore University for Management Sciences. He is currently working with the Government of Canada.