The paper investigates the long- and short-run relationship between sovereign credit ratings and macroeconomic variables in Malaysia by employing quarterly data from 1991 to 2004. A robust and recent time series technique known as the Unrestricted Error Correction Model—Bound Test was used which is applicable irrespective of whether the regressors are I(0) or I(1). The results show that in the long run, debt to GDP, debt service to reserve and US Treasury Bill rate (3 months) appear to have a significant impact on Malaysia's sovereign credit ratings. The findings of the study show that Malaysia's long-term ability to pay its debt contains information for the prediction of the credit ratings.

Forces of the globalization and liberalization in world market have almost become a cliché nowadays. Besides that, our economy has now become smaller with no gap or border. Malaysia as an open and free country does not deny the importance of capital inflow to generate development of the economy, and therefore, the basic principle of scarcity of resources has been proven. However, there is an alternative or option to resolve the scarcity problem. One of the alternatives is to acquire funds from abroad to support the productive activities. Acquiring capital or borrowing from the international market may help a country overcome the problem of scarce resources. In this aspect, sovereign credit rating, rated by rating agencies, is very important for bond issuer in order to acquire maximum funds from international market. There are several factors that are taken into account by a rating agency while determining these ratings.

Malaysia has experienced and been ra ted for several levels based on the performance of its economy as well as political stability. During the period 1994-97, Malaysia has been rated highly on its sovereign bonds supported by bullish economy during the period (Figure 1). However, due to 1997 financial crisis contagion effect from Thailand and Indonesia, a downturn in the Malaysian economy had affected the sovereign ratings as Malaysia was rated BBB- in Q3 1998 which was the worst and lowest rate in the country's history. Recovery policies implemented by the government later were successful and resulted in the upgrading of the ratings to A-. Malaysia's strong and improving economic fundamentals had led to several sovereign-rating upgrades in 2004. During the year, Malaysia's sovereign ratings were further upgraded by several credit rating agencies. In January 2004, Rating and Investment Information Inc. upgraded Malaysia's long-term foreign currency rating to A- from BBB+. Later, in May 2004, Standard & Poor's reaffirmed Malaysia's long-term foreign currency sovereign credit rating at A-. Fitch International assigned a positive outlook to Malaysia's rating by allowing A- instead of BBB+ on November 8, 2004 based on its stable outlook. After assigning the outlook for Malaysia's sovereign ratings to positive from a stable outlook in February 2004, Moody's Investor Service upgraded the rating further to A3, from Baa 1 in December 2004 (Central Bank of Malaysia Annual Report, 2004).

Sovereign Credit Ratings, Macroeconomic Variables, Bound Test Approach, Error Correction Model, Cointegration analysis, Autoregressive Distributed Lag, ARDL, Schwarz Bayesian Criteria, SBC, Akaike Information Criteria, AIC, National Bureau of Economics Research.