Credit Rating Agencies (CRAs) play a central role in the financial world. They provide an investor credit risk benchmark for debt issuers and structured finance instruments that are traded on debt capital markets (DCM). In short, they have a disproportionate influence on the interest rates that countries or companies pay to lenders.
Last year, around 20 African rulers owed more than $ 100 billion in Eurobonds at one point, supplanting multilateral lenders as Africa’s main source of finance.
So the difference of a few percentage points in what you pay your lenders starts to get pretty big. A 2015 study by the University of Michigan estimated that African rulers of sub-Saharan Africa (SSA) paid a 2.9% premium over the rest of the world. Thus, downgrades (which increase the premium) are extremely costly for the continent.
Following the economic shock caused by the Covid-19 pandemic, low-income countries did not have the monetary and fiscal instruments available to developed countries to support their economies. In response, a G20 initiative was put on the table to delay debt service payments for low-income countries.
Credit rating agencies in their outlook statements consistently said this would amount to default, forcing countries to make the difficult choice between using resources to meet immediate health and economic needs or ensuring the debt service for fear of being alienated from international capital markets. .
Abebe Selassie, Africa Director at the IMF, calls for more flexibility on the part of credit rating agencies, as the debt moratoria proposed by Paris Club and G20 creditors do not require comparability of treatment of private creditors. This is a novelty, specifically put in place to protect sovereign ratings.
Many countries also feel penalized by an implicit bias on the part of those conducting the analysis. For example, in an interview with Bloomberg Markets, Ghana’s Finance Minister Ken Ofori-Atta said his country was paying a higher premium than Belarus, an autocracy now mired in political instability, and more than Argentina, a country that seems to be in a never-ending cycle of defaults.
A biased perception of the risk of SSA
The three largest credit rating agencies are all from the United States: Moody’s Investors Services (Moody’s), S&P Global Ratings (S&P) and Fitch Ratings (Fitch). Is their perception of the risks of SSA still biased negatively, as so many complain?
Carlos Lopes, economist and professor at the Mandela School of Public Governance at the University of Cape Town, thinks so. “The generally biased perception of risk in the SSA region dates back to the mid-1970s,” he says.
Lopes argues that as a result of well-intentioned but disastrous policies imposed on African countries in the form of structural adjustments, local economies have been decimated. Over the years, the fiscal position of countries has deteriorated, which has given them a bad image among international investors. In the mid-1990s, when it became apparent that structural adjustments were failing, they were replaced by a list of conditionalities that offered more flexibility to countries in sub-Saharan Africa,
“This was when a growing number of countries in sub-Saharan Africa were willing to diversify their sources of funding,” says Lopes. “They approached the rating agencies to obtain ratings that would allow them to approach the financial markets. However, US-based rating agencies in the mid-1990s did not have sufficient vision to fairly assess SSA sovereign risk and took a very cautious approach.
“The inexperience of African leaders in dealing with The rating agencies led to the lack of discussion on the first ratings assigned and the methodology applied. SSA countries began their journey into debt capital markets with an unfair premium on sovereign debt which is still a benchmark for sovereign pricing of SSA today.
Any SAA country that violates a conditional fiscal rule would be threatened with a rating action by rating agencies, even if the violation of the rule could be beneficial to the country.
Lopes says this is happening right in front of our eyes, with the way the CRAs have handled the announcement of the EU aid package versus the aid package from multilateral organizations to support countries in sub-Saharan Africa. The EU support package was received positively as SSA support prompted threats of downgrading.
“The rating agencies take a mechanical and hard position towards the countries of sub-Saharan Africa and effectively threaten these countries to lower their rating if they accept a moratorium offer on the debt of the IMF, the WB, the G20, the Paris Club and AfDB, ”said Lopes.
The mechanical approach is unfair
Rating agencies argue that they are working strictly by the rules when it comes to countries in sub-Saharan Africa and that the economic shock and standstill agreements are evidence of a weakened credit profile requiring a downgrade. Zambia’s default in September is a case in point.
Common sense must prevail, argues Lopes. “We are in a particular time of global instability where measures and clauses in loan agreements should not be articulated and triggered as they would in normal times.
“The international pandemic crisis does not discriminate against countries and CRAs must not ignore the Covid-19 emergency. Instead, they should take a flexible and holistic approach to risk in the face of the current situation in countries in sub-Saharan Africa. Mechanically penalizing these countries is unfair and will not help. “
The reality is that African countries are between a rock and a hard place. They don’t have the luxury of printing their own currency, as they do in the West and in more developed countries. As such, they are limited in terms of options for raising liquidity, hence the importance of deferring their debt obligations.
Many experts we spoke to for this article, including Alexandra Mousavizadeh, former analyst at Moody’s, are calling on rating agencies to review their approach to sovereign risk in sub-Saharan Africa. Along with Lopes, they agree that the risk of SSA countries is distorted by the actions of major rating agencies and can be improved.
“The realities facing African countries are different than those faced by European countries. Sub-Saharan African countries have limited options for raising liquidity to cope with the fallout from this global crisis compared to European countries. They don’t have access to funding from any local or regional union, so there is a lot of pressure to defer their debt obligations during this global crisis, ”said Yvonne Ike, Head of Sub-Saharan Africa (ex-RSA) at Bank of America. .
African experts often say that risk perception in Africa cannot follow the same protocol as for mature markets. To understand the local context and its particularities, you need a constant local presence to build a global image. This is the first flaw in the ARC’s approach to SSA. With virtually no presence on the ground, this can only lead to a good “rough guess” of a country’s risk perception.
Andrei Ugarov, CEO-designate for Sber Middle East and former partner of PwC Nigeria, agrees and says information is difficult to come by in developing markets, especially in sub-Saharan Africa and rating agencies do not have established the local relationships needed to build a holistic picture and understand the environment.
Ike offers a solution: “To overcome the lack of local knowledge, it would be essential to create physical links with companies and government officials in order to facilitate a better understanding of the environment and access more precise information. It would be more constructive for rating agencies not to threaten short-term downgrades and instead should take a narrow but long-term view of sub-Saharan African name ratings at this time. This will help reduce the tendency of the markets to panic with every press release. “
Inadequate scoring methodology
Another point that rating agencies should address is their rating methodology. Rating agencies need to readjust it to capture the essence of SSA risk. “Even at the scale of the African continent, the risk approach does not sufficiently take into account the inherent differences between countries. We are in a unique situation on a global scale, ”explains Mousavizadeh.
Credit rating primarily includes political and economic risk. The political risk component is difficult to quantify, explains Mousavizadeh, especially in a region where political structures are complex and different from Western models. Economic risk assessment is where most efforts should be made to improve the accuracy of a rating, she argues.
“To establish a country’s macroeconomic risk profile, rating agency methodologies rely on the provision and analysis of detailed data,” explains Ike. “However, in this region, the empirical data required for their scoring models is limited and may not be timely enough.”
In addition, credit rating agencies do not give enough weight to other factors, such as the demographic dividend for example. The economic component should be more granular, explains Mousavizadeh. For example, more emphasis should be placed on the nature of the debt contracted by the government and its purpose. Failure to do so puts countries in sub-Saharan Africa that have a strong debt management office and those that don’t. It is unfair for the most productive countries in the region.
What Lopes and others are asking for is not preferential treatment, but rather fair assessment by rating agencies. Some voices have called for an African regulator to monitor the actions of rating agencies on the African continent.
Ike says countries need to think differently about the use of international capital: “If an instrument is well structured for clearly identified projects and funds can only be requested by governments and sponsors when milestones are reached, investors are ready to engage even when country ratings are challenged. “
And there should be more efforts to improve failures where they occur on the African side. “All the blame cannot be attributed solely to the CRAs,” Ugarov argues. “African countries need to be more transparent in terms of full disclosure and present a full level of detail in the information provided. “
Investors also need to better assess African risk. “Until investors and rating agencies spend more time [in the relationship], rating agencies and investors are likely to over-compensate for risk in sub-Saharan African markets, ”Ugarov concludes.