Credit Rating Agencies (CRAs) play a pivotal role within the financial sphere. They provide a solvency risk benchmark to investors for debt issuers and structured finance instruments which are traded on debt capital markets (DCM). In short, they have an outsized influence on the interest rates countries or corporates pay lenders.
Last year, some 20 African sovereigns were owing more than $100bn through Eurobonds at any one time, displacing multilateral lenders as Africa’s main source of funding.
So the difference of a few percentage points in what you pay your lenders starts to become quite material. A study in 2015 by Michigan University estimated that African sovereigns in sub-Saharan Africa (SSA) were paying a premium of 2.9% over the rest of the world. As such, downgrades (which raise the premium) are extremely costly for the continent.
Following the economic shock caused by the Covid-19 pandemic, low-income countries lacked 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.
The CRAs in their outlook statements were consistently saying this would amount to a default, thus forcing countries to make the difficult choice between using resources to deal with the immediate healthcare and economic need or servicing a debt in fear of being alienated from the international capital markets.
Abebe Selassie, Africa director at the IMF, calls for more flexibility from CRAs as the debt standstills offered by the Paris Club and G20 creditors do not require comparability of treatment from private creditors. This is something new, specifically put in place to protect sovereign ratings.
Many countries also feel penalised by an implicit bias in those conducting the analysis. For example, in an interview with Bloomberg Markets, Ghana’s Finance Minister Ken Ofori-Atta said his country is paying a higher premium than Belarus, an autocracy that is today mired in political instability, and more than Argentina, a country that seems to be in a never-ending cycle of defaults.
A biased risk perception of SSA
The three most important CRAs all hail from the US: Moody’s Investors Services (Moody’s), S&P Global Ratings (S&P) and Fitch Ratings (Fitch). Is their risk perception when it comes to SSA still negatively biased, as so many complain?
Carlos Lopes, Economist and Professor at the Mandela School of Public Governance at the University of Cape Town thinks it is. “The generally biased risk perception of the SSA region can be tracked back to the mid-70s,” he says.
Lopes argues that following the well-intentioned but disastrous policies forced upon African countries in the form of structural adjustments, local economies were decimated. Over the years, countries’ fiscal position deteriorated which gave them a poor image to international investors. In the mid-90s, when it became apparent that the structural adjustments were failing, they were replaced by a list of conditionalities which provided more flexibility to SSA countries,
“This was when a growing number of SSA countries were willing to diversify their source of funding’’ says Lopes. “They approached CRAs to get ratings that would enable them to approach financial markets. However, American-based CRAs in the mid-90s did not have sufficient insight to fairly assess SSA sovereign risk and took a very conservative approach.
“The inexperience of African leaders in dealing with CRAs led to the absence of any discussions regarding the early ratings ascribed and the methodology applied. SSA countries started their journey on the Debt Capital Markets with an unfair premium on sovereign debt which is still today a reference point to SSA sovereign pricing.”
Any SAA country that infringes a conditional fiscal rule would receive the threat of a rating action from the CRAs, even if breaking the rule could be beneficial for the country.
Lopes says this is happening in front of our eyes, with the way the CRAs have treated the announcement of the EU aid package compared to the aid package from multilateral organisations to support SSA countries. The EU support package was received positively whereas the SSA support provoked threats of rating downgrades.
“CRAs are taking a mechanical and harsh stance towards SSA countries and are effectively threatening these countries with rating downgrades should they accept a debt moratorium offer from the IMF, WB, G20, the Paris Club and AfDB,” says Lopes
Mechanical approach is unfair
CRAs argue that they are working strictly by the book when it comes to SSA countries, and that the economic shock and the moratorium arrangements are proof of a weakened credit profile necessitating a rating downgrade. Zambia’s default in September is a case in point.
Common sense should prevail, argues Lopes. “We are in special period of global instability where metrics and loan agreements clauses should not be articulated and triggered as they would in a normal era.
“The international pandemic crisis does not discriminate against countries and CRAs should not be oblivious to the Covid-19 emergency. Instead, they should adopt a flexible and holistic risk approach to the situation SSA countries are in now. Mechanically penalising these countries is unfair and is not going to help.”
The reality is that African countries are between a rock and a hard place. They don’t have the luxury to print their own money – as is happening in the West and more developed countries. As such they are limited in terms of their options to source liquidity, hence the importance of deferring their debt obligations.
Many of the experts we spoke to for this piece, including Alexandra Mousavizadeh a former analyst at Moody’s, are calling for the CRAs to revise their approach to SSA sovereign risk. Alongside Lopes, they agree that SSA countries risk is being misrepresented by the major CRAs’ actions and can be improved.
“The realities faced by African countries are different than those faced by European countries. SSA countries have limited options to source liquidity to help cope with the fallout of this global crisis compared to European countries. They do not have access to financing from any local or regional union so there is a lot of pressure to defer their debt obligations during this global crisis,” says Yvonne Ike, head of sub-Saharan Africa (ex-RSA) at Bank of America.
Africa experts often say that Africa risk perception cannot follow the same protocol as for mature markets. To grasp the local context and its particularities requires a constant local presence to build up a comprehensive picture. This is the first flaw of the CRAs’ approach to SSA. With practically no presence on the ground, this can only lead to at best a good ‘rough estimate’ of a country’s risk perception.
Andrei Ugarov, CEO designate for Sber Middle East and ex-Partner at PwC Nigeria agrees and says information is hard to obtain in developing markets, especially in SSA and CRAs have not built the necessary local relationships to draw a holistic picture and comprehend the environment.
Ike offers a solution: “To address the lack of local knowledge, it would be essential to create physical links with corporates and government officials so as to facilitate a better understanding of the environment and access more accurate information. It would be more constructive for CRAs not to threaten short-term downgrades and instead should take a close but long-term ratings view on SSA names at this time. This will help reduce the tendency for the markets to panic at every news release.”
Inadequate rating methodology
Another point that CRAs should address is their rating methodology. CRAs need to retune it to capture the essence of SSA risk. “Even at the African continental scale, the approach to risk does not take sufficiently into consideration inherent differences between countries. We are in a situation of one size fits all on a global scale,” says Mousavizadeh.
The rating notation comprises principally political and economic risk. The political risk component is difficult to quantify, says Mousavizadeh, especially in a region where political structures are complex and different from Western models. Economic risk assessment is where most of the effort should be made to improve the accuracy of a rating, she argues.
“To establish the macro-economic risk profile of a country, CRAs’ methodologies rely on the provision and analysis of extensive data,” says Ike. “However, in this region, empirical data required for their rating models is limited and may not be timely enough.”
Additionally, CRAs do not give sufficient weight to other factors, such as a demographic dividend for example. The economic component should be more granular, explains Mousavizadeh. For instance, more importance should be given to the nature of debt that government takes on and its purpose. Failure to do so puts SSA countries that have a strong debt management office and those that do not in the same basket. It is unfair for the most productive countries in the region.
What Lopes and others are calling for is not preferential treatment but rather a fair assessment from the CRAs. Some voices have called for an African regulatory body to monitor CRAs actions on the African continent.
Ike says that countries need to think differently about tapping international capital: “If an instrument is well structured for clearly identified projects and funds can only be called upon by governments and sponsors when milestones are reached, investors are willing to engage even when country ratings are challenged.”
And there should be more effort to improve failings where they occur on the African side. “All the blame cannot be solely attributed to CRAs,” argues Ugarov. “African countries need to be more transparent in terms of full disclosure and present a comprehensive level of detail in the information provided.”
Investors must also be better at evaluating African risk. “Until both the investors and the CRAs invest more time [in the relationship], CRAs and investors are likely to overcompensate for the risk in the SSA markets,” concludes Ugarov.