The African Union aims to set up an African Credit Rating Agency (AfCRA) in Mauritius next year. This, it says, is needed to counteract the anti-African bias that it detects among the ‘big 3’ rating agencies – Fitch, Moody’s and Standard & Poor’s – who dominate the analysis of default risk by sovereign and corporate borrowers.
The AU’s claim is hat these agencies, lacking any meaningful physical presence in the region, exercise judgments about African countries’ creditworthiness which ignore local conditions, and which value austerity over policies that ‘may promote growth’.
The big rating agencies, not to mention global capital markets, are by no means perfect. Yet setting up AfCRA is the wrong way of responding to that imperfection. The views that AfCRA will express about African creditworthiness are likely to be more optimistic than those of the ‘big 3’, and will be questionable for exactly that reason. The initiative won’t ‘level the playing field’, as its supporters claim. Instead, the chances are that it will be seen as an effort to shift the goalposts.
Risk appetite, and ‘lagging’ the market
Rating agencies are used by fund managers and market participants who allocate capital globally to facilitate comparisons of default risk between different countries in different regions.
If there happened to be a pool of the world’s capital that was ringfenced to be available for Africa alone, then an AfCRA might make sense. Indeed, when it comes to rating issuers borrowing in local currencies, an AfCRA may well have value. But when it comes to international sources of funding, African borrowers are competing in a global capital market, and so an Africa-only view of creditworthiness can’t help.
One important reason why rating agencies get things wrong is that creditworthiness depends on some forces that are as invisible to them as to everyone else: the ebbs and flows of global risk appetite. These are driven primarily by sudden and unpredictable changes in US monetary conditions.
When risk appetite is strong, there’s plenty of demand for emerging markets bonds and all developing countries become more creditworthy – simply because it’s easier for them to fund themselves. But when risk appetite diminishes, it is the riskiest, or lowest-rated, borrowers, particularly in sub-Saharan Africa, that suffer most, losing the confidence of creditors most quickly.
This is partly why the rating agencies are so often, and correctly, accused of ‘lagging’ the market, changing their ratings in response to changes in risk appetite. If market participants suddenly lose their willingness to lend, borrowers’ creditworthiness changes too and so ratings might need to adjust. And ratings downgrades have especially unpleasant consequences for the least creditworthy: a one-notch downgrade from single-B brings a country a lot closer to a default-level rating than a one-notch downgrade from AAA.
Africa’s higher risk premiums
The claim that there is an anti-African bias in global capital markets should be taken seriously, but needs scrutiny. One unconvincing approach is contained in a widely cited UNDP study. This concludes that a more ‘accurate’ set of sovereign ratings could unlock over $70 billion in new financing for African borrowers, if their ratings were based more closely on economic fundamentals.
But to make their case, the paper’s authors compare the rating agencies’ sovereign risk scores with a set of economic scores which, they acknowledge, ‘do not necessarily represent the most accurate assessment of sovereign default risk’.
There is certainly evidence to show that borrowers in sub-Saharan Africa pay higher credit spreads, or risk premiums, than similarly rated countries in other parts of the world.
Since default risk is precisely what the rating agencies are trying to assess, this study comes too close to comparing apples with pears. Moody’s research has, in the end, a better grasp of this issue, presenting evidence to suggest that default rates for African sovereign borrowers are actually very similar to those of similarly rated sovereigns in other parts of the world.
It is therefore difficult to argue that the rating agencies have an anti-African bias. But there is certainly evidence to show that borrowers in sub-Saharan Africa pay higher credit spreads, or risk premiums, than similarly rated countries in other parts of the world, as a 2023 IMF paper demonstrated. Even South Africa, the beneficiary of a sovereign rating upgrade earlier this month, has tended to pay marginally higher spreads than its rating might imply.
Yet the IMF’s analysis suggests that the ‘bias’ disappears after taking into account factors which constrain many African countries’ development: low levels of fiscal transparency, unreliable regulation, large amounts of informal economic activity that remain untaxed, and weak financial sectors.
These are crucially important issues, since it is widely understood that ‘governance’ indicators – including political stability, the quality of bureaucracy and the strength of the rule of law – are the most reliable guide to sovereign default risk, along with per capita GDP.
A better way forward
Rather than create an African Credit Rating Agency, greater effort should be made to address some of the underlying shortcomings that constrain African creditworthiness.
That’s easier said than done, of course. But there are two practical steps that should be considered as a realistic focus for policymakers in the region.
The first is to invest in data transparency, particularly with respect to budgets and debt stocks. There are good reasons to believe that transparency can reduce borrowing costs: uncertainty about the exact nature of a country’s liabilities will naturally lead bondholders to add a risk premium to compensate for that lack of clarity.
The saga of Senegal’s ‘hidden debt’, in which some $11 billion worth of public liabilities – a third of the country’s GDP – was brought to light after a change in government last year, is a cautionary tale.
The second is to strengthen African governments’ capacity to communicate with rating agencies and with bondholders. Dedicated investor relations teams within emerging economies’ finance ministries began to flourish thirty years ago.
Since the reputation of the ‘big 3’ rating agencies seems so tarnished across Africa, they ought to consider making their own efforts to support African governments.
The dialogue they generate – through explaining policies, presenting data, and answering questions – can be truly helpful in allowing rating agencies and bondholders to understand a country better. Egypt is a leader here – but more African countries should follow.
Since the reputation of the ‘big 3’ rating agencies seems so tarnished across Africa, they ought to consider making their own efforts to support African governments in achieving these goals. Providing advice about the data they need most urgently would be a useful start.
The most natural explanation for the evidently high cost of foreign borrowing for African governments is the mere fact that many African economies are, from a bondholder’s purely financial point of view, risky. If bias exists, the best way to counter this is not an AfCRA. That will invite critics to accuse Africa of grading its own homework. The best solution is a more dedicated effort to present reliable data, and talk to the market.
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