Bretton Woods Committee | Fri, Nov 4, 2022
by Mahesh Kotecha
The ratings of African governments have allowed a robust Eurobond market for African sovereign bonds with over $300 billion issued in the last couple of decades. Maintaining access to this market has persuaded many African countries not to seek debt relief under the misconceived G-20 Common Framework (CF) which only three countries have filed to use – Zambia, Ethiopia and Chad -- and none of them has an agreement yet two years after the CF was announced.
The CF has been ineffective for two important reasons. First, it requires in effect that those who file under it default on their Eurobonds, which would shut off the country from the markets: so most countries avoid the CF as they would rather continue to be able to issue Eurobonds. Second, CF is available only to the Least Developed Countries and does apply to Middle Income Countries like Sri Lanka, which is in default.
Notwithstanding this revealed preference that even countries under debt distress as defined by IMF stay away from CF so as to maintain market access afforded by even B or B- category (deeply non-investment grade) ratings there is a school of thought (at the African Union for example and at parts of the UN) that African ratings are too low. The subtext is that there is bias against African credits among rating agencies and market participants and thus they have to pay an African “premium” due to this purported misperception of African risk. By contrast, major industrialized countries such as Germany and US are rated AAA and borrow at fine rate whereas Zambia has languished with D ratings since it defaulted two years ago and has no market access. The Economic Commission for Africa (ECA) has under Vera Songwe (no longer there) identified one reason for this premium (liquidity risk) and proposed a Liquidity Support Facility to reduce this risk, an interesting long term initiative on which she has supporters such as PIMCO.
African Union and others have proposed an African rating agency to provide alternative ratings. Not a bad idea if Africa has an investor base who will listen to such a rating agency as for example Chinese, Japanese, Indian, Malaysian and Nigerian investors listen to rating agencies based in those countries. One such new agency Sovereign Africa Rating (SAR) just assigned BBB rating to South Africa which is rated non-investment grade by the big three. The credibility of an agency that gives out such higher ratings is likely to be discounted by international investors just like grades in different tier educational institutions.
Rating criteria of the international agencies are indeed “one size fits all” by design as they are meant to assess the likelihood of repayment or default which has proven metrics from a long history of sovereign defaults (see Reinhart and Rogoff in “This Time Is Different”) and the rating agency models have been tested over time as seen in their corporate default studies over seventy plus years. The agencies explain low African ratings on the bases of African countries’ low levels of economic development, undiversified economies, high levels of debt, limited financial flexibility and high political risks. But they do err from time to time -- as they did for example on South Korea in the Asian financial crisis -- as no such system is perfect. Rating agencies do learn from such mistakes or market comments and make adjustments in their criteria from time to time.
The greater benefit for countries and companies in Africa seeking ratings is from learning the ropes and getting a rating they deserve -- nothing less, as they often can and do fall short. And with improved performance they can achieve better ratings over time. One client – First Bank of Nigeria – was just upgraded by Fitch under our advice a few weeks ago.
There is a role for an Africa-only focused rating agency for investors who focus only on Africa and seek only relative risk assessment across this universe. For them the definition of investment grade need not be the same if their risk tolerance is higher. But investors will generally continue to rely on the big three rating agencies.