The Need for a Pan-African Rating Coalition in Contextualizing the African Continent
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The Need for a Pan-African Rating Coalition in Contextualizing the African Continent
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By, Davis Mwania, Botho Analyst
April 25, 2023
By 2022, 20 of the 32 African countries rated by Credit Rating Agencies (CRAs) were downgraded or given negative outlooks by at least one of the Big 3 international CRAs namely Fitch, Moody, and Standard & Poor (S&P). These CRAs control 95% of the credit rating business globally and have been active players in various African countries, such as Nigeria. Moody first rated Nigeria in 2012 citing “strong economic resilience and strength, moderate event risk due to heightened security conditions in the north of the country”. Following Bola Tinubu’s Presidential election in February this year, Fitch downgraded Nigeria’s short-term social stability, attributing it to “Tinubu's ‘weak’ mandate”. In the same month, S&P also published a negative outlook for Nigeria, pointing to “increasing risks to the country’s debt servicing capacity over the next one to two years”.
While the CRAs play an important role in assessing a country’s creditworthiness and aiding investors to understand the continent’s fiscal and monetary position, they do not always give a comprehensive and balanced rating and analysis of the continent. CRAs are constrained by a limited understanding of contextual dynamics, various biases, and limited local private sector insights. These gaps call for the need for a pan-African rating coalition that would enhance the capacity of local credit rating agencies to solidify local analyses, highlight local nuances, curate regional databases, and shape proper investor responses to African events.
Having said that, CRAs do not always downgrade African countries and give them negative outlooks. For instance, Fitch affirmed Angola’s Long-term Foreign Currency Issuer Default Rating (IDR) at B- with a positive outlook since there was a “sharp decline in Angola's central government debt, large current account surpluses and lower government financing risks underpinned by a supportive oil price environment.”
Constraints: Limited Contextual Nuances and Biases
However positive or negative the outlook, CRAs have limited sources of information as they tend to rely on publicly available data from governments and multilateral organizations. In an effort to standardize their criteria, they end up with the unintended consequence of sidelining local insights from the private sector. CRAs have also been marked by various biases including ‘home bias’, ‘financial center bias’, and political bias. On average, the rating CRAs assign to their home countries is approximately a category higher than that of other nations that are deemed culturally and linguistically distant. During the pandemic, CRAs threatened to downgrade the credit rating of African countries that were giving financial stimulus packages to boost their economies while favorably responding to European Union aid packages.
Similarly, CRAs rated metropolitan areas and regions within the global financial center index (GFCI), which are a ‘natural habitat’ of CRAs, a notch higher than what would be indicated by underlying economic fundamentals, indicating a ‘financial center bias’. Furthermore, CRAs were found to have a partial and more lenient attitude towards developed than developing economies. Though the former had large debt increases and economic slowdowns, they did not face as many downgrades as the latter, which strengthened their access to affordable market financing. Additionally, due to political bias, it appears that CRAs veer towards pessimism around various electoral candidates they do not prefer along with their policy regulatory space.
CRAs rarely correct themselves for biased ratings or acknowledge these limitations, which may negatively affect sovereign risk perceptions and a country’s degree of access to international capital markets and refinancing costs. During the pandemic, the numerous credit rating downgrades contributed to an 18% decline in FDI to Africa by $8 billion in 2020. In January 2023, Nigerian government bonds fell after Moody’s downgraded the country because the government’s fiscal and debt position was expected to keep deteriorating. CRA ratings have direct and indirect impacts on financial markets, e.g. African countries pay 2.9% higher interest premiums than non-African countries for Eurobonds given the correlation between downgrading and increase in yields.
The Pan-African Rating Coalition
These limitations point to the need for a pan-African rating coalition (hereafter the coalition) that would help investors grasp local nuances and, in turn, shape proper investor response. The coalition would constitute regional representatives from both local and international CRAs as well as private and public actors to ensure a balanced independent voice. It would also foster trust among governments, companies, and investors and increase competition with the big 3 CRAs, and, consequently, reduce dependency on them. The coalition would also ensure that economic arguments are backed by a plurality of CRAs from different countries and cultural backgrounds to minimize biases within the coalition.
With political goodwill at a continental level evidenced by the proposal for a pan-African financial rating agency by the AU Chair, President Macky Sall, the coalition would offer investors alternative networks beyond international CRAs. This would foster a fair assessment of the implications of local and regional African political economy dynamics. The coalition could also establish a shared regional database that would bridge the differential access to high-quality and up-to-date data and minimize subjective estimations. Through shared learning, as well as internal and external capacity building, it would also streamline the rating methodologies across regions and make them more transparent and predictable.
The coalition would also spur government effectiveness and improve the regulatory quality of institutions through mobilizing sound debt management reforms across governments. It could publicly disclose credit risk deviations between preannouncements and announcements by CRAs and bolster the continent’s agency by showcasing an alternative narrative of its ground realities. Furthermore, it will laud the ongoing advancements in Africa and denounce historical biases that risk sabotaging the region’s economic development. With such a one-stop shop coalition in place, communication between investors and stakeholders in African markets would improve, thus lowering risk perceptions.
Davis Mwania is a Research Analyst at Botho Emerging Markets Group