Rating the rating agencies in Africa

The recent Jubilee Report on global sovereign debt, chaired by famed economist Joseph Stiglitz, was a sobering read. Over 750mn people in Africa, it said, live in countries that spend more on debt servicing than on education or healthcare.

The report added to the pressure on global credit rating agencies, pointing to their “outsized influence on sovereign debt dynamics” and claiming that “the evidence of [their] accuracy . . . remains weak”.

This added to a chorus of complaints from government officials in Africa, blaming rating agencies for unfairly pushing up their borrowing costs. Is it justified?

INTERNATIONAL DEVELOPMENT

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Almost ever since John Moody set up a business to assess railway securities in 1909, the world’s credit rating agencies have faced heat from unhappy bond issuers who feel they’re being judged too harshly. But rarely has that criticism been so strong and sustained as the complaints they’ve been facing from African governments.

The dominant “big three” rating agencies — S&P Global, Moody’s and Fitch — stand accused of holding back the development of African countries, by pushing up their borrowing costs through unduly weak credit ratings. African presidents, finance ministers and bank chiefs have all railed against supposedly unfair assessments.

At last month’s UN Financing for Development conference in Seville, nations agreed to push rating agencies to “refine their methodologies”, and to explore ways to “make credit rating agencies more accountable for their actions”. That agreement also endorsed the creation of a new Africa Credit Rating Agency, which is being pursued by the African Union.

“Global credit rating agencies have not only dealt us a bad hand, they have also deliberately failed Africa,” Kenyan President William Ruto said earlier this year.

Are such claims fair? Studies on this question have shown a mixed picture. A widely cited UN Development Programme report in 2023 estimated that African nations faced an extra $74.5bn in “excess interest and foregone funding” thanks to what it called “idiosyncrasies” of the agencies’ approach.

To arrive at that figure, the UNDP authors compared the real-world ratings with an alternative methodology focused tightly on “macroeconomic and public finance fundamentals”. While the latter approach might prove more objective, it risks excluding wider data points and political factors that would be of interest to sovereign bond investors.

A contrasting analysis came from an IMF working paper in the same year. It found that African countries faced a premium in their borrowing costs, compared with peers from other regions. But when they controlled for four other factors — financial sector development, budget transparency, the size of the formal economy, and the strength of institutions — that premium disappeared. In other words, the authors found, the “Africa premium” can be ascribed to investor concern about identifiable factors, rather than a broad negative bias towards the continent.

Credit rating agencies have made similar arguments in their own defence, asserting that they apply the same rating methodologies in Africa as anywhere else. Historic performance does not indicate they’ve been too bearish about African issuers, they argue. “On the basis of the data we have, we don’t see signs of bias,” says Moody’s global head of sovereign risk Marie Diron. “There’s no indication that African sovereigns don’t default as much as the ratings would suggest.”

Moritz Kraemer, former chief ratings officer at S&P, went so far as to claim last year that in fact “Africa’s ratings have been too high, not too low” — because African issuers have had a slightly higher default rate than non-African issuers with the same rating level.

But the agencies’ critics have some strong counter-arguments to make. For one thing, they point out, credit rating downgrades themselves can dramatically increase the risk of a sovereign default, by pushing up the cost of refinancing its debt, or even making it unfeasible. If it comes from a rating agency, a gloomy prophecy can be self-fulfilling.

This dynamic sparked particular concern in Africa when the Covid-19 pandemic took hold in 2020. Rating agencies engaged in what Hippolyte Fofack, chief economist of the African Export-Import Bank, called a “landslide of procyclical downgrades”, at a much higher rate than was seen in other regions.

It’s also fair to question the agencies’ thin presence on the ground. Of the big three rating agencies, only S&P has any sovereign rating analysts based in sub-Saharan Africa — and only at its office in Johannesburg. All three of the agencies stress that their analysts make regular in-person visits to the countries that they rate — typically a week-long trip once a year.

But it’s hard to contest the argument that a deeper presence on the continent would give them a more detailed and nuanced view of its economic landscape. More frequent in-person engagements with African governments would help to reduce tensions and boost mutual understanding, argues Daouda Sembene, chief executive of international development consultancy AfriCatalyst.

These issues have strengthened the case for the new Africa Credit Rating Agency. But it faces plenty of questions of its own. While the initiative has been incubated by the African Union, it will need to have operational and financial independence in order to be credible, says Misheck Mutize, an AU official leading its development. It will therefore pursue a self-sustaining business model, charging issuers for ratings much like the existing agencies. Details of that model, and of the investment that will get it off the ground, have yet to fall into place. The agency’s launch, planned for September, has now been pushed back, Mutize says.

An additional source of economic data for investors should in principle be a good thing, says Vera Songwe, a Cameroonian economist and former head of the UN Economic Commission for Africa. But she cautions that the new agency should not “crowd out private credit rating agencies that already exist on the continent and are doing a good job”, such as Côte d’Ivoire’s Bloomfield Investment Corporation and Nigeria’s Agusto & Co.

And while African governments are right to push rating agencies to refine their approach, they must also work to ensure that they aren’t undermining their own ratings — for example, by failing to produce high-quality economic data, argues Sembene. “They must do what they need to do, to really reduce the risk that investors might be facing.”

Songwe points out that credit ratings are just one factor in African borrowing costs. Another is the lack of secondary market liquidity in their bonds (she now runs the Liquidity and Stability Facility, an initiative targeting this problem).

Moreover, Songwe adds, wide differences are often seen among countries with the same rating. She points to recent research by the LSF and S&P using iBoxx scores, an average of ratings from the big three agencies.

B-rated Benin and Namibia, for example, have lower borrowing costs than the global average for emerging market sovereign borrowers with that score (in contrast with Cameroon and Angola, which have the same iBoxx score but much higher borrowing costs).

That’s largely because of specific measures taken by the governments in question, Songwe says. Benin, for instance, has put in place a government debt management office with processes that have won the respect of analysts and bond investors.

“There is still some work that rating agencies need to do, that’s for sure,” Songwe says. “But there is even more work that countries need to do.”

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