Credit rating agencies are key players in financial markets, no two ways about it. They provide important and generally robust opinions of the creditworthiness of a borrower, enabling businesses and countries alike to attract much-needed investment to fund growth and development while giving investors clarity on whether or not they are likely to get their money back.
The dividing line between profit and loss for investors often comes down to the information at their fingertips: what they’re assessing, how, and what they are comparing each investment opportunity to. Hence the importance—and influence—of credit rating agencies.
So far, so good. The problem is, of course, that the global credit-rating landscape is dominated, some may say monopolized, by three main players: Moody’s, Standard & Poor’s, and Fitch; Moody’s and S&P between them issue 80% of international ratings. And while they may do a good job rating developed economies, they don’t fully understand the context of emerging markets. For example, Moody’s has just one office in Johannesburg that services all 28 countries it assesses on the African continent. It’s simply impossible to fully understand the nuance and potential across such a diverse continent with such a limited view.
The consequences of this are severe, especially for Africa, where borrowing is on the rise and traditional funding sources are drying up.
Why WEIRD countries dominate
The top three credit rating agencies have a particular skew towards WEIRD countries: Western, Educated, Industrialised, Rich, and Democratic. It’s understandable – these countries have long track records with the most abundant, relevant, and up-to-date data, collected from a variety of credible sources. But what about those countries, that fall outside of the club, that are taking solid steps to build their economies but lack the track record to show it? Right now, they are struggling to get a look in, exacerbating a cycle of underinvestment that is driving unemployment and infrastructure deterioration, which, you guessed it, further weakens their credit ratings.
Rating agencies are naturally risk averse, and they take comfort in track records. But this means that they’re likely to miss the niche advantages that developing economies offer and where, by the way, the majority of people live and work.
Thus, as countries across Africa try to wrestle their way free from various challenges, including corruption, unemployment, disease, and colonial-shaped legacy institutions, rating agency stickers of ‘risky business’ jeopardize their ability to shape a new narrative. As these countries work to get out of the hole they’re in, exaggerated credit assessments trample them down again.
For example, Ghana has recently appealed against a ratings downgrade by both Fitch and Moody’s, citing that it was “gravely concerned” key data had been omitted in the assessments, including “2022 budget expenditure control measures and 2022 upfront fiscal adjustments”, as well as alleging “inaccurate balance-of-payments statistics…based entirely on a desktop exercise (and) virtual discussions” without the agencies ever visiting Ghana.
So, what can be done? Some think it’s time to take matters into their own hands with the establishment of a pan-African credit rating agency to better contextualize African growth stories with adjusted methodologies and more nuanced weightings. However, such an entity will need to be credible to be taken seriously and have the desired effect.
A move towards fairer assessments in Africa
On the eve of the 54th session of the Conference of African Ministers of Finance, Planning and Economic Development (CoM2022), Senegal’s president, Macky Sall, also currently head of the African Union, revived interest in a pan-African credit rating agency to balance the “sometimes very arbitrary ratings” used by the likes of Fitch, Moody’s and S&P. He quoted research suggesting “at least 20% of the rating criteria for African countries are based on more subjective factors, cultural or linguistic ones for example, which bear no relation to the parameters used for measuring economic stability”. As a result, the risk perception of investing in Africa is higher, and borrowing, therefore, comes at a premium.
Enter the Sovereign Africa Rating Agency (SARA), which has been recently established as an independent entity with the potential to fill the role of a pan-African rating agency. In a recent interview, COO Zweli Maziya spelled out what fairer assessment methodologies could look like. SARA is proposing to consider full repayment records and to look at naturalized growth rates, among other measures, to balance the different combinations of variables across countries. However, despite introducing more nuanced and contextualized measures, their core business will remain to assess the ability and willingness of countries to meet their financial commitments.
Positively shaping Africa’s future financial landscape
A key shift that an African rating agency must seek to bring to the table is a more forward-looking orientation. Many of the measures global rating agencies use, such as per capita income, GDP growth, inflation, fiscal balance, and current account deficits, may be considered lagging measures not leading measures. They’re indicators of what’s gone on in the past, and not what’s coming. Africa has a great story to tell if you look at future demographics and resource potential. A credible, context-sensitive, African rating agency may be better placed to tell this story. Two ingredients will be key to its success.
First, it will need to partner with universities, business schools, and research institutions around the world to ensure data collection and analysis, as well as the methodologies used for assessments, are robust and credible. The lack of adequate data is frequently cited by the big three rating agencies as a concern. Second, we will need sufficient regulation and oversight of the goings on within. Transparency is vital to back up the credibility of the research and assessment methods. This of course applies to all rating agencies operating on the continent and may require the establishment of a continental regulatory body with teeth to protect those countries that are downgraded unfairly and ensure appropriate guidance in line with global standards.
Overall, SARA will need to ensure that it avoids the perception – and reality – of becoming a mouthpiece for propaganda, spinning a positive story where there isn’t one. It must not be afraid of collecting data it doesn’t like; make reality its friend; and stick to facts, not fantasies.
An African credit rating agency has significant potential to shape a more promising economic story for Africa and to challenge other rating agencies as to what’s being measured and why; however, in practice, it faces a tricky balancing act ahead to deliver on its promise. It will need support from key entities across the continent to help it on its journey.
Jon Foster-Pedley is Dean and Director of Henley Business School in Africa, Chair of the Association of African Business Schools, and Chair of the British Chamber of Business in Southern Africa.