The African Union Publishes Report on Credit Rating Dynamic on the Continent, But What Can be Done?

Here in Financial Regulation Matters, we are more than aware of the pressure that credit rating agencies have been piling on the African continent on account of the pandemic. We looked recently at the dynamic here, and have also reviewed the views of many current and former rating analysts – a representative example of the argument is here – that consists of the understanding that investors in African debt knew the risks, and should subsequently suffer the consequences. However, there is more to the story than that and, even more importantly, that view maintains the status quo and does not seek to advance the position of the countries in question. In that light, the question needs to be ‘what can be done?’, but also ‘should it be done?’

 

The African Union, via its African Peer Review Mechanism (APRM), has developed a report entitled the ‘African Sovereign Credit Rating Review’, which was published recently and is available here. The report, which the APRM’s CEO is the first of its kind on the continent, aims to present the picture of the dynamic affecting the continent, and present some options for moving forward. It tells us how 11 countries have been downgraded in 2020 so far, and that only 3 countries have managed to access foreign capital recently: Egypt, Ghana, and Gabon, with only Egypt having managed the feat after the outbreak of the pandemic. The report continues by declaring that this lack of access, and a raft of downgrades based upon the inability of countries to meet their obligations and weather the storm, is not based upon factual and statistical considerations, but that it is demonstrative of the procyclical effect of credit ratings more generally: ‘evidence from past crises proves that aggressive downgrades during periods when economies are already strained create procyclical effects that exacerbate the impact of the crises… like a self-fulfilling prophecy, even countries with strong macroeconomic fundamentals, once downgraded, past evidence shows that fundamentals deteriorate to converge with model-predicted ratings’. It is then argued that rating agencies were too quick to pull the trigger and downgrade countries who were actively attempting to implement policies to protect those said fundamentals, a suggestion which points towards the researched understanding that agencies have been biased against such countries. After detailing the dynamic more for us, the report offers a number of valid and considered recommendations, including: better participation from countries; the need for legislative frameworks for rating agency registration (to improve that communicative issue); the adoption by countries of international standards for rating agency processes; the subscription to informational disclosure standards like the Special Data Dissemination Standard; an increased focus on honouring commercial debt obligations; and also better designing of financial contracts to allow for a longer-term focus and manoeuvrability for the countries.

 

The proposals are appropriate, but the reality of the situation as it is playing suggests a different picture. At the moment, Zambia is becoming almost a ‘test case’ for the dynamic as it is unfolding. Zambia has declared that it will likely have to default on its debt obligations if private creditors do not agree to a moratorium, which has had the effect of highlighting the tensions that exist within the rating dynamic; private creditors are dismayed by this idea and, in citing the fact that Zambia has been reluctant to a. share data on its fundamentals, b. liaise with private creditors, and perhaps most crucially c. to fully reveal its debt obligations to massive lenders like China. It is clear that Africa is, as it often has been, caught in the middle of a geopolitical clash. Zambia’s reluctance to reveal its position with China will likely be replicated across the board, and there are a number of confirmed and/or potential reasons for that. Nevertheless, unless that position is revealed, private creditors will not agree to a deal that sees them potentially lose whilst another lender remains unaffected. China will have little interest in losing out, American-centred interests (like the World Bank) will have no interest in losing out, and private creditors have the ability (like in the case of Zambia) to refuse to allow the plans of the countries to take place. The result? The result is, regrettably, likely to be the one that credit rating analysts, former and current, have predicted – the continuation of the status quo, consisting of sovereign defaults, the continuation of the presence of major geopolitical entities restraining the development of the African continent, and the continued lack of access to the credit markets. Yes African countries will eventually be able to return to the capital markets, but at what cost? Higher than usual interest rates, a continued suspicion of their ability to meet their obligations, and a continued bias against them from credit rating agencies. There has to be a better way forward. The suggestions by the APRM, particularly with regards to dialogue and interaction with agencies, is something that needs to be pursued. In fact, Zambia’s creditors have been calling out for more interaction between themselves and the country, thus signifying the need to increase communication across the board. But, what if Zambia cannot do this? What if their position with China, perhaps how China has designed the financing, does not allow them to reveal such a position, or at least the preference that China has on the country’s meeting of its obligations? If that is the case, then what use would increased dialogue be? It could even exacerbate the situation and make things much worse. There is no possible pressure that can be put on China as an entity in this situation, so if this is indeed the case, the options for moving forward in the interests of the countries in question are not so great. There are initiatives in place - the APRM deserves a lot of praise for its plans on the issue - and currently being built – I myself am leading a team to develop a credit-rating based solution (and please feel free to reach out to me if you are interested in knowing more) – but the truth may be that, unless the Chinese elephant in the room is not addressed, progress may be tragically slow.

 

Keywords – credit rating agencies, Africa, sovereign debt, China, @finregmatters