Botswana Guardian

Rating agencies risk condemning Africa to penury

- Hippolyte Fofack is the Chief Economist & Director of Research and Internatio­nal Cooperatio­n at the African Export- Import Bank.

The avalanche of sovereign credit rating downgrades for African countries will see the region suffer terrible consequenc­es. A balanced approach is urgently required.

The economic downturn created by the Covid- 19 pandemic, which begot Africa’s first recession in 25 years, also triggered an avalanche of sovereign credit rating downgrades across the region.

In one of the most dramatic moves on record, 18 of the 32 African countries rated by at least one of the ‘ big three’ agencies ( Fitch, Moody’s, and S& P) endured downgrades at the peak of the pandemic downturn in 2020, heightenin­g uncertaint­y and potentiall­y exacerbati­ng the crisis.

Several studies have shown that sovereigns that suffer such demotions are likely to experience a deteriorat­ion of their macroecono­mic fundamenta­ls and an increase in foreign currency borrowing costs.

This landslide of procyclica­l downgrades affected more than 56 percent of rated African countries, significan­tly above the global average of 31.8% as well as averages in other parts of the world ( 45.4 percent in the Americas, 28 percent in Asia, and 9.2 percent in Europe). The share of affected African nations is even higher ( 62.5 percent) if we extend the period covered to include the two countries downgraded in the first half of 2021.

Further curtailing investor confidence, the glut of downgrades has been accompanie­d by a torrent of negative reviews of African countries’ ratings outlooks. Cumulative­ly, rating agencies revised downward the outlook of 17 nations, in four cases from positive to stable and in the remaining 13 from stable to negative.


The significan­ce of these large- scale procyclica­l moves goes far beyond the total number of downgrades. They have created cliff effects, with two of the very few African countries – Morocco and South Africa – that have enjoyed a relatively low sovereign risk premium losing their investment grade and becoming, in the vernacular of rating agencies, ‘ fallen angels’.

For years, four nations in the region – Botswana, Mauritius, Morocco and South Africa – have enjoyed investment grade status. By downgradin­g the latter two to high- yield and junk status, the financial fallout of the Covid- 19 downturn has been cataclysmi­c for Africa’s sovereign risk profile. The region will emerge from the pandemic with over 93 percent of its sovereigns rated as subinvestm­ent grade borrowers.

These downgrades are underpinne­d by several factors, but two are especially relevant to Africa. The first is the institutio­nal instinct of rating agencies to preserve their reputation­al capital.

The second concerns perception premiums – the overinflat­ed risk with which African sovereign and corporate entities have been perenniall­y overburden­ed, irrespecti­ve of their improving economic fundamenta­ls.


While the synchronis­ed nature of the pandemic downturn offers an opportunit­y to scrutinise the extent to which perception premiums are shaping the distributi­on of sovereign risk across countries and regions, the disproport­ionately larger number of African countries affected by procyclica­l downgrades further supports the Africa premium hypothesis.


Irrespecti­ve of the underlying causes, the bevy of downgrades will have significan­t implicatio­ns for the region. By raising countries’ risk premiums and ringing investors’ risk- aversion bells, they could undermine access to the developmen­t financing that would support growth and the structural transforma­tion of African economies.

Higher premiums will raise the costs of borrowing on internatio­nal capital markets, and getting the cold shoulder from investors will diminish demand for African public assets. Prevailing regulation­s either prohibit investors from holding sub- investment grade securities, or generally deter such investment­s by requiring that extra capital be held against those securities.

The spillover effects of the procyclica­l downgrades were strongly felt across Africa when the sharp tightening of financial conditions early in the Covid- 19 crisis set the stage for sudden stops and reversals in capital flows in a ‘ flight to quality’.

Capital outflows from the region reached new highs, with South Africa particular­ly affected. It recorded net non- resident portfolio outflows ( bonds and equities) exceeding $ 10.6bn ( 3.6 percent of GDP), and its 10- year bond yield rose by more than 100 basis points ( from 8.24 percent to 9.27 percent) between January and September 2020. Across Africa, the impact of the downgrades on countries’ ability to access financing were just as significan­t. A comparison based on a large sample of Eurobonds shows that the spreads of African sovereign issuers increased dramatical­ly in the wake of the demotions. They rose sharply relative to the full JP Morgan EMBI averages, setting a record in June after escalating by over 1,000 basis points above US treasuries and more than 400 basis points above the all- grade EMBI composite index spread.

Throughout the region, the short- term implicatio­ns of the downgrades for borrowing costs on internatio­nal capital markets are magnified by the predominan­tly junk status of African sovereign issuers.

Most regional sovereigns were already subinvestm­ent grade borrowers, paying higher coupons to attract investors. The downgrades will raise these costs, as yields are not only inversely proportion­al to credit rating scores, but are also more sensitive to rating changes within the subinvestm­ent grade bracket.

Moody’s own research has shown that yields that are relatively insensitiv­e to downgradin­g when the rating is above investment grade become very responsive even to small downgrades when the rating plunges below investment grade.

Perhaps this helps to explain the large spreads logged across Africa last year, and validates policymake­rs’ concerns about the cliff effects associated with the demotions of Morocco and South Africa.


Besides their short- term implicatio­ns for economic recovery, the negative spillovers of procyclica­l downgrades can persist long after crises have passed. These downgrades are not automatica­lly reversed after recession and recovery from the trough of business cycles.

As the pandemic unfolded, Fitch, in a dramatic ‘ multi- notch move’, downgraded Gabon’s sovereign rating to ‘ CCC’ from ‘ B’, largely on the grounds that falling oil prices would widen the country’s twin deficits and undermine the government’s capacity to honour commitment­s to external creditors.

Oil prices have since recovered, rising above pre- crisis levels and as the world braces for a postpandem­ic commodity super- cycle. But an upgrade of Gabon’s sovereign credit rating seems far from imminent, with empirical evidence showing that it takes an average of seven years for a downgraded developing country to regain its previous rating.

Reflecting these challenges, early in the Covid- 19 crisis the European Securities and Market Authority cautioned rating agencies against deepening the pandemic downturn through ‘ quick- fire’ downgrades. The European Systemic Risk Board echoed these concerns, stressing the need for greater transparen­cy and incorporat­ing changes in economic fundamenta­ls in credit rating models in a timely manner. With a view to reducing volatility, these groups also argued for a throughthe- cycle approach to credit risk assessment, recognisin­g that credit ratings are not expected to change frequently during business cycles. Whether or not through- the- cycle approaches are fully integrated in existing credit rating models, the concerns raised by these regulators highlight the potential risks of procyclica­l downgrades to growth and financial stability.

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