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Monday, 24 April 2017

Are credit rating agencies the problem or part of the solution?

  Carmel Rawhani and Elizabeth Sidiropoulos
Are credit rating agencies the problem or part of the solution? Photo © GotCredit/Flickr

When it comes to the economic reputation of a country are credit rating agencies (CRAs) part of the problem or part of the solution? This question has received increasing focus since the 2008 financial crisis, particularly in light of the impact these agencies’ ratings can have on already vulnerable countries by affecting their ability to access capital markets and, importantly, foreign direct investment.

Of course, CRAs play an essential role in minimising informational asymmetries between lenders or investors, on the one hand, and issuers on the other, thereby facilitating international financial flows. Nonetheless, a low rating can stick for a long time, potentially aggravating an already unfavourable financial environment in the country it applies to.

Click here to read our related article 'Is anyone listening? Of downgrades, hubris and redemption'.

Credit rating is a highly concentrated industry and therefore inherently problematic. Of the top three companies, two (Moody’s Investors Service (Moody’s) and Standard and Poor’s (S&P)), control 80% of the global market. Fitch Ratings (Fitch) controls another 15%, meaning that these three control a combined 95% of the global market. Rating agencies such as the ‘big three’ mentioned here produce sovereign credit ratings, statistics which give investors an idea of the risk associated with investing in a country, expressed both in the form of a ranking and an accompanying assessment of the country’s outlook (which indicates the likelihood of the ranking changing in the coming year, and whether that change will be positive or negative). A country’s overall rating has a significant impact on its economy as it signals its economic strength- particularly the perceived likelihood of a country being able to service loans. With ratings decisions concentrated in the hands of a minority like the ‘big three’, the potential impact of these decisions becomes huge. Moody’s, for example, received a fine in January this year after admitting to issuing false high ratings to American home loans which defaulted in 2008 and triggered an international financial crisis.

While it is easy to point the finger of critique at CRAs when ratings change and countries feel hard done by, the truth of the matter is far more nuanced, and there is no hard and fast answer to the question posed in the opening paragraph. Greece, for example, enjoyed a higher rating than many would posit it deserved, simply because it was a member of the Eurozone and it was assumed that it would be bailed out in the event of defaulting. While this may have bought it a few years before the financial crisis really took its toll on the country, in the medium to long run it probably allowed Greece’s problems to become far worse. On the other hand, labelling a country with a low rating has also made CRAs the target of criticism, bringing them under fire for the effects these ratings have on developing countries. Despite the number of examples, though, it seems we are no closer to an answer on the value of CRAs than we were when they failed to predict the Asian financial crisis of the late 1990s.

The table below lists the credit ratings of the BRICS countries as well as those African countries which have been rated by at least two of the ‘big three’ (S&P, Moody’s, and Fitch). Those countries whose rating labels them as ‘non-investment grade’ (also termed sub-investment) have been highlighted in blue. Interestingly, the only countries not ranked as sub-investment across the board are China, India, Botswana, and Namibia (with the important caveat that Botswana and Namibia have only been rated by two of the ‘big three’). Morocco has an investment grade from two ratings agencies, but is rated sub-investment by Moody’s.

    S&P Moody's Fitch
    rating outlook rating outlook rating outlook
BRICS South Africa BB+ Negative Baa2 Negative BB+ Stable
Brazil BB Negative Ba2 Stable BB Negative
China AA- Negative Aa3 Negative A+ Stable
India BBB- Stable Baa3 Positive BBB- Stable
Russia BB+ Positive Ba1 Stable BBB- Stable
Africa Angola B Negative B1 Negative B Negative
Botswana A-/A-2 Negative A2 Stable    
Cameroon B Stable B2 Stable B Stable
Cape Verde B Negative Watch     B Stable
Republic of the
B-/B Negative B3 Stable    
Egypt B- Stable B3 Stable B Stable
Ethiopia B Stable B1 Stable B Stable
Gabon B Stable B1 Negative B+ Negative
Ghana B-/B Stable B3 Stable B Negative
Ivory Coast   Ba3 Stable B+ Stable
Kenya B+/B Stable B1 Stable B+ Negative
Morocco BBB- Stable Ba1 Positive BBB- Stable
Mozambique SD/D N/A Caa3 Negative CC N/A
Namibia     Baa3 Negative BBB- Negative
Nigeria B Stable B1 Stable B+ Negative
Republic of the
B-/B Stable B3 Negative CCC N/A
Rwanda B Stable B2 Stable B+ Stable
Senegal B+/B Stable B1 Positive    
Tunisia BB- Negative Ba3 Negative B+ Stable
Uganda B Stable B2 Stable B+ Stable
Zambia B Negative B3 Negative B Negative

Source: S&P Global Ratings ‘Global Sovereigns’’ [Accessed 18 April 2017]; Trading Economics ‘Credit Rating’, [Accessed on 5 April 2017]

With South Africa’s recent downgrade to junk status the country faces higher costs on petrol and other imports (although exports may benefit from a weaker rand), higher debt financing costs, reduced business confidence, and exodus by institutional investors whose funds may ban investments in countries with sub-investment ratings. It is important to note that 90% of South Africa’s debt is rand-denominated, which means that in the short to medium term a weakening rand should not impact significantly on the debt-to-GDP ratio.

Clearly, CRAs are both helpful and problematic. Where investors and international financial institutions are unfamiliar with a country a centralised ratings system can be helpful. However, it can also be dangerously simplistic. Ultimately, CRAs remain important, and there is no replacement for the information they produce and provide. However, to mitigate the often adverse effects of the uptake of this information, they should additionally provide easily accessible information on the accuracy of their rating, and all of the factors which influence the ultimate ranking including the data on which a rating is based.

Carmel Rawhani is a programme officer in the governance and foreign policy programme and Elizabeth Sidiropoulos is the chief executive at the South African Institute of International Affairs (SAIIA).

Read our related opinion piece on South Africa's economic downgrade:
The impact of the cabinet reshuffle on South Africa’s standing as an emerging power