Sovereign credit rating--how it works and why it is vital: why are organisations such as Moody's and Standard and Poor's so influential? Who are they and what do they do? What is sovereign credit rating? Neil Ford provides answers to these and other investment related questions.
One of the main factors that deters foreign companies from investing in sub-Saharan Africa outside the oil, gas and mining sectors is ignorance. Many globally well known conglomerates simply do not know much about the region. Investors use many sources of information to judge the attractiveness of any particular market, but none more so than the credit risk ratings that are provided by companies such as Fitch Ratings Fitch Ratings
An international rating agency for financial institutions, insurance companies, and corporate, sovereign, and municipal debt. Fitch Ratings has headquarters in New York and London and is wholly owned by FIMALAC of Paris. , Moody's and Standard and Poor's Noun 1. Standard and Poor's - a broadly based stock market index
Standard and Poor's Index .
Until recently, these firms largely ignored sub-Saharan Africa beyond South Africa South Africa, Afrikaans Suid-Afrika, officially Republic of South Africa, republic (2005 est. pop. 44,344,000), 471,442 sq mi (1,221,037 sq km), S Africa. but some have now begun to offer ratings under a scheme developed by the UN. These ratings should provide some assurance for companies willing to dip their toes in African waters.
During 2003, the United Nations Development Programme (UNDP UNDP United Nations Development Programme
UNDP Unión Nacional para la Democracia y el Progreso (National Union for Democracy and Progress) ) launched a credit rating programme with Standard and Poor's (S & P's) to provide sovereign risk Sovereign Risk
The risk that a foreign central bank will alter its foreign-exchange regulations thereby significantly reducing or completely nulling the value of foreign-exchange contracts. ratings for much of Africa.
Ghana was the first to be assessed, with a B+ long term foreign currency rating, followed by Cameroon and Benin with long term and short ratings.
The list of ratings was extended during the course of 2004 and now comprises the African Development Bank, Benin, Botswana, Burkina Faso Burkina Faso (burkē`nə fä`sō), republic (2005 est. pop. 13,925,000), 105,869 sq mi (274,200 sq km), W Africa. It borders on Mali in the west and north, on Niger in the northeast, on Benin in the southeast, and on Togo, Ghana, and , Cameroon, Development Bank of Southern Africa The Development Bank of Southern Africa (DBSA) is a Development Finance Institution based in South Africa that focuses on investments and joint ventures/partnerships in public and private sector financing, mainly for infrastructural development throughout Sub-Saharan Africa. , Egypt, Madagascar, Mali, Morocco, Mozambique, Senegal, South Africa and Tunisia.
It is hoped that the ratings will help provide comprehensive economic statistics to potential investors and assist African governments in accessing international capital markets.
In 2004, the associate administrator of the UNDP, Zephirin Diabre, appealed for the expansion of sovereign risk coverage to take in yet more African countries. He told delegates at a Corporate Council on Africa The Corporate Council on Africa (CCA) is a non-governmental organization (NGO) focusing on strengthening commercial relationships between the United States and the African continent. (CCA (1) (Common Cryptographic Architecture) Cryptography software from IBM for MVS and DOS applications.
(2) (Compatible Communications A ) conference: "The investment potential in Africa is huge. Through our credit rating initiative, we intend to support countries in their efforts to mobilise resources from private capital markets. We hope that better access to financing will help African countries to tackle a broad range of poverty alleviation issues and provide an incentive to achieve the Millennium Development Goals “MDG” redirects here. For other uses, see MDG (disambiguation).
The Millennium Development Goals are eight goals that 192 United Nations member states have agreed to try to achieve by the year 2015. ." At the same time, the US sponsored CCA is attempting to highlight the fact that African investment projects can be profitable for financiers.
When Mali was added to S & P's list last year, Diabre explained: "With this rating, Mali appears on the map of rated countries and increases its visibility on the international financial scene. The rating will increase the capacity of Mali to mobilise financing and allocate additional resources to poverty reduction."
On the surface, Mali seems an unlikely target for foreign direct investment (FDI FDI
See: Foreign direct investment ) outside the gold sector given its negative international profile. It ranks among the lowest 10 countries on the Human Development index, two thirds of the population cannot read or write and its infant mortality rate infant mortality rate
The ratio of the number of deaths in the first year of life to the number of live births occurring in the same population during the same period of time. is one of the highest in the world. Yet S & P's allocation of B long term and B short term risk ratings, plus its conclusion that the country's outlook is stable provides an element of confidence that the level of sovereign risk is manageable.
The government's sound fiscal policies should ensure that bilateral and multilateral donor support will continue. A credit analyst at S & P's, Luc Marchand, commented: "The ratings on Mali balance the challenges of its underdeveloped economic structure and weak public finances with the benefits accruing from its membership in the West African Economic and Monetary Union The West African Economic and Monetary Union (or UEMOA from its name in French, Union économique et monétaire ouest-africaine) is an organization of eight states of West Africa established to promote economic integration among countries that share a common currency, (WAEMU WAEMU West African Economic and Monetary Union ) and from donor and official creditor support."
Africa's own credit risk companies
The UNDP is also trying to assist in the development of Africa's stock exchanges. It has held a series of meetings under the umbrella of the African Capital Markets Development Forum, to allow stock exchange managers to study best practice. The Forum aims to help the region's bourses attract international investors by improving liquidity and their regulatory frameworks. The events have also attracted delegates from African governments and investment banks.
However, S & P's is not the only company to provide credit risk ratings for African countries. Export credit insurance agencies, such as Compagnie Francaise d'Assurance pour le Commerce Exterieur (Coface) in France, for example, offer their own ratings. Coface provides ratings on 151 countries, including many in sub-Saharan Africa, reflecting the average level of short term non-payment risk associated with companies in each country. Export credit insurance organisations have long offered insurance for firms targeting emerging markets for goods that have been despatched but not yet paid for but they are now increasingly active in African markets.
Table 1 explains what the ratings provided by companies like Coface actually mean. For example, the agency recently upgraded the rating for Gabon from C to B because of the improvement in the government's fiscal position. Higher oil revenues and more successful adherence to the IMF IMF
See: International Monetary Fund
See International Monetary Fund (IMF). programme agreed in 2004 have led to a budget surplus and have enabled the government to settle its debts on time. The country's diversification programme is also back on course and increased FDI in the timber and mining sectors is likely.
Two African agencies, Credit Insurance Zimbabwe Ltd (Credsure) and South Africa's Credit Guarantee Insurance Corporation of Africa Ltd (CGIC CGIC Clinical Global Impression of Change
CGIC Credit Guarantee Insurance Corporation (South Africa)
CGIC Co-operators General Insurance Company
CGIC Capital Guaranty Insurance Company
CGIC Canadian Geoscience Information Center ), are both members of the international association of export credit insurance bodies, known as the Berne Union.
CGIC is owned by a range of financial organisations, including Munich Reinsurance The contract made between an insurance company and a third party to protect the insurance company from losses. The contract provides for the third party to pay for the loss sustained by the insurance company when the company makes a payment on the original contract. Company of Africa and Barclays Bank's new South African acquisition, Absa Bank. It offers credit risk that is underwritten by a number of different insurance firms and has set up joint ventures with local companies to offer export credit insurance in Ghana, Kenya, Mauritius and Namibia.
While many investors may worry about the possibility of non-payment by African customers, much of CGIC's work involves sorting out payment delays by European and North American North American
named after North America.
North American blastomycosis
see North American blastomycosis.
North American cattle tick
see boophilusannulatus. importers that have failed to settle their accounts with African exporters.
The Common Market for Eastern and Southern Africa The Common Market for Eastern and Southern Africa, is a preferential trading area with twenty member states stretching from Libya to Zimbabwe. COMESA formed in December 1994, replacing a Preferential Trade Area which had existed since 1981. (Comesa) has set up a similar agency to assist exporters in its member states. The African Trade Insurance Agency (ATI (ATI Technologies Inc., Markham Ontario, http://ati.amd.com) A leading manufacturer of graphics chips and display adapters. Founded in 1985 by K. Y. Ho, Benny Lau and Lee Lau, ATI chips and boards are widely used by OEMs. ) already covers Burundi, Eritrea, Kenya, Madagascar, Malawi, Rwanda, Tanzania, Uganda and Zambia. ATI member states have taken on financial liability for any political risk losses that could affect trade in their own countries and the organisation is also able to insure against terrorism physical damage risks.
In addition, ATI works alongside the Multilateral Investment Guarantee Agency Multilateral Investment Guarantee Agency (MIGA), specialized agency of the United Nations. Formed in 1988, with headquarters in Washington, D.C., it is a member of the World Bank Group (see International Bank for Reconstruction and Development) and membership in the (MIGA See Multilateral Investment Guarantee Agency. ) to promote investment in African economies. Bernie de Haldevang, speaking in his former capacity as managing director and chief executive of ATI, commented that the agreement with MIGA "heralds a major breakthrough in the bid to increase African private sector growth as a tool for reducing poverty. It will also serve to ensure that ATI can better fulfil its mandate to encourage and support new investments into and among African countries."
Even in a decade's time, it will be very difficult to judge how much impact the ratings have had on attracting new investment in the listed countries. So many other factors play a large role in determining levels of economic growth and FDI that it may be almost impossible to discern which factor has made a significant contribution.
However, there is no doubt that the provision of credit risk ratings cannot help but inform potential investors and help break down the culture of ignorance that surrounds many investors' view of the continent.
Moreover, the ratings should also help to normalise Verb 1. normalise - become normal or return to its normal state; "Let us hope that relations with this country will normalize soon"
change - undergo a change; become different in essence; losing one's or its original nature; "She changed completely the view of African economies by bringing them into the mainstream and placing them on a par with other countries in the world. It is understandable that collapsed economies, like Somalia and Afghanistan, should be accorded special treatment and placed in their own category, but most African states deserve to be judged on an equal basis with other economies in the world.
Many African countries still have major structural failings in their investment climate but the provision of more information is sure to put those failings into perspective. All too often, African economies have appeared beneath the radar of many investors, but the increasing application of credit risk ratings to the continent should help put countries like Mali and Benin on the map.
Table 1: COFACE COUNTRY RATINGS A1: The steady political and economic environment has positive effects on an already good payment record of companies. Very weak default probability A2: Default probability is still weak even in the case when one country's political and economic environment or the payment record of companies is not as good as in A1-rated countries. A3: Adverse political or economic circumstances may lead to a worsening payment record that is already lower than the previous categories, although the probability of a payment default is still low. A4: An already patchy payment record could be further worsened by a deteriorating political and economic environment. Nevertheless, the probability of a default is still acceptable. B: An unsteady political and economic environment is likely to affect further an already poor payment record. C: A very unsteady political and economic environment could deteriorate an already bad payment record. D: The high risk profile of a country's economic and political environment will further worsen a generally very bad payment record. Source: Coface