LocationsDevelopment Context of Sovereign Credit Ratings
Sovereign credit ratings are important to international investors because they quantify an assessment of country risk. Sovereign ratings have the capacity to coordinate investors’ beliefs. In theory, developing marketplaces can benefit from using these internationally-recognised standards of creditworthiness.
THE DEVELOPMENT IMPACT OF SOVEREIGN CREDIT RATINGS
The credit rating agencies have been noted to act in a ‘procyclical’ manner, meaning they rate positively during periods of growth but when the market turns, their ratings plummet and create wide instability. There are also concerns over bias in the rating processes, conflicts of interest, and methodological issues concerning transparency.
There is a growing body of research that confirms a high level of subjectivity within the credit ratings produced by the large credit rating agencies. In addition, investors are increasingly becoming reliant on the qualitative considerations of the credit rating agencies in relation to developing economies, which is leading to ‘shortcuts’ being taken instead of proper due diligence.
What Led Developing Countries To Borrow on Capital Markets?
For developing countries, issuing Eurobonds and accessing the global capital markets is a relatively new endeavour. Traditionally, concessional loans from multilateral organisations like the World Bank or development banks was the usual approach. However, with more African countries graduating from least developed countries (LDC) status, and having limited access to concessional financing, commercial loans and bond issuances are now more common.
The reality of the new relationship between international investor and developing country is complex. Many countries in Africa are considered as particularly risky by investors. This is at the core of why African countries are paying significant premiums compared to relative peers in other parts of the world.
What is worth noting is that the relationship between the country and the investor is now determined by the credit rating agency. The role of the credit rating agency, in the investors’ eyes, is to provide an impartial, third-party opinion on the creditworthiness of the issuer. However, whilst the issuer pays for the rating to be created (known as ‘issuer-pays’), the credit rating agency has a legal obligation to protect the investor.
Limits imposed by the ‘Rating Ceiling’
The ‘rating ceiling’ relates to the notion that a corporate issuer is seldom rated higher than the sovereign that it resides within. In the leading developed countries, this is rarely an issue because most (usually) hold AAA ratings. Yet, in developing countries, this practice severely restricts the development opportunities of a sovereign, because its domestic marketplace is efficiently constrained.
As a result, a sovereign downgrade triggers corporate downgrades, meaning the sovereign credit rating impact is doubled – both the sovereign issuer and the corporate issuers within the sovereign are negatively affected. However, research suggests that the converse is not true when there is an upgrade.