The pandemic crisis has increased one of the serious challenges facing Africa in its path of development: the high costs of premiums collected, the inflated risks periodically assigned to Africa, regardless of the improvement of its macroeconomic fundamentals, the economic environment and the growth prospects of each country. . The global nature of the pandemic crisis provides an opportunity to examine the extent to which perception premiums are shaping the distribution of sovereign risk between countries and regions; the disproportionately larger number of African nations affected by procyclical degradation further supports the premium hypothesis.
More than 56 per cent of African countries rated by at least one of the three major credit rating agencies (Standard & Poor’s, Fitch and Moody’s) fell short of the 2020 pandemic, while only 9.2 per cent one percent in Europe and 28 percent in Asia led to a global average of 31.8 percent. The disproportionate degradation occurred despite Africa showing greater resistance to growth in the face of the global synchronized recession triggered by a pandemic, which contracted by less than 2%, compared to a global average of 3.3%.
However, African countries continue to face higher premiums, with lasting consequences. In the short term, these premiums increase the risk of debt overruns and restrict fiscal space, undermining the ability of governments to respond effectively to recurring adverse global shocks — as illustrated by the challenges associated with debt management. COVID-19 crisis. While significantly lower interest rates (negative in real terms) have allowed advanced economies to navigate effectively through the pandemic crisis by extending a large monetary and fiscal stimulus, the debt rates of African assets, crushers of the pandemic. growth and driven by default, they have set the stage for a divergence. recovery and increase the risk of excess debt.
These premiums also have far-reaching consequences for macroeconomic management and long-term sustainable development. By deterring investors and limiting access to long-term financing, they exacerbate liquidity constraints and undermine the process of economic transformation needed for Africa’s effective integration into the world economy, which traps countries in a perpetual trap. debt that jeopardizes global financial stability.
Calls from a growing number of leaders to address this issue are steps in the right direction. For example, at the annual meetings of the World Bank-IMF, held in October 2020, the Managing Director of the IMF, Kristalina Georgieva, remarked that “great attention must be paid to reducing the real and perceived risk of ‘Investing in Africa, so we can see this huge availability of funding for the rest of the world is schooled in Africa.’ Earlier this year, French President Emmanuel Macron, who has called for “fairer financing rules for African economies,” hosted a summit on financing African economies. Indeed, strong engagement and effective coordination among stakeholders will be key to the emergence of an international financial architecture that fosters a globally inclusive approach to affordable financing for development.
What can and should be done?
For African nations, governments should intensify ongoing efforts to improve the information architecture, deepen economic and institutional reforms, and accelerate the implementation of the African Continental Free Trade Agreement (AfCFTA) to promote diversifying sources of growth and exports and expanding the tax base. As the pandemic unfolded, Fitch, in a dramatic “multi-notch movement,” downgraded Gabon’s sovereign rating to CCC from B, largely based on falling oil prices that would raise twins. of the country and would undermine the government’s ability to meet external creditor commitments. Standard & Poor’s downgraded Botswana, one of the leading diamond exporters and the only A-country in Africa, for the same reason. Economic diversification will reduce the unhealthy correlation between growth cycles and commodity prices and sustainably drive growth in foreign reserves and government revenue to place the region on the path to fiscal and debt sustainability. long-term, both positive in credit rating.
But to get Africa out of this vicious cycle — a model in which the colonial development model of resource extraction is both a risk factor and a deterrent to long-term development financing — African sovereign risk models must integrate the diversity of African countries and their brightest economic prospects. . Low debt-to-GDP levels and strong economic growth should be positively correlated with sovereign credit scores for greater coherence and attractiveness on the road to macroeconomic reforms. As strong economic reformers are rewarded for growing access to finance for sustainable development, they could follow incentives for more countries to adopt difficult reforms, kicking off a virtuous cycle of accelerating growth driven by competitive access to all the world to affordable financing for development.
At the same time, rating agencies should refrain from pro-cyclical degradations, which often trigger sudden stops and reversals of capital flows in a “flight to quality” and, instead, they should capture the long-term perspective of debtors. By increasing borrowing costs and increasing liquidity constraints, pro-cyclical degradations can prolong and deepen economic crises. For example, by increasing balance of payments pressures and undermining investment growth, persistent liquidity crises can turn into long-term solvency crises and cascading defaults. Fostering transparency and strengthening coordination between the IMF and credit rating agencies will ensure greater coherence and gradually alleviate the lack of perception leading to pro-cyclical degradations and ruinous premiums in Africa.
While sovereign credit ratings have a direct impact on an affected country’s ability to mobilize long-term financing, the consequences of large-scale pro-cyclical degradations can be far-reaching, with potential risks to financial stability. international. A globally coordinated approach that promotes accountability and transparency in the production of consistent sovereign risk estimates will be more effective in regulating the commercial practices of rating agencies. This body could follow the models established by the United States Securities and Exchange Commission and the European Securities and Markets Authority. Except for South Africa, which assigned to its Financial Services Council the administration of the Credit Rating Services Act 2012 and the oversight of the operations of credit rating agencies, no other country in the region has a similar structure. .
In the medium and long term, the development of deep, efficient and well-regulated national capital markets will be vital to diversify sources of financing and reduce liquidity and foreign exchange risks. These markets will reduce dependence on foreign currency debt and improve countries’ ability to withstand volatile capital outflows. They will provide a secure and stable source of funding, while helping countries build appropriate yield curves to improve investment decisions and keep them on a long-term path of strong economic growth. At the same time, they will increase the effectiveness of monetary policy and ultimately put countries on the path of cyclical improvement in liquidity and borrowing costs.
That said, to advance in the development of vibrant public bond markets in local currency in the region will need to transcend national constructions to integrate fragmented and very illiquid financial markets to reflect the game-changing integration of continental trade, grounded for free continental African trade. Okay. Subsequently, the emergence of a continental financial ecosystem that favors the development of a money market to provide short-term liquidity to governments, commercial banks and other large institutions, as well as a vibrant replacement market to provide interest-backed loans meet short-term financing and liquidity: will be the next critical puzzle of economic stability and financing of sustainable development in Africa.
In particular, while a vibrant money market is a necessary condition for the emergence of successful and liquid stock markets, the development of a local replenishment market is key to improving the money market and bond market nexus. However, success in the development of local sovereign bond markets also depends on intensifying reforms to improve Africa’s regulatory and political environment and foster policy coherence.
The perceived quality of the institutional environment, which has been identified as a key driver of market access, is positive in the credit rating. When combined with the diversification of sources of growth and exports, which will reduce the correlation between growth and price cycles of commodities and cultivate Africa’s foreign reserve assets, it will act as a booster and multiplier of the rating. credit, placing the region on a long-term trajectory. of fiscal and debt sustainability.
Over time, this mutually reinforcing combination of institutional reforms and diversification of growth sources will stimulate global demand for African assets and gradually reduce the credit spreads of African sovereign and corporate bond issuers to equalize access. to the global reserve of financial resources and unlock competition. world capital for sustainable economic development.
For more on this topic, see my recent article, “The Ruinous Price for Africa of Pernicious“ Perception Premiums ”.