Analysis: KALENGO SIMUKOKO
ZAMBIA received its first sovereign rating by Fitch about five years ago and over the last couple of years, Fitch, Moody’s and Standard & Poor’s, which are the world’s “big three” credit rating agencies, have had to upgrade and downgrade the country’s rating at different intervals.
Fitch and Moody’s ratings remain unchanged at B- and B3- as announced in February 2017 but Standards and Poor’ revised its rating few days ago from B with a negative outlook to B with a positive outlook a result which has elated the Finance Minister with press releases promptly sent to all leading media houses by the Treasury.
But what do these sovereign ratings mean? Are they really necessary and how are they any one of us – ordinary citizens’ business? What are their implications on the country?
Different CRAs present their ratings differently but they are all a reflection of their opinion with respect to the borrower’s ability to meet interest and principal repayment obligations in a timely manner. As a result, they influence both the decisions to lend or invest and the price at which funds are lent or invested.
Obligors with ratings from BBB to AAA (for S & P) are referred to as invest grade or low risk while those below BBB (D to BB) are referred to as non-investment grade or high risk. Borrowers or debt issuers falling in the latter category often pay high interest rates and have to provide secondary repayment sources or collateral as the likelihood of default is considered high while those rated BBB to AAA enjoy lower interest rates and borrow without collateral.
At the request of the country, a CRA will evaluate the economic and political environment to derive a representative credit rating called a sovereign rating which most investors use as independent confirmations of a country’s credit standing or to gain insight into the level of risk associated with investing in a particular country.
Thus a good sovereign rating helps a country in accessing funding in global markets at better prices and is also an important driver of foreign direct investment inflows.
Therefore S &P’s recent upgrading of Zambia’s rating from B negative to B positive on the back of the ongoing economic reforms, still places the country in the high risk or junk category, and has a number of implications.
First, an upgraded sovereign rating has a positive impact on the country’s ability to compete for and attract foreign direct investment (direct cross-border investments where investors have control or a significant degree of influence over the management of a company in a foreign recipient country).
Since FDI cannot be easily withdrawn when the recipient country’s economic conditions decline, international investors who want to diversify their portfolios in different countries depend on, among other things, sovereign ratings for information regarding the financial status of a country. Thus a good sovereign rating increases the potential to attract FDI which leads to increased job creation resulting in reduced poverty levels in the country.
It is worth noting though that in some instances an emerging economy with low sovereign rating may still attract high FDI inflows depending on investor risk attitude and the amount of trade between donor and recipient country. Also regional or neighbouring countries’ investment environments or stability affect the levels of FDI inflows into a country which is why countries actively engage in diplomatic efforts that ensure peace and stability in their regions or neighbourhoods.
Zambia mobilises revenues for development from taxes and through borrowings from foreign and domestic creditors by issuing bonds like the current Eurobonds or contracting normal loan facilities. The coupon or interest rate it pays to bondholders or lenders depends on its credit rating. A rating upgrade like the one S& P announced few days ago signals an improvement in the country’s capacity to service its debts which has the potential to lead to reduced interest rates or coupon rates for the Euro bonds. Lower coupon or interest burden means the country can save and re-assign resources to other priorities. The reverse is also true-an increased interest burden may lead to suspension of some of the developmental projects or disruption of service delivery.
The impact of sovereign rating upgrades/downgrades extends to the ratings and cost of debt or capital for individual businesses domiciled in Zambia as generally firms cannot have credit ratings above that of their country of domiciliation. Thus a sovereign rating upgrade helps Zambian domiciled businesses to attract financing in global markets at better rates and vice versa.
For instance, if Zambia attained an investment grade rating (BBB to AAA), not only would the interest rates at which Zambian domiciled companies or projects access financing in the global markets reduce but also demands for sovereign guarantees as collateral for government and state-owned enterprises (SOEs) projects, which seems to be the norm currently, would greatly reduce. And increased access to cost effective financing by the SOEs would increase projects implement rate resulting in increased business opportunities, job and wealth creation.
Some empirical evidence also suggests that where a well-developed equity market exists, a sovereign rating upgrade can lead to decreased stock market and bond price volatilities. The reverse is also true.
Although credit rating agencies have been under a cloud of suspicion following their role in the 2007-2009 global financial crisis and other corporate failures, their ratings still do affect our bread and butter as they influence capital flows and investment decisions which create the jobs and wealth that we all so much desire.
With a B rating Zambia still falls in the high risk or junk category. However, the country can build on this foundation and confidence the rating upgrade has provided and continue to address the determinants for sovereign credit ratings such as per capita income (as the greater the potential tax base of the country, the greater its ability to repay debt), GDP growth (making the country’s existing debt burden to become easier to service over time), inflation rate, level of external debt, economic development et cetera in order to improve future ratings.
Given the increased competition for FDI in Sub Saharan Africa and in order to reduce the cost of debt/capital for both state and businesses, Zambia must make becoming an investment grade rated country like Botswana one of its medium term goals.
The author is finance and economic commentator, certified Financial Consultant and a director at United Bank for Africa (UBA).