This is not the first time rating agencies have adopted a procyclical approach, that is, one in which bad news is simply piled on bad news.
During the 2008 global financial crisis, rating agencies were accused of aggressively downgrading countries whose economies were already strained. Reports by the European and US Commissions found evidence that their decisions worsened the financial crisis.
Ten African countries have been downgraded since the COVID-19 pandemic started: Angola, Botswana, Cameroon, Cape Verde, Democratic Republic of the Congo, Gabon, Nigeria, South Africa, Mauritius and Zambia.
These decisions were based on expectations that their fiscal situations would deteriorate and their health systems would be severely strained by the pandemic.
But, in my view, the downgrade decisions reflect monumental bad timing. I would also argue that, in most cases, they were premature and unjustified.
These downgrades deep into junk impose a wave of other problems, worse than COVID-19. They cut sovereign bond value as collateral in central bank funding operations and drive interest rates high. Sovereign bond values are grossly discounted, at the same time escalating the cost of interest repayment instalments, ultimately contributing to a rise in the cost of debt. A wave of corporate downgrades also follows because of the sovereign ceiling concept, a country’s rating generally dictates the highest rating assigned to companies within its borders.
In response to the procyclical COVID-19 induced downgrades, African countries need to implement these four measures.
First, to curb the procyclical nature of rating actions that disrupt markets by triggering market panic, the timing of rating announcements needs to be regulated.
Second, the rules of disclosure and transparency should be enhanced during rating reviews. Rating methodologies, descriptions of models and key rating assumptions should be disclosed to enable investors to perform their own due diligence to reach their own conclusions.
Third, in collaboration with other market regulatory bodies in the financial markets, transactions that unfairly benefit from crisis-driven price falls should be restricted. This includes short-selling of securities, a market strategy that allows investors to profit from securities when their value goes down.
Lastly, African countries need to develop the capacity for rigorous engagement with rating agencies during rating reviews and appeals. They need to make sure that the agencies have all the information required to make a fair assessment of their rating profiles.
The African Union and its policy organs need to fast track the adoption of its continental policy framework of mechanisms on rating agencies’ support for countries. This will assist them to manage the practices of rating agencies.
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