African credit ratings carry significant weight

Credit ratings are more than just a technical assessment for development finance institutions and sovereigns in Africa. They influence how much capital can be raised and how cheaply it can be accessed, ultimately affecting the financing of roads, hospitals, power plants, and businesses.

The recent affirmation of African Export-Import Bank (Afreximbank) at BBB+ with a Stable Outlook by S&P Global Ratings is significant.

Origins of Credit Ratings

The first credit ratings were introduced by John Moody in 1909 for securities issued by steam railroad companies. Moody’s Analyses of Railroad Investments was a publication that sold out within three months and received positive reviews, marking the beginning of a new era in credit assessment.

Other rating agencies, such as Poor’s Publishing and Fitch Publishing Company, soon followed. The Big Three rating agencies – Moody’s, Standard & Poor’s, and Fitch – remain dominant today, evaluating the creditworthiness of entities that issue debt.

The rating system assigns alphabetic markers to denote the ability and willingness of debt issuers to meet their financial obligations. The system has evolved over time, with some differences in notation and methodology between the rating agencies.

Importance of Ratings for African Institutions

Ratings represent a vote of confidence in Africa’s development finance institutions, which play a critical role in mobilizing capital for development projects. With rising debt service costs and declining access to concessional financing, African governments are grappling with significant financing gaps.

The “Africa risk premium” refers to the disproportionate rate at which Africa borrows compared to other regions. President Ruto of Kenya has criticized global credit rating agencies for relying on flawed models and outdated assumptions, leading to distorted ratings and high borrowing costs. There is a growing recognition of the need for more Africa-specific data and regional context in credit rating analysis.

The Africa Credit Rating Agency (AfCRA) aims to address this need by incorporating more local data and context into its analysis.

Afreximbank, a pan-African financial institution, has become increasingly important in trade finance and development projects.

Wale Olusi, director of deals advisory at PwC Nigeria, notes that Afreximbank’s role is often underestimated. The bank’s support for the African Continental Free Trade Area (AfCFTA) and financing of industrial parks and special export processing zones has made it a critical player in Africa’s economic transformation.

A strong credit rating can lower borrowing costs and expand access to institutional investors, ultimately benefiting development projects and the continent’s economic growth.

Ayokunle Olubunmi, head of financial institutions ratings at Agusto & Co, notes that good credit ratings are essential for development finance institutions to raise funds at low interest rates and support businesses at subsidized rates.

Olusi points out that Afreximbank’s significance extends beyond lending, representing an emerging confidence in African-led solutions to African challenges. The recent S&P upgrade for Afreximbank strengthens the institution’s ability to attract capital and expands the scope for future interventions across critical sectors.

Evolution of Rating Methodologies

Moody’s system uses a mix of uppercase and lowercase letters, allowing finer distinctions within a rating band.

Within each band, Moody’s adds the numbers 1 through 3 to signal relative strength, a practice not shared by its rivals.

S&P and Fitch rely on plus and minus signs to indicate incremental differences, simplifying the visual cue for market participants.

Fitch also places an “R” before a “D” rating, creating a distinct category that precedes full default status.

DFIs as Intermediaries in a Tightening Market

Development finance institutions serve as bridges between global capital pools and the continent’s infrastructure needs.