written for the blog strategieswithdouglas.com by douglas...
TRANSCRIPT
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Written for the Blog Strategieswithdouglas.com by Douglas Maseka
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1. EXECUTIVE SUMMARY
This article is written for the blog strategieswithdouglas.com with the view of contributing
to the public’s general knowledge on the appropriate application of specialized economic
and financial information. It provides a detailed explanation of the meaning of the recently
issued public statement by the 3 major Credit Rating Agencies on Zambia’s
creditworthiness. It is hoped that by reading this article, readers will have a clear
understanding of the implication of the recently issued public statement by the 3 major
Credit Rating Agencies on Zambia’s creditworthiness and confidently assess the
correctness of media statements and comments from economic and financial analysts.
The three (3) major global rating agencies,
Moody’s, Standard & Poors and Fitch
recently released their latest Sovereign
Credit Rating for Zambia. On January 10th,
2018, Fitch issued a statement affirming
its B rating for Zambia and changed the
outlook to stable from negative. This
statement follows the statement Fitch
issued on November 27th, 2017 in which
the Country’s B rating was yet again
affirmed but this time the outlook was
negative.
In a similar move, Moody’s, in a press
statement released on January 26, 2018,
changed the outlook on Zambia’s B3
rating to stable from negative and
affirmed the B3 rating. This is the latest
credit opinion statement on Zambia since
the November 1st, 2017 press release in
which the Country’s B3 rating was yet
again affirmed although the outlook was
negative.
A few weeks later On February 23, 2018,
Standard & Poors (S&P) also affirmed
Zambia’s B rating and maintained the
stable outlook. Unlike Moody’s and Fitch
who only changed the rating outlook from
negative to stable this year, S&P changed
its rating outlook from negative to stable
in August 2017 and also affirmed the B
rating.
There has since been a lot of reaction to
these statements from various sections of
the society. In this article, the author
provides the meaning and interpretation
credit rating statements on Zambia. The
article starts by explaining the general
meaning of Zambia’s rating before doing
a deep dive on the actual meaning of the
statements above.
2. TYPE AND MEANING OF THE
RATINGS
To ensure the ratings are interpreted
correctly and used appropriately, it is
important to understand the type and
meaning each rating agency attaches to
Zambia’s rating. Readers who are keen
followers of publications on
strategieswithdouglas.com would recall
that in the publication ‘The Structure of
The main objective of the ‘articles series’ on the blog strategieswithdouglas.com is to provide
costless decision ready information to the public as well as spark public debate on topical issues.
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Zambia’s Public Debt’, this author
indicated that it is of paramount
importance that each time data from
any source is used, greater effort must be
made to understand the parameters used
in deriving the data and purpose for
which the data is collected in order to
correctly interpret the data. This is the
importance of knowing the meaning each
rating agencies attaches to its rating.
2.1. TYPE OF THE RATING FOR
ZAMBIA
To derive the appropriate
meaning of Zambia’s rating, it
is important to know the type
of the rating. It may interest the
readers to know that each of
the three rating agencies
undertakes several different
ratings. Each rating type
conveys somewhat different
messages. Examples of these
ratings are; Issue Rating, Issuer
rating, National rating, Bank
Deposit Ratings and Credit
Default Swap Rating.
To remain attuned to the main
objective of this article, which
is explaining the meaning or
the message conveyed by the
statements from the 3 rating
agencies on Zambia’s
creditworthiness, only the
rating to which these
statements relate will be
covered here.
S&P categories Zambia’s rating
as the Issuer Credit Rating
(ICR) while Fitch categories it
as Issuer Default Ratings
(IDRs). Moody’s on the other
hand, categories Zambia’s
rating as Issuer Rating. Within
this broad category of Issuers
are corporations, countries,
banks etc. An Issuer (Zambia in
this case) is basically a country
borrowing funds by way of
floating (issuing) securities,
such as bonds. More broadly,
an Issuer can be viewed as
someone looking to borrow
funds or borrowing funds in
exchange for an ‘I owe you’.
Thus, all the 3 ratings on
Zambia relate to Zambia as a
borrower. A country rating is
usually referred to as a
Sovereign rating. S&P defines
a Sovereign as a state that
administers its own
government and is not subject
to or dependent on another
sovereign for all or most
prerogatives. The rating agency
considers the right to
determine the currency a
sovereign state uses, as well as
the right to determine political
and fiscal frameworks in which
it operates as one of the most
important prerogatives of a
sovereign.
2.2. THE GENERAL MEANING
OF THE RATING TYPE FOR
ZAMBIA
Having considered the type of
rating for Zambia, it is now
time to know the meaning
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attached to this by each
respective agency.
2.2.1. MOODY’S
According to Moody’s,
Issuer Ratings are
opinions of the ability
of the country to honor
senior unsecured debt
and debt like
obligations. Issuer
ratings reflect the risk
that debt and debt-
like claims are not
serviced on a timely
basis. However, the
ratings do not reflect
the risk that a
contract or other non-
debt obligation will be
subjected to
commercial disputes.
Additionally, while an
issuer may have senior
unsecured obligations
held by both
supranational
institutions (e.g. World
Bank or IMF), as well as
other investors, Issuer
Ratings reflect only
the risks faced by
other investors.
2.2.2. FITCH
Similarly, Fitch
considers the Issuer
Default Rating (IDR) as
opinions on the
relative ability of a
country to meet
financial commitments,
such as interest,
repayment of principal
or counterparty
obligations. It reflects a
country’s relative
vulnerability to default
on financial obligations.
The threshold default
risk addressed by the
IDR is generally that
of the financial
obligations whose
non-payment would
best reflect the
uncured failure of
that country. In
general, IDRs provide an
ordinal ranking of
Issuers based on the
agency's view of their
relative vulnerability
to default, rather than
a prediction of a
specific percentage
likelihood of default.
Fitch clearly states that
its credit ratings do not
directly address any risk
other than credit risk.
2.2.3. STANDARD & POORS
(S&P)
For S&P, Issuer Credit
Rating is a forward-
looking opinion about
an Issuer’s or obligor's
overall
creditworthiness.
Specifically, ratings
express a relative
ranking of
creditworthiness with
the likelihood of default
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being the primary factor
in the analysis of credit
worthiness. S&P
observes that the
opinion focuses on the
Issuer’s or obligor's
capacity and
willingness to meet its
financial
commitments as they
come due. It does not
apply to any specific
financial obligation, as it
does not take into
account the nature of
and provisions of the
obligation, statutory
preferences, or the
legality and
enforceability of the
obligation. In addition,
sovereign ratings
particularly pertain to
a sovereign's ability
and willingness to
service financial
obligations to
nonofficial
(commercial)
creditors. The issuer
credit rating (ICR) on a
sovereign does not
reflect its ability and
willingness to service
other types of
obligations, such as
obligations to other
governments (Paris
Club debt or
intergovernmental
debt); obligations to
supranationals, such as
the International
Monetary Fund (IMF) or
the World Bank;
obligations to public-
sector enterprises or
local governments.
From each rating agency’s interpretations
above, the following commonalities can
be derived;
a. That the ratings are opinions
b. That the ratings are only primarily
concern with Credit Risk
c. That not all debts or obligations
are incorporated when deriving
the ratings and therefore may be
less useful for certain creditors or
investors. In the same vein actual
country exposure to all creditors
may generally be worse than the
ratings reflect.
d. That the ratings do not predict a
percentage of likelihood of default
e. That the targeted users of the
ratings are portfolio investors
because it they that stand to lose if
a country fails to owner on its
obligations.
These commonalities are crucial to the
interpretation and application of
sovereign ratings. Firstly sovereign
ratings are expert opinions on the
country’s credit risk and they should
be considered as such. The same way
one visits a doctor and agrees to the
doctor’s prescription when such
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prescription is given without laboratory
tests having been undertaken, is the same
way these rating should be considered.
Note that expert opinions are largely
dependent on the quality of data used in
deriving them. For countries where data
quality is a challenge, so is the quality of
the opinion provided regardless of how
well qualified the expert is (i.e. how well
the Doctor’s prescription works is
dependent on how accurate the
description of your symptoms were)
Secondly, Sovereign Credit Rating
(SCR) directly address credit risk and
not country risk. This distinction is as
important as the difference between
Portfolio Investment (PI) and Foreign
Direct Investment (FDI). The
distinction between credit risk as covered
by a sovereign credit rating and country
risk is provided below. This distinction
helps clarify that there is no direct link
between SCR and the flow of FDI in
Zambia. However, there is a direct link
between SCR and the cost of funds (i.e.
interest on government securities) and to
some extent to the flow of PI.
Thirdly, SCR only covers the risk of
default on financial obligations to
nonofficial or commercial creditors
and not risk of default on obligations
to other governments (Paris Club debt
or intergovernmental debt),
obligations to supranationals
(International Monetary Fund (IMF)
or the World Bank), obligations to
public-sector enterprises or local
governments. In addition, SCR does not
reflect the risk that a particular contract
will be subject to commercial disputes.
One important implication of this is that
SCR is not an appropriate proxy of country
risk because it is limited in coverage or
scope.
Finally SCR reflects the country’s relative
vulnerability to default NOT the
percentage likelihood to default and that
it reflects the risk that country may not
service its debts to private or commercial
investors on time and NOT that the
country may fail to service a specific debt
(say the Zambian Eurobond).
3. THE MEANING OF THE RATING
AGENCIES’ PRESS STATEMENTS
Having considered the general meaning
of the ratings on Zambia in the previous
section, it is time to do a deep dive on the
actual meaning of the statements recently
issued on Zambia’s creditworthiness. For
easy of reference, these statements are
reproduced here.
On January 10th, 2018 Fitch issued a
statement affirming its B rating for
Zambia and changed the outlook to
stable from negative. On January 26,
2018, Moody’s changed outlook on
Zambia’s B3 rating to stable from
negative and affirmed the B3 rating.
On February 23, 2018, Standard & Poors
(S&P) also affirmed Zambia’s B rating
and maintained the stable outlook
All the three statements have a similar
wording structure; Zambia’s rating is
affirmed, outlook changed to stable or
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stable outlook maintained. In certain
circumstances, these statements might
have read Zambia’s a rating is confirmed.
Confirmed and affirmed have different
implications or meanings.
What does it mean to affirm a rating?
According to Fitch, an affirmed rate
means the rating has been reviewed
with no change in rating. For Moody’s,
an affirmation of a rating is a public
statement that the current Credit
Rating assigned to an issuer, which is
not currently under review, continues to
be appropriately positioned. In this
regard, by affirming Zambia’s B rating,
the rating agencies are merely
advising that Zambia’s rating has NOT
changed. Thus, the rating has remained
as B3 since Moody’s downgraded it from B2
in April, 2016 or B for Fitch since the
downgrade in 2013 from B+ or B for S&P
since the downgrade from B+ in 2015. This
helps clarify some distortions in some
recently issued statements by some
analysts claiming the Country’s rating has
be upgraded.
Readers may already know that the B
rating by Fitch implies that Zambia has a
present material default risk although its
limited margin of safety remains. Which
goes to say that the Country is currently
meeting it financial commitments but its
capacity for continued payment is
vulnerable to deterioration in its business
and economic environment. Similarly,
the B3 rating by Moody’s implies that
Zambia, as an issuer, is highly speculative
and subject to high credit risk. S&P, with
its B rating for Zambia, looks at the
country as currently having the capacity
to meet its financial commitments but
that the country is more vulnerable to
adverse business, financial, or economic
conditions which will likely impair it’s
capacity or willingness to meet its
financial commitments.
The other component in the wording
structure is ‘the stable outlook’. What
then is an outlook? According to Fitch, an
outlook indicates the direction a rating
is likely to move over a one- to two-year
period. Thus, it reflects financial or
other trends that have not yet reached
or been sustained the level that would
cause a rating action, but which may do
so if such trends continue. For S&P an
outlook indicates the company’s (i.e.
S&P’s) view regarding the potential
direction of a long-term credit rating
over the intermediate term (typically
six months to two years). Similarly, for
Moody’s an outlook is an opinion
regarding the likely rating direction
over the medium term. Broadly defined,
an outlook is a signal that measures being
implemented may help improve the
country’s creditworthiness or worsen its
creditworthiness.
You may liken an outlook to traffic lights.
When you are driving and approaching
traffic lights, GREEN signals you to
continue driving because you have the
right of way, AMBER cautions you to start
applying breaks because you are about to
give way to others and RED signals you to
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stop because you have no right of way.
Using the traffic light analogy, the GREEN
light can be likened to a POSITIVE
outlook, signaling you to continue with
policy measures because the financial,
economic and political trends are being
sustained. AMBER light can be likened to
STABLE outlook, cautioning you the
policy measures being implemented,
though improving the financial, economic
and political trends, could easily be
derailed because these trends are yet to be
sustained. Finally RED can be likened to
NEGATIVE outlook, signaling you to stop
and refocus whatever policy measures
being undertaking because the financial,
economic and political trends are
worsening.
According to S&P, a negative outlook
indicates a rating may be lowered while a
stable outlook is assigned when it believes
that the rating is not likely to be changed.
The company, however, warns that its
outlooks should not be confused with
expected stability of the Issuer’s (in this
case country’s) financial or economic
performance. For Moody’s a negative
outlook indicates a higher likelihood of a
rating being lowered over the medium
term while stable outlook indicates a low
likelihood of a rating changing over the
medium term.
Given the above, the recent change in
the Country’s outlook from Negative
to Stable means that the rating
agencies have particularly seen
improving financial, economic and
political trends but that these trends
are yet to be sustained to cause a
rating change such that Zambia is
likely to remain B3 or B rated in the
medium term. There is no doubt that
the country has made remarkable
improvements in its economic and
financial indicators (such as drop in
inflation rate and monetary policy
rate – the bench mark interest rates for
most retail loans) since the Zambian
government embarked on an economic
stabilization programme dabbed
‘Zambia Plus’. However, it is important
for the government to remain committed
to this programme so that the gains being
realized are sustained for the country to
yield positive results. It is worth noting
that from the perspective of a portfolio
investor, the change in outlook from
negative to stable does not really change
the credit risk and therefore the premium
required to take up this risk. What will
improve the country’s credit risk is a
rating upgrade (say from B to B+ or
from B3 to B1 or indeed from B to A). An
easy way of looking at the impact of an
outlook on the Country’s credit risk
profile from the investor’s perspective is
to use the financial reporting standard on
Provisions and Contingent Assets and
Liabilities. Thus, outlooks can be looked
at as events that will have a positive or
negative effect on the company’s financial
assets in the foreseeable future and noted
in the notes to company’s financial
statements but not probable enough to
warrant for impairment provisioning. In
this regard it may not be appropriate for an
analyst to claim the change in the
country’s outlook from negative to stable
will improve the country’s
creditworthiness although of course this
improves creditor perception of the
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country. Only when the actual credit
rating improves will making such a
statement be appropriate. Remember it is
the credit ratings that are used by
investors as indications of the likelihood
of receiving the money owed to them in
accordance with the terms on which they
invested.
It is this author’s wish that this section has
clarified the meaning of the recently
issued statements on Zambia’s
creditworthiness. The next section
explains the difference between risk
measured by the Sovereign Credit Rating
and the Country Risk.
4. DIFFERENCE BETWEEN SOVEREIGN
CREDIT RATING RISK AND
COUNTRY RISK
Sovereign Credit Rating (SCR), as
explained in section 2 above, directly
address credit risk and not country risk.
Credit Risk is simply the risk that the
borrower will fail to meet its financial
commitments, such as interest,
repayment of principal or
counterparty payments on a timely
basis. This risk does not arise unless
you intend to lend out funds or you
have already lent out funds as the case
is for Portfolio Investors. This
particular risk does not arise in instances
of Foreign Direct Investment (FDI).
Country risks, also referred to as
Sovereign risk, is the risk that arises
from investing or doing business in a
particular country, and it depends on
the country’s economic, political, and
social environment. This risk is
broader than the country’s credit risk
and affects all investor in the country,
portfolio and FDI investors. Country
risk generally include the risk associated
with changes in tax rates, regulations,
currency conversion, and exchange rates.
Country risk also includes the risk that
investor property will be expropriated
without adequate compensation, that the
host country will impose new stipulations
concerning local production, sourcing, or
hiring practices and that there might be
damage or destruction of facilities due to
internal strife. Countries with stable
economic, social, political, and regulatory
systems provide a safer climate for
investment and therefore have less
country risk than less stable nations.
The country risk measure is quoted each
year in the International Country Risk
Guide of the Financial Times group of
companies. The risk guide is an annual
survey of institutional assessment of
countries in terms of their risk. The
monthly issue of this guide publishes
political, financial, and economic risk
ratings for countries and offers analyses of
events that affect the risk ratings along
with the economic and financial data
underlying financial and economic risk
ratings.
With this clarification, readers can now
see the inadequacies of statements such
as this “First, an upgraded sovereign credit
rating has a positive impact on the
country’s ability to compete for and attract
foreign direct investment. Thus a good
sovereign credit rating increases the
potential to attract FDI which leads to
increased job creation resulting in reduced
poverty levels in the country.” The rating
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only has, if any, remote effect on FDI. It is
the country risk which directly impacts
FDI and which has a positive impact on
the country’s ability to compete for FDI.
Figure 1 below demonstrates this point.
See however, the effect of the credit down
grade on the cost of funds as shown in
table 1 below.
Table 1
Date Issue Amount Rating Interest on Funds Data Source
Sep-12 Euro Bond I US$750m B+ 5.625% Reuters
Apr-14 Euro Bond II US$1bn B 8.625% Reuters
Jul-15 Euro Bond III US$1.25bn B 9.000% The Economist
Note: Fitch downgraded Zambia from B+ to B in October 2013
5. CONCLUSION
The change in the Country’s outlook from
Negative to Stable reaffirms the
improvements in financial, economic and
political trends in recent months. It is
important that the government remains
resolved in delivering the Zambia Plus
programme so that the gains being
realized are sustained for the country’s
credit rating to be upgraded.
Consequently this will deliver real
benefits to the country. Consider the cost
saving if both Euro bonds II and III were
issued at 5.625%.
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Q1
ZAMBIA GROSS FOREIGN DIRECT INVESTMENT (US$ million)
Moody's Highest
Zambia Rating B1
Nov 2012
Moody's downgrades
Rating to B2 Sept 2015 Moody's downgrades
Rating to B3 April 2016
Figure 1
Data Source: Tradingeconomics.com
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