The Big Three: How reflective are Egypt’s credit ratings of reality?

Egypt has been offering a remarkable number of treasury bills since the devaluation of the Egyptian pound in November 2016 (Courtesy of Alpha Stock Images)

“Investors are ignoring Egypt’s credit ratings” – Bloomberg’s headline on April 12, 2018 sent whispers across the market, as the media outlet contrasted credit ratings given to Egypt by major agencies with the country’s score of insuring debt.

While there are less than a handful of prominent credit rating agencies (CRAs) globally, namely Standard & Poor’s (S&P), Moody’s and Fitch Group, Bloomberg argues that although two of them rank Egypt lower than Nigeria and Argentina, the country’s cost of insuring debt against default for five years is lower than the two other nations.

“The suggestion is that investors are prepared to look past credit ratings when assessing a nation’s ability to repay debt,” Bloomberg argues.

Credit rating agencies are there to give information to investors, mainly institutional and retail, on whether the issuers of debt instruments and fixed-income securities are up to their obligations – namely, whether they are creditworthy or not.

Egypt has been offering a remarkable number of treasury bills since the devaluation of the Egyptian pound in November 2016, attracting as much as $20 billion in investment.

Business Forward talks to Nashwa Saleh, founding member of BAST Ratings, about the performance of global CRAs and how Egypt’s economic reform program affected its credit ratings.

Q: Do you think Egypt’s economic reform program contributed to ameliorating the investment and business environment, and in turn improved Egypt’s rating?

A: The reform program has tackled a number of key structural reforms successfully ensuring a solid foundation for sustainable growth. This has not been fully reflected by the rating agencies yet, with a gap between what Egypt’s Credit Default Swap (CDS – which is the equivalent to what an investor would pay as a premium to “insure” credit exposure to Egypt) is trading. Rating agencies tend to more often than not lag market developments. This is in part due to wanting to see full fruits of reforms before taking action and in part because of a heavy credit rating process which does not permit rapid change easily.

In some cases the reading, and in turn rating of a market, is subject to some perception bias

Q: What are the steps that should be taken to further improve Egypt’s credit rating and assist its economic growth?

A: Further consolidation of reforms along the same path we are currently following as well as the development of domestic debt capital markets. Additionally, reducing the exposure of Egyptian banks to the sovereign, with Egyptian banks holding close to 30 percent of their assets in the form of government treasuries.

Q: Why are CRAs important for developing countries and emerging economies? Do you think it helped Egypt adopt more sensible monetary and fiscal policies?

A: Rating agencies and indeed international investors who cover emerging markets have an important role to play in providing a systematic and external view of market dynamics. These views are akin to having to take periodic exams or “check-ups”. It helps motivate you to keep studying, keep healthy. They can also spot dynamics which we could be too close to capture and be willing to deliver a message which has a strong dose of medicine. However, in some cases the reading, and in turn rating of a market, is subject to some perception bias, which means it is up to this particular market or country to also work on the perception issues and help educate the rating agencies and the international investor community. It’s a two-way street.

CRAs suffered a lot of scrutiny in the wake of the global financial crisis of 2008

Q: How accurate are CRAs?

A: CRAs suffered a lot of scrutiny in the wake of the global financial crisis of 2008, which they did not flag and not seem to be aware of their magnitude. I am not sure that the lessons learnt from the crisis were properly taken on board. The massive wave of additional regulations rating agencies had to comply with did not help in my view. The result was a very complicated process and rating criteria which was more about form rather than substance, along with long disclaimers to ensure they cannot be attacked by regulators, but not the important essence of analytics and professional judgment.

Q: Would it help to have more than three key competing CRAs in the market?

A: The oligopolistic market structure, with three rating agencies capturing most of the ratings universe and one agency capturing almost 50% of all ratings globally, means that they have become complacent. Complacency is the first pitfall towards getting disrupted. Look at the explosion in the number of credit scoring artificial intelligence algorithms for basic credit risk mapping in two segments and microfinance lending to individuals and SME scoring which offer very cheap and easy ways of measuring credit risk. It is true that these do not give you a full rating report with analytics, which means if the agencies were providing the analytics, there would still be value in their product, but they are mostly not.

Another source of industry disruption is new EC directives which require the incorporation of sustainability indicators explicitly in the rating process. This will mean rating agencies will need to change their approach and methodology, with more regulation coming their way and competition by those who do this better. For example, one of the most recently licensed rating agencies with a focus on sustainability metrics, Beyond Ratings, has taken advantage of this change in the market landscape.

In the Europe, Middle East and Africa region, there is huge demand for the development of strong national rating agencies to cater to the domestic capital markets and specifically for the micro-, small- and medium-sized enterprises segments. This is what would help with the capital markets and institutional investor base development aspects. The large agencies would not be incentivized nor are they qualified to undertake this task. Local market knowledge is essential while maintaining compliance with International Organisation of Securities Commissions governance codes for rating agency processes of course.

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