Should Moody's credit rating downgrades worry the average Motswana?
Mphoeng Mphoeng | Friday May 14, 2021 16:38
It should be noted that the rating had been adjusted in May 2020 from A2 with a stable outlook to A2 with a negative outlook, essentially forecasting the current downgrade. Previously, Botswana had been rated as A2 and stable since November 2011 but has been on A2 since 2001. The question, therefore, is what does this all mean? Is it significant? How will it affect us as Botswana and should we be worried?
Firstly, what is a credit rating and what does it try to tell us?
A credit rating is essentially a score assigned by a credit rating agency in an effort to give guidance on the risk of a particular entity with regards to its ability to pay back its loan obligations. Whilst we don’t have the service in Botswana, in most countries you can have a credit rating/score for individuals, companies and even municipalities and the country. The credit rating agency would collect information about all entities that borrow money and make an assessment of how risky they are and give a score so that other entities looking to lend the entity money have a third-party assessment of the riskiness of the borrower. These credit ratings are determined by studying the economy of the country, looking at the fiscal position of the country, how much debt the country has, how much growth the country is expecting, the politics and even things such as corruption, which speak to how well the country is being managed.
In this particular instance, Moody’s is a credit rating agency that ranks countries, municipalities and companies that issue bonds and provide a ranking so investors can compare the riskiness of the different entities when looking to invest in their assets. Moody’s ranks these assets from the least risky (best) being Aaa, Aa1, Aa2, Aa3, A1, A2, A3 (Botswana’s current rating), Baa1, Baa2 all the way to C. From Aaa to Baa3 is considered investment grade, which means they are considered high quality and pose the least risk when it comes to the possibility of not being able to repay its loans. These include countries like UK, US, Japan, Norway, Sweden, China and Botswana despite the downgrade. (Contrary to what was reported widely, we are not one step away from leaving investment grade; there are three notches below where we currently are). Below investment grade, you get into ratings that are considered junk status. This is from Ba1 to C grade and to give perspective, South Africa entered this status in 2017 and has remained there since. It should also be noted that Moody’s is not the only credit rating agency, with S&P another big player in the ratings industry. S&P downgraded Botswana to BBB+ from A- with a negative outlook in May 2020. Botswana had been graded as A from 2001 with the outlook fluctuating between stable and negative during this period. S&P follows an easier to understand ranking system of AAA being the best, then AA+, AA, AA-, A+, A, A-, BBB+ (where Botswana is), BBB, BBB- until you get to D. Investment grade is AAA to BBB- which Botswana is two grades above (That means S&P rating for Botswana is worse than Moody’s).
So why are credit ratings important and does it matter that your grade is below investment grade?
The first and most important reason why ratings matter in respect to Botswana, is the signalling of a deterioration in our economy and the fiscal position. Whilst this deterioration was pushed over the edge by COVID-19, it is important that Batswana acknowledge that the economy needs a restructuring regardless of COVID-19. Our recurrent budget has gotten too large and primarily dominated by salaries, growth in the real economy is non-existent, private sector is struggling with very little investment planned and an over-dependence on a luxury good with an undiversified economy that creates very few jobs and imports everything points to an unsustainable uncertain future. The downgrade is just an external signal telling us we are reaching a tipping point. Since credit ratings downgrades are used to signal an increase in risk, a downgrade usually means that investors will expect to get paid more interest when you borrow from them, to compensate for the increase in risk. This means that the worse your credit rating, the more expensive it is to borrow and service your loans. This is problematic as it means your interest paymentsvwhen constructing the country’s budget, will now be taking up a lot more resources that should have been used on other things like education and health care. In the budget year 2018-2019 Botswana paid just over P1 billion on servicing of public debt meaning depending on terms in those agreements, it is possible that this could increase as it gets more expensive to get new loans as well as adjustments to current loans.
Whilst this is a problem for Botswana, it isn’t as serious as for countries like SA. Botswana mainly issues bonds to local investors so their sensitivity to external credit ratings will not be as acute.
Countries like SA on the other hand, are big global players with more than $175 billion in bonds on the market. Moving from investment grade to junk status has a direct effect on them as most international investment mandates would require investment-grade status.
This move would therefore trigger a sell-off, which would push subsequent borrowing costs higher. For a country like Botswana with $1 billion, our bond market is too small and therefore international investors have no interest in it.
So even though we are investment grade, very few international investors would purchase our bonds because we are so small and liquidity and trading are low.
For a country like SA, a sell off would also mean a sell off of the currency, which would weaken the currency (as seen when they were downgraded in 2017) resulting in an increase in inflation.
This isn’t the case in Botswana because our currency is a basket pegged against other currencies. In actual fact, SA being downgraded and having the currency weaken, affected us more than when we get downgraded ourselves.
Linked to the issue of increased borrowing costs, in well-functioning markets (which Botswana is not) ordinarily other entities such as companies and municipalities would borrow from bond markets as well and this would be dependent on the rating of the country.
So an increase in the cost of capital for the country would trickle down to consumers as banks would increase rates as a result because they borrow at a higher rate in the market. This is not the case in Botswana since lending rates are determined by prime and the bank rate only.
In conclusion, it should be a worry to most Batswana that the country’s credit rating is now at its lowest in 20 years.
Whilst the practical manifestations that haunt other countries when this happens don’t necessarily apply in Botswana, this does not mean we should not be worried.
More especially considering we are likely to see more downgrades in the next two years as our fiscal position worsens due to COVID-19 and our general inability to turn the economy around. While I pray I am wrong, the worst may be ahead of us.
*Mphoeng is a partner in a 100% Botswana citizen-owned company called Spectrum Analytics. Spectrum Analytics specialises in consulting and providing enterprise solutions in Data Analytics and Digital Transformation. To contact Mphoeng and give feedback on the article, email him at mphoengm@spectrumcs.co.bw