Behind high borrowing costs: How credit rating agencies keep developing nations in the red

The global financial system is under mounting pressure to evolve. At the heart of this system lies the credit ratings industry, a critical yet often overlooked component that significantly shapes how capital flows across borders. The sector is dominated by three powerful agencies, often known as the Big Three, Moody’s, Standard & Poor’s (S & P) and Fitch.

Credit rating agencies play an outsized role in the global financial system. Their ratings have been known to influence borrowing costs, investor confidence, and access to international capital markets. CRAs have been accused of systemic bias against low- and middle-income countries (LMICs), often being opaque and pro-cyclical, leading to inequity and disadvantages for these developing nations in the debt market.

For instance, compared to other continents, the cost of borrowing in Africa is significantly higher. In 2023, bond yields in Asia and Oceania averaged 5.3 percent, and in Latin America and the Caribbean, they averaged 6.8 percent. In contrast, Africa’s bond yields averaged 9.8 percent, highlighting the region’s unique challenges in accessing affordable financing.

Moreover, the estimated annual financing gap to achieve the Sustainable Development Goals (SDGs) in developing countries has ballooned, with current financial flows falling far short. Around 462 million people in sub-Saharan Africa live in extreme poverty, defined as less than $2.15 of spending power a day, highlighting a lack of social and development finance.

Lack of transparency and accountability

Global financial safety nets and reserve tranches, such as Special Drawing Rights (SDRs) from the International Monetary Fund (IMF), are often allocated based on economic size (quotas), meaning wealthier countries receive more, while vulnerable countries with greater needs receive disproportionately less.

During the COVID-19 pandemic, several African and Latin American countries saw their credit ratings downgraded, making it even harder for them to respond to public health emergencies and the ensuing economic fallout. Zambia’s credit rating was downgraded multiple times, ultimately being classified as “selective default” by S&P after it missed a Eurobond interest payment. Other nations like Ghana and Ethiopia also defaulted or imposed harsh austerity measures like increased taxes and borrowing to avoid the same fate.

Moreover, CRAs typically focus on fiscal and macroeconomic indicators, neglecting long-term development investments or social spending that may temporarily increase deficits but yield future gains. Moody’s downgraded South Africa to junk status in March 2020, followed by further downgrades from other agencies. The downgrades increased borrowing costs and placed pressure on the national currency (rand), raising the cost of imports like medical equipment and vaccines.

Such behavior by credit rating agencies during the COVID-19 crisis underscores the urgency of reforming how sovereign creditworthiness is assessed. To avoid such unequal access to safety nets, CRAs must be held to higher standards of transparency and accountability. CRAs must confront the deep-seated post-colonial biases in their models that favor large, developed economies. 

It’s imperative to rethink the risk premiums applied to nations in the Global South, which are often based on outdated or unjustified assumptions. Their methodologies, assumptions, and potential conflicts of interest should be openly disclosed and subjected to regular independent audits and oversight. The 2008 global financial crisis underscored the dangers of opaque rating practices, particularly in the realm of mortgage-backed securities.

Reform within the G20 Framework

The G20 is uniquely positioned to spearhead credit rating reform. As a platform comprising both developed and emerging economies in Africa, Asia and Latin America, it reflects a broader spectrum of interests and can mediate between divergent financial priorities. Additionally, the G20’s Sustainable Finance Working Group and its increasing engagement with the African Union and other developing regions, make it an ideal forum for systemic change.

Such reforms can include the establishment of international guidelines for credit rating operations, including minimum disclosure standards, stakeholder engagement protocols, and grievance redress mechanisms. For instance, an independent oversight body could be created under the auspices of the Financial Stability Board (FSB) or another G20-affiliated institution to monitor compliance and investigate misconduct. Enhanced transparency would not only improve the credibility of ratings but also empower countries and investors to make more informed decisions.

Credit rating reform is thus imperative if the global financial system is to become truly inclusive and developmental. These efforts ought to be spearheaded within high-impact multilateral platforms like the G20, which have the political and economic leverage to drive change. 

Direct investment and ESG criteria

A truly human-centered credit rating system must integrate developmental and ESG (Environmental, Social, and Governance) criteria, recognizing social and technological investments like healthcare, education, renewable energy and green infrastructure as credit-positive frontiers.

Direct investment is critical for Africa to leverage upon its wealth, being home to at least 40% of the minerals key to renewable and low-carbon technologies. The continent owns over 60% of renewable energy sources such as geothermal, solar, and wind. However, this immense wealth is yet to benefit Africans, evidenced by the fact that GDP per capita rates have only climbed by 1.1% in the last 30 years, compared to over 14% in Asia. 

African countries can renegotiate mining deals and concessions agreed upon in the past through a G20-led framework, in much fairer terms that reflect global standards. African countries can also negotiate for Free Trade Agreements with individual members of the G20, similar to the African Growth and Opportunity Act (AGOA) currently in place with the United States of America, and the Economic Partnership Agreements (EPA) that some African countries have with the European Union.

Homegrown solutions

In recent years, Africa has seen a constraining of fiscal space, a reduction of concessional financing, and sharp increases in the cost of capital.  Central to these issues is the perception of risk by both investors and development partners.   Ensuring that risks are measured and communicated in a way that is evidence-driven is critical to ensuring that Africa’s credit ratings more adequately reflect the continent’s reality and potential.   This is of particular importance because the future of development financing involves the private sector, and not development assistance, which is steadily declining. 

Reforming credit rating practices requires the creation of public and regional alternatives that rival the “Big Three” CRAs – S&P Global Ratings (S&P), Moody’s, and Fitch Group – to better reflect diverse economic realities. Regional rating agencies, such as the African Credit Rating Agency (ACRA), under development by the African Union, can offer localized insights and development-oriented assessments that challenge the dominance and biases of traditional Western agencies. 

By working with countries to enhance their credit ratings through targeted partnerships that improve data and facilitate processes, ACRA’s overarching aim is to increase the number of investment grade countries across the continent, thereby transforming prospects for private sector-led development. Moreover, it seeks to leverage deep regional knowledge and contextual understanding of African economies, something often lacking in assessments by global CRAs. Accelerating progress with the Sustainable Development Goals (SDGs) in Africa is contingent upon the availability of adequate and affordable public and private sector financing.  With such local expertise, ACRA can factor in long-term development investments in infrastructure, education, healthcare, and climate resilience. 

Moreover, regional institutions like the African Export Import Bank (Afrexim Bank), underscore the pivotal role that multilateral development institutions play in providing guarantees, attracting external investors and financing initial roll-outs. For instance, in 2023, Afrexim set up $500 million in climate projects. Such initiatives provide concessional funding, grant funding and guarantees to investors on projects widely considered as risky. 

Empowering public institutions, including development banks, to produce independent credit evaluations would diversify perspectives and serve as credible counterpoints to private-sector ratings, fostering a more inclusive global financial system.

The role of civil society advocacy

Credit rating reform cannot be achieved solely through top-down processes. Civil society organizations, academic institutions, and local communities must play a vital role in shaping the new paradigm. Participatory approaches can help ensure that reform efforts are grounded in real-world needs and responsive to the lived experiences of affected populations.

G20 members should facilitate dialogues between CRAs and local stakeholders, particularly in the Global South, to co-create rating methodologies that reflect diverse perspectives. Citizen engagement can also enhance accountability by subjecting rating agencies to public scrutiny and pressure.

In an era defined by unprecedented global challenges, there is a critical opportunity to chart a different course. Within the G20 framework, a human-centered approach to credit rating reform can unlock access to affordable capital, promote sustainable development, and create a financial system that truly serves humanity. As the world grapples with complex, interconnected challenges, rethinking credit ratings is not just a policy imperative – it is a moral one.

References

African Union Commission. (2023). Creation of the African Credit Rating Agency (ACRA): A milestone for financial inclusion. African Union.

International Monetary Fund. (2024). Special drawing rights (SDR) allocations and quota shares. https://www.imf.org/en/Topics/sdr

International Monetary Fund. (2023). Regional economic outlook: Sub-Saharan Africa. https://www.imf.org/en/Publications/REO/SSA

Moody’s Investors Service. (2020, March 27). South Africa downgraded to Ba1; outlook negative. https://www.moodys.com/research/Moodys-downgrades-South-Africa-to-Ba1–outlook-negative–PR_436285

Organisation for Economic Co-operation and Development. (2022). Debt service suspension initiative (DSSI): Impact and lessons. OECD Publishing.

Standard & Poor’s Global Ratings. (2021). Sovereign credit ratings: Methodology and country risk assessment. https://www.spglobal.com/ratings/en/research/articles/210601-sovereign-credit-ratings-methodology-country-risk-assessment-12148987

United Nations Conference on Trade and Development. (2023). Financing for sustainable development report 2023: The $4 trillion question. United Nations. https://unctad.org/system/files/official-document/tdr2023_en.pdf

World Bank. (2024). Global financial development database 2024. https://www.worldbank.org/en/publication/gfdr

World Bank. (2023). Africa’s bond market development: Trends and challenges. World Bank Publications.

Zhao, L., & García, M. (2022). The pro-cyclicality of credit ratings: Effects on emerging markets. Journal of International Finance, 18(3), 255–273. https://doi.org/10.1016/j.jif.2022.03.005