Debt Colonies End: Non-Western Rating Agencies for the Global South

As the BRICS group seeks to develop alternatives to the Western financial system, the creation of credit rating agencies independent of the West could be on the agenda at their annual summit in October. In addition to developing an alternative payment system for trade transactions in local currencies, the Global South’s credit rating agencies could prove critical to the bloc’s recent efforts to increase financial autonomy among emerging market economies and end the US-led version of globalization. Russian central bank governor Elvira Nabiullina said the development of rating agencies will be a key initiative during Russia’s presidency of the BRICS summit in 2024. She stressed that new rating agencies should be “supra-national” and cover all the countries. This desire by the BRICS countries to strengthen their economic autonomy from the hegemony of the US-controlled financial system should come as no surprise. The newly enlarged bloc is already an economic giant, controlling about half of the world’s rice, wheat and oil production and a GDP in purchasing power units larger than the Group of Seven (G7). However, despite dominance in commodities, trade and manufacturing, the generally more indebted and slower growing economies of the West still have access to cheaper investment capital. The failures of Western rating agencies The BRICS evolved into an integrated political entity after the 2008 financial crisis, which was caused in part by the failure of US credit rating agencies to address systemic risks in the US mortgage market. The speculative bonds underlying the sub-prime mortgages that triggered the global recession were given AAA ratings, the highest rating of any BRICS country today. Although the global economy eventually recovered, developing countries continue to wonder why they often have lower credit ratings than advanced economies with higher debt-to-GDP ratios. While this could be due to risks in the foreign exchange market or political risk, emerging markets argue that credit ratings can become self-fulfilling prophecies where sovereigns with lower credit ratings are more likely to default due to higher costs borrowing despite the weak economic figures. Africa is a good example of this. According to Moody’s Ratings, African countries have the world’s lowest default rate for infrastructure projects at 5.5%. This is lower than Latin America (12.9%), Asia (8.8%) and Western Europe (5.9%). And yet borrowing costs for African countries remain among the highest in the world, with a handful of countries, such as Mauritius and Botswana, having investment grade ratings. Of course, exchange rate risk is a major factor in this anomaly, which is precisely why so many countries wish to join the BRICS group and promote the use of their domestic currencies in trade. Another example of this phenomenon is the difference in borrowing costs between Brazil and Finland. The two countries have the same debt-to-GDP ratio (74%) and similar inflation rates (3.6% for the end of 2023 in Finland and 4.6% for Brazil). Brazil, South America’s largest economy, grew 3% in 2023 despite higher real interest rates, while the much smaller Finnish economy shrank 0.5% despite the European Central Bank keeping interest rates high . Both the euro and the Brazilian real are back to levels against the dollar four years ago, while the real has strengthened against the euro over the past three years.   These are supposed to be the most important factors in determining a country’s creditworthiness. Risk premium over inflation is critical, while currency risk can affect foreign currency returns. Economic growth factors will also indicate whether a country can grow fast enough to be able to service its debts. Brazil outperforms Finland on all of these metrics, and yet Brazil’s government has to pay 9.9% in interest on its two-year bonds, while Finland’s two-year bonds yield just 2.9%. The same applies to Brazil’s BB credit rating and Finland’s AAA rating. Quantitative easing One possible explanation for these disparities is that countries with currencies that are used as foreign exchange reserves can monetize their debts through quantitative easing (QE), which means that the risk of debt default is lower because central banks banks can “print” money and use that liquidity to buy government bonds at will. But QE comes with inflationary risks and suggests that G7 central banks could continue to implement monetary policy more easily than countries such as Zimbabwe and Argentina without facing negative consequences. Even in the US, whose dollar remains the world’s dominant reserve currency, QE is still fraught with risks. Inflation has surged to multi-decade highs in the US following pandemic-era fiscal and monetary measures. When the Fed raised interest rates to contain the inflation it was largely responsible for fueling, it hurt the value of long-term US bonds and resulted in the collapse of many major banks. Similarly, the Bank of England was forced to intervene in the debt market as higher interest rates caused significant losses to UK pension funds, delaying much-needed credit tightening, while the Bank of Japan opted to sell foreign reserves to defend the yen rather than risk raise interest rates excessively. Loose fiscal and monetary policy in the EU and UK has been accompanied by sharp depreciations in the euro and sterling, while gold and bitcoin, which serve as hedges against fiat currencies (those issued by central banks), have rallied at record highs. Similar policies in Japan have driven the yen’s real current exchange rate to record lows. This suggests that developed countries may find it difficult to continue to manage their public debts through monetary policy without experiencing the risk of currency depreciation and higher inflation rates. Japan’s practice The Japanese example is illustrative. The country’s central bank is the largest holder of Japanese government debt and corporate bonds. This lowered debt servicing costs but weakened gen. Extremely low interest rates have also created uncompetitive “zombie” companies, reducing Japan’s share of world trade. Having run a trade surplus for decades, Japan has significant foreign exchange reserves (almost $1.2 trillion) with which to defend the yen, but other G7 nations such as the UK (under $200 billion) and the US (under $40 billion). they do not hold significant reserves to defend their currencies. Unconventional monetary interventions After all, few developing countries would be willing or able to resort to historically unconventional monetary policy interventions like QE, and many have arguably better economic fundamentals than current credit ratings suggest. The BRICS group therefore wants to develop its own credit rating agencies to complement recent efforts to de-dollarize global trade and development finance. Meanwhile, debt-challenged emerging markets will continue to argue rationally that high debt servicing costs cause rather than reflect the risk of sovereign defaults, trapping economies in the long run.