African countries’ credit ratings could improve the most judged by demographic and environmental opportunities facing sovereigns while ratings in the Middle East and Central and Eastern Europe are most vulnerable over the long-term, says Scope Ratings.
The findings in a new study by Scope come as ESG factors are a growing area of concern and increasingly relevant for sovereign ratings. The factors relate mostly to structural, long-term drivers that can have an impact on a sovereign’s economic growth and the sustainability of public finances.
“We identify significant, multi-notch regional differences when comparing our current quantitatively implied sovereign ratings with an assessment based only on ESG factors. This points to divergent, potential rating-relevant challenges and opportunities that may over time inform our rating actions,” says Alvise Lennkh, deputy head of sovereign and public sector ratings at Scope.
Scope has analysed the relationship between the indicative sovereign ratings using the quantitative model of its sovereign methodology and the scores based on the methodology’s stand-alone ESG pillar. Scope, the first major credit rating agency to explicitly include an ESG pillar in its sovereign-rating methodology, gives ESG factors a 20% weighting, providing a forward-looking assessment of these factors for its current ratings.
“However, by comparing the overall rating with the ESG-specific scores for 11 regions, we can identify some of the potential long-term ESG factors that are relevant for the sovereign ratings outlook beyond the current economic cycle,” says Lennkh.
Looking at individual ESG factors, Scope finds that transition risks represent a big challenge for the Middle East while in Africa and Latin America, resource opportunities, if wisely used, may partly offset physical and transitions risks. Asian and Anglosphere countries (Australia, Canada, New Zealand, UK, US) face greater environmental challenges than the euro area.
“On the social front, increased government spending and sluggish growth related to demographics – ageing populations – could be a drag on the long-term credit outlooks of the euro area, the Anglosphere and CEE,” says Levon Kameryan, analyst at Scope and co-author of today’s research.
Conversely, African countries with high proportions of young workers could convert this demographic opportunity into a rating-relevant dividend, provided governance frameworks and policies adequately exploit these opportunities.
Governance scores, a critical proxy for long-term income levels and thus creditworthiness, are below current indicative ratings for all regions except for the advanced economies.
“This underscores the need to strengthen institutions, improve the ease of doing business and entrenching the rule of law to attract investment to enable sustainable economic growth,” says Kameryan.
Since October 2020, Scope’s sovereign ratings include a quantitative and qualitative assessment of the ESG risks with an impact on a country’s public finances. “While we currently rate 36 sovereigns publicly, our model includes 132 countries which enables us to draw a few stylised conclusions for our ESG risk factors across and within regions,” says Lennkh.
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