A credit rating is a financial evaluation and appraisal of the creditworthiness of an individual, business firm, or government enterprise. It is a numerical and statistical depiction with an illustration of the creditworthiness of the enterprises. It indicates the probability that they will be in a position to pay back the money they borrowed. In other words, they fulfill their financial obligations on time. Credit rating agencies such as Standard & Poor’s, Fitch, or Moody’s assign rates for credit ratings. The credit rating is communicated through a letter that reveals the risk associated with lending money to the entity or borrowing country.
Higher credit ratings show lower credit risk, suggesting a higher likelihood of timely repayment. On the other hand, lower ratings imply higher risk and a greater possibility of default. Credit rating agencies appraise various factors when deciding on a credit rating, including the financial stability of the borrower, its history of payment, debt levels, and general creditworthiness. Such ratings are widely applied by investors, lenders, and financial institutions to decide about lending money. These ratings are also used when issuing bonds, or investing in financial instruments.
Credit rating plays a crucial role in the economic development of developing countries, including Ethiopia. It influences various aspects of their financial health. It has some potential effects on these countries in relation to their access to capital. A higher credit rating normally makes it easier for a country to have access to international capital markets.
Financial investors are more interested in lending money to countries with favorable credit ratings. They may also offer those loans at more favorable interest rates. Countries with higher credit ratings are generally entitled to lower borrowing costs. This means that they can issue bonds and other debt instruments at lower interest rates, thereby reducing the cost of debt servicing. Such a record also entitles them to rounds of borrowing money from the international capital markets. In the past, Ethiopia used to enjoy borrowing money at reduced cost or paying lower interest rates due to favorable credit rating.
A favorable credit rating can attract foreign investors and this attracts foreign direct investment (FDI) into the country. Investors are more likely to put their money into countries with stable and positive economic outlooks. They avoid investing in countries where there are rampant social unrest, strife, conflict, disturbance and war. These situations impede economic improvement, including currency stability. A favorable credit rating may contribute to the stability of the currency of a country. It builds confidence in the economic policy makers of a country. This reduces the chance of depreciation of the currency of a country.
Moreover, a higher credit rating provides the chance for governments to finance their budgetary needs more efficiently and effectively. It allows for flexibility in terms of spending on economic infrastructure, including roads, dams, irrigation canals, and storage facilities. It also provides resources for implementing social programs and project including health, education and training of the youth. Counties with higher credit ratings may also undertake other developmental projects.
Higher credit rating may boost economic confidence among investors, businesses, and consumers in all sectors of the economy. This confidence can lead to increased economic activity, job creation, and improved living standards. However, currently investors may not have such confidence in Ethiopia due to its economic instability caused by social conflicts and war. They do not seem to have credible policy that applies to all sectors of the economy leading to low credit worthiness of the country.
Maintaining a good credit rating indicates to the international markets that the country is committed to sound economic policies. Such credibility may build trust in the government’s ability to manage its financial responsibly. On the other hand, a lower credit rating may have a negative and opposite effect, leading to higher costs of borrowing. It also leads to reduced access to capital that discourages further investment. Low credit rating reduces confidence of investors in the economy. It is, therefore, important for countries to manage their fiscal policies effectively.
They should also address structural economic issues such as deficit that implies that borrowing becomes increasingly unsustainable or expensive. They may also implement reforms to maintain or improve their credit ratings through time. The International Monetary Fund (IMF) and the World Bank (WB) may provide financial and technical assistance to member countries. They require austerity policies and programs to be implemented by governments with heavy credits. These governments have to collaborate with the financial institutions in meeting their requirements. They do require the governments to reduce budget deficits and stabilize the economy.
Austerity measures normally involve reducing government spending on purchase of luxury goods that contribute nothing to economic growth. They also require the government to increase taxes and raise its revenues. Of course, the implementation of structural reforms is also an issue. Both the IMF and the WB may advise and recommend austerity measures as necessary conditions for financial assistance to countries, including Ethiopia, facing economic challenges.
Generally, the IMF provides short-term financial assistance to member countries facing balance of payments problems or economic crises. Balance of payment (BOP) is the record of all international financial transactions made by the residents of a country. There are three main categories of BOP and these are the current account, the capital account and financial account.
When a country such as Ethiopia requests assistance from the IMF, it often comes with conditions attached. Austerity measures may be among these conditions, requiring the borrowing country to implement policies with the goal of reducing budget deficits and restoring economic stability. Common austerity measures include reducing public sector wages, cutting social spending, eliminating subsidies, and implementing tax increases. Some of these conditions are difficult to meet for the government of Ethiopia. Reducing wages in the face of galloping inflation, including imported inflation, is like encouraging corruption in the civil service. Similarly reduction in social spending and subsidies will definitely make the life a civil servant intolerable.
The WB focuses on long-term economic development and poverty reduction. To this end, it provides loans and grants for development projects in Ethiopia. In line with the IMF, the WB may attach conditions to its loans that involve economic reforms and policy adjustments. The WB prescribes austerity measures that may include structural reforms to improve the efficiency of public services. It also encourages privatization of government owned enterprises. These measures are believed to enhance the overall economic environment in the country.
However, critics believe that austerity measures may have negative social impacts, as they may lead to inefficient public services. This policy direction leads to increased unemployment in the face of rising labor force and income inequality. Also, some economists have argued that stringent and severe observance of austerity may deter and hamper economic growth and development in Ethiopia that is facing social unrest, conflict and strife practically in most of its regions.
It is useful to note that the effectiveness and appropriateness of austerity policy is influenced by situation on the ground. It is argued that this policy may vary based on the specific conditions and circumstance observed in Ethiopia. Credit rating may be influenced by the level of conspicuous consumption displayed by a few political entrepreneurs in Ethiopia. But, this group does not represent the large majority of people who may not afford to cover the cost of living due to inflation.
Actually, conspicuous consumption refers to the public display of wealth through the lavish spending of money on goods and services that are not essential for survival. While it is a phenomenon often associated with more developed economies, elements of conspicuous consumption can be observed in various societies. In Ethiopia, a country with a diverse cultural and economic landscape, conspicuous consumption may be manifested in different ways by the emerging middle class. This may influence the modality of credit rating in Ethiopia.
In major urban centers, there is a rising middle class with increased purchasing power. This group may engage in conspicuous consumption by purchasing luxury items such as fashionable and expensive cars, and modern houses with impressive furniture and household facilities. Flaunting and displaying of wealth through these luxurious items becomes a way to display a social status. Added to these are celebratory events taking place in different parts of Ethiopia. The country has a rich cultural heritage with a variety of customary and fixed ceremonies and festivals. In these events, there is an emphasis on presenting oneself in the best possible situation. This may result in conspicuous consumption through the purchase of sophisticated clothes and expensive jewelry. These are displayed by hosting lavish festivities mainly in the urban residential areas. The construction of modern and lavish houses may be taken as a display of conspicuous consumption. It is observed that persons who have accumulated wealth do invest in luxurious items. In so doing, they contribute to the ostentatious display of wealth within their communities.
These consumers give a wrong picture to those institutions engaged in credit rating. These consumers use borrowed money for the purchase of modern imported items. Their demand for luxury goods and services such as high fashion goods and services may be seen as a form of conspicuous consumption. A few wealthy individuals may use these items to signal their social status and success in Ethiopia where the majority of the people suffer from inflation.
What is amazing is the rise of social media that has influenced consumption patterns in Ethiopia. A few individuals may engage in conspicuous consumption to display their lifestyles, achievements, and possessions. However, there is no research on how these persons have accessed wealth in an ocean of poverty. It may be necessary to note that conspicuous consumption in Ethiopia may vary from one region to the other based on cultural practices, and economic disparities.
It is possible that some individuals may actively engage in showing of their wealth, while others may spend on modest and conservative manner. Moreover, social and cultural values play a major role in determining and influencing the pattern of conspicuous consumption within Ethiopian society. These factors may mislead financial appraisal of the creditworthiness of the country. Therefore, the credit raters have to see beyond figures.
Editor’s Note: The views entertained in this article do not necessarily reflect the stance of The Ethiopian Herald
BY GETACHEW MINAS
The Ethiopian Herald March 17/2024
