Monday, November 25, 2013

Sierra Leone Doesn't Have a Credit Rating, So Why Don't I Provide One?

Lately, I have become more interested in the world of credit ratings. Although it might seem like a bunch of financial jargon, how it reflects and impacts macroeconomic stability is quite intriguing. I was reading an International Monetary Fund (IMF) report on Sierra Leone this past weekend. I thought to myself, "What do the credit rating agencies think of Sierra Leone?" Much to my shock, I found that neither Moody's, Standard and Poor's, nor Fitch have credit ratings for Sierra Leone. Maybe it was the years of political instability. Whatever the case may be, I thought that I could take a look at the country's overall macroeconomic trends and devise something myself.

Sierra Leone had been marred by a particularly nasty civil war that lasted from 1991 to 2001. Political stability is an important factor in credit ratings because warfare creates economic inefficiencies. With 2 million people (i.e., about a third of the population) displaced by the war, it takes time to recoup (see World Bank report). Although Sierra Leone is a constitutional republic, as Freedom House points out, there have been periods of political upheaval, which have this subsided. Its improvement in governmental institutions would explain why Freedom House gave it a score of 2.5 (Free). But looking at the score from Transparency Institute, an international organization looking at corruption levels, Sierra Leone ranks 123 out of 176, which is to say it has a while to go.

Political factors are important, but so are economic factors (see World Bank fact sheet). There are two main economic indexes measuring economic freedom. The Fraser Institute (p. 147) shows enough improvement where it is ranked 115 out of 152. The Heritage Foundation, on the other hand, shows a decrease in its scoring, as well as a score that is below the regional average. The World Bank's Doing Business Index shows that it is a tad more difficult to do business in Sierra Leone that it was the previous year (Sierra Leone is ranked as the median in regional ease of doing business). Overall tax revenue as a percent of GDP is small, which is good because it signals that the government does not have to tax the citizenry to death to fund its expenditures. Conversely, top tax rates are around 30 percent, which is not exactly optimal. Recent iron ore production (see IMF report, p. 4) has caused a great boost in GDP. As nice as it is to see the boost in GDP, it is a bit disconcerting to rely on one industry because it signals a weak resource base, and without diversification, the economy of Sierra Leone becomes heavily dependent on iron ore. At least external public debt has decreased dramatically. And although poverty has decreased in Sierra Leone since the civil war, the poverty rate is over 50 percent (see IMF report; World Bank report). Even with the tapering inflation, it is still a concern because it exceeds GDP growth, which means lack of growth in real dollars. Debt distress is only moderate because compared to where it was a decade ago, the debt-to-GDP ratio is much lower. Being able to service debt is a plus in Sierra Leone's favor.

Conclusion: There are a plethora of factors to consider, and the hyperlinked documents cover the factors in much detail. If I were working at Standard and Poor's right now (credit rating system here), I would give Sierra Leone a CCC rating. Sierra Leone has shown remarkable improvement in the past decade, but it has a while to go. As long as the political situation can remain stable, I would consider reevaluating its credit rating within the next year or two. Both the World Bank and the Heritage Foundation show economic instability within their indexes. If there is a continued downward trend in economic progress, then I would consider a downgrade. Relying on one industry is suspect. The iron ore industry would have to prove medium-term growth to be substantive, and not just a short-term blip that would send Sierra Leone to more political upheaval once the resource has been extracted to its maximum potential. However, if inflation decreases, GDP growth increases, and Sierra Leone can maintain political stability, then I very well would consider an upgrade in the near future.

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