Monday, September 19, 2016 2:30pm /S & P Global Ratings
· Nigeria's economy has weakened more than we expected owing to a marked contraction in oil production, a restrictive foreign exchange regime, and delayed fiscal stimulus.
· Although Nigeria's general government debt remains low, debt servicing costs as a percentage of general government revenues are high and rising.
· We are therefore lowering our long-term global scale ratings on Nigeria to'B' from 'B+' and our long- and short-term national scale ratings on Nigeria to 'ngBBB/ngA-2' from 'ngA/ngA-1'.
· The stable outlook signals our assessments that at this lower rating the risks to the government’s credit standing are balanced.
On Sept. 16, 2016, S&P Global Ratings lowered its long-term foreign and local currency sovereign credit ratings on the Federal Republic of Nigeria to 'B' from 'B+'. We also affirmed our 'B' short-term foreign and local currency sovereign credit ratings on Nigeria. The outlook on the long-term ratings is stable.
At the same time, we lowered our long- and short-term Nigeria national scale ratings on the sovereign to 'ngBBB/ngA-2' from 'ngA/ngA-1'. We also revised down our transfer and convertibility (T&C) assessment on Nigeria to 'B' from ‘B+'.
Since our last review in March 2016, when we expected Nigeria's economy would grow by at least 3% in 2016-2019, the economy has weakened significantly. Both the oil and non-oil sectors contracted markedly in the first two quarters of 2016.
The oil sector narrowed the most in the second quarter, falling by close to 20% year-on-year following intensified pipeline vandalism in the Niger delta. Although our oil price assumptions have remained unchanged since our last review, oil production levels have declined from an average of 2.1 million barrels per day (bpd) in the first quarter to an average of 1.7 million bpd in the second quarter.
The non-oil sector, which has traditionally been a driver of economic growth, also dropped in both quarters as industry and financial sectors continued to experience foreign currency shortages under the restrictive foreign exchange regime in the first six months of the year.
The 2016 budget, which the authorities designed as a stimulus budget, was delayed for a number of months in the legislative process and only passed in the middle of the second quarter. Lower electricity output and overall rising prices have also contributed to the faltering economy.
We are now expecting a 1% contraction in Nigeria's real GDP growth in 2016, feeble growth of 2% next year, and a return to higher growth of 4% only from 2018. We believe that since passing the fiscal budget, government spending together with liberalization of the interbank foreign exchange market, may boost the economy and spur positive GDP growth next year.
Oil production in the third quarter has remained weak but may improve in the fourth quarter and next year as the government negotiates with militants and sabotaged pipelines are repaired, mainly Shell's Forcados export pipeline with a capacity around 300 thousand bpd.
Due to the naira's devaluation in mid-2016, we now expect Nigeria's wealth, measured by GDP per capita, will average $2,000 in 2016. Nevertheless, we think that medium-term prospects could brighten with a rebound in the oil price, as well as government reforms across the economy, including the establishment of a treasury single account (TSA), improvements in the power sector, reforms to the Nigerian National Petroleum Company (NNPC), and reforms to increase non-oil fiscal revenues and reduce fiscal leakages.
Although the country is a sizable producer of crude, the oil sector's share of Nigeria's GDP is small relative to those of other oil economies, at about 10%. Consequently, in the next few years, the economy may be able to adjust to a subdued oil price or production shocks.
Although NNPC is considering alternative funding models over the next few years, we understand it plans to clear its arrears this year--about US$6 billion (1.5% of GDP) accumulated in 2015--with its international oil companies' joint venture partners. This financing strategy, if passed by the authorities, involves charging the federal escrow account as part of cost of production to clear the arrears to international oil companies.
In June 2016, the Central Bank of Nigeria (CBN) revised its foreign exchange rate regime from what we viewed as fixed arrangement to what we now regard as a managed float with a short track record.
Our assessment focuses principally on the liberalized interbank exchange rate, where most foreign currency trading activity takes place. Because of an inadequate supply of foreign currency, the naira trades in the parallel market at lower levels than the interbank market rates.
The interbank rate traded between Nigerian naira (NGN) 300 and NGN320 in August 2016. This is a wholesale market. At the same time, Nigeria still maintains foreign exchange controls on both current and capital transactions, including import restrictions on 41 categories of goods.
As a result of the above, we estimate that banks have pending foreign exchange orders with the CBN amounting to about 15% of its international reserves.
These orders are partly to settle letters of credit opened on behalf of their customers. To make timely payment, banks have either had to draw down their external assets or increase their short-term external borrowing.
The Nigerian banks' weak external position has been exacerbated by a recent directive to transfer foreign currency public-sector deposits to the TSA at the CBN. Nine banks did not comply, and the CBN suspended them from dealing in the foreign currency market.
The total amount due to the CBN was about $2.3 billion in August 2016. Subsequently, some banks executed their customer payment orders and others presented payment plans to the CBN. As a result, all banks have since regained access to the foreign currency interbank market.
In addition to tightening external liquidity, the Nigerian banking sector is facing declining asset quality, capital, and profitability. We estimate that sectorwide credit losses will likely range between 3.0% and 3.5% of loans in both 2016 and 2017. Weakness is likely to stem from loans to domestic oil companies, utilities, and manufacturing companies, and borrowers of foreign currency without foreign currency receivables.
We have placed our ratings on three Nigerian banks on CreditWatch with negative implications, reflecting our view that their financial profiles could deteriorate further as a result of pressure on their U.S. dollar liquidity and capitalization (see "Related Research" below).
The central bank, which was pursuing an accommodative monetary policy to boost credit growth and the economy until early this year, is now facing stagflation, or rising inflation in a weak economy. Inflation has increased from around 10% at start of the year to about 16% in June 2016.
The price hikes have followed rising food prices and higher administered costs for electricity and transport. Consequently, in its last monetary policy decision in July 2016, the CBN raised the monetary policy rate by 2% to 14%, among other measures.
Due to delays until May 2016 to pass the fiscal budget, budgetary implementation has been slower than planned. We expect that the general government will increase capital expenditures at a faster pace in the last six months of the year than in the first half. However, fiscal revenues are also underperforming due to lower oil production than budgeted and a slower pace of realizing gains from non-oil revenues than the government had expected.
Due to our expectations on general government spending and potential revenue shortfalls, we are still anticipating weaker fiscal flows, with the annual change in general government debt averaging 2.6% over 2016-2019.
Although the states have received some financial assistance from the federal government, we believe many are still running salary and supplier arrears that require further federal government assistance.
Apart from arrears, deficits at the state level are largely contained by states' limited ability to borrow from the markets--they remain largely reliant on constitutionally mandated transfers of funds from the federation revenue pool.
We forecast that the general government will meet its 3.6% of GDP 2016 gross borrowing requirement through domestic issuance, mostly taken up by the banks, and through external debt. We expect the government will borrow up to 1.5% of GDP on a blended basis from the World Bank and African Development Bank, from Chinese bilateral lenders, and from the international capital market.
Overall, we forecast that Nigeria's general government debt stock (consolidating debt at all levels of government, including the federal, state, and local government) will average 21% of GDP for 2016-2019, comparing favorably with peer countries' ratios. We also anticipate that general government debt, net of liquid assets, will average 17% of GDP in 2016-2019.
We include debt of the Asset Management Company of Nigeria in our calculation of gross and net debt, in line with our treatment of such entities elsewhere. Over 80% of government debt is in the domestic currency, which mitigates the impact of naira devaluation on the government's debt burden. Despite low government debt stock, debt servicing costs as a ratio of revenue have increased in recent years from below 10% in 2014 to our projection of 16% on average in 2016-2019.
The central government alone has debt servicing costs of close to 40% of revenues, which in our opinion reduces fiscal flexibility. The steep increases in the ratio are due to a combination of the decline in oil revenues since 2014 and higher borrowing costs in the domestic market. Therefore, the government's efforts in improving non-oil revenues are key to increasing fiscal flexibility.
The government is also undertaking a series of reforms and transparency measures across the economy, which could improve prospects--including establishing a TSA, improvements in the power sector, reforming the NNPC, increasing non-oil fiscal revenues, and cutting fiscal expenditures.
We expect an average annual current account deficit just shy of 3% of GDP in 2016-2019, down from an average surplus of 2.8% in 2011-2014. Narrow net external debt (external debt minus liquid external assets) will average 56% of current account receipts (CARs) in 2016-2019, in our base-case scenario. We expect gross external financing needs will average 146% of CARs in 2016-2019, compared with 83% in 2011-2014.
In elections held in March and April 2015, the All Progressive Congress (APC) led by theretired General Buhari defeated the incumbent People's Democratic Party (PDP), led by former President Goodluck Jonathan.
It was Nigeria's first-ever democratic handover of power between rival political parties, and was largely peaceful, highlighting the country's improving institutions. The new administration has focused on tackling corruption and increasing the efficiency of institutions. We believe these anti-corruption and efficiency measures could bear fruit in the next several years.
The long-awaited Petroleum Investment Bill, aimed at reforming the petroleum sector and boosting production, first drafted over a decade ago, is to be amended and broken up into smaller legislation that can more easily be presented and passed by parliament. In an effort to improve oversight, almost all government revenues and expenditures have, since September 2015, been transferred to a TSA, which should allow for better monitoring and control of funds.
Since his inauguration in May 2015, President Buhari has intensified military efforts in conjunction with Chad, Niger, and Cameroon to defeat Boko Haram, an insurgency group. So far, his campaign has been broadly successful, with Boko Haram losing control of territory and being forced to revert to guerrilla tactics.
In the south of the country, however, President Buhari's government has experienced a number of attacks from various militant groups, leading to shutdowns of major pipelines, reducing oil production. In response, he has extended the longstanding amnesty for former insurgents in the oil-rich Niger delta for at least a year.
The ratings on Nigeria are constrained by our view of its low GDP per capita, significant infrastructure shortcomings, internal political tensions, and weak, albeit strengthening, institutions.
The ratings are supported by relatively low general government and external debt burdens and ample oil reserves, and recent positive measures toward tackling corruption and developing the non-oil sector. Nigeria relies on oil and gas for over 90% of its exports and at least half of its fiscal revenues, but only about 10% of GDP.
The stable outlook signals our assessments that at this lower rating the risks to the government’s credit standing are balanced.
We may lower the ratings if we observe further deterioration of Nigeria's fiscal or external accounts, or greater stress in the financial sector than we currently expect.
We could raise our ratings on Nigeria if we see policy responses that improve domestic growth prospects on a structural basis. These could include, for example, an easing of controls on current and capital account transactions that lead to an adjustment in external accounts or a successful implementation of the government's anti-corruption measures that materially boosts non-oil revenues.
Ratings Score Snapshot
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