April 06, 2020 / 10:39 AM / By Fitch Ratings / Header
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Fitch Ratings has downgraded Nigeria's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B' from 'B+. The Outlook is Negative.
Key Rating Drivers
The downgrade and Negative Outlook reflect the aggravation of ongoing pressures on Nigeria's external finances following the recent slump in oil prices and the pandemic shock. Intensifying external pressures raise risks of disruptive macroeconomic adjustment given Nigeria's precarious monetary and exchange rate policy setting and lack of fiscal buffers. The shock will also raise government debt and interest payment-to-revenue ratios from already particularly high levels and lead to a renewed economic recession.
The plunge in international oil prices, which we assume will average of USD35/barrel in 2020 after USD64.1/barrel in 2019, highlights Nigeria's high dependence on the oil sector, with hydrocarbon revenues representing 57% of current-account receipts and nearly half of fiscal revenue over the last three years. This shock exacerbates the overvaluation of the naira and remedial policy actions taken by the Central Bank of Nigeria (CBN) will not suffice to address deteriorating external imbalances, in our view. The CBN allowed the exchange rate on the Investor and Exporter Window, on which the bulk of foreign-currency (FC) transactions is held, to depreciate by 6.7% since mid-January and devalued the official exchange rate by 15% in March.
The scope of the enacted adjustment is small relative to magnitude of the shock as well as to the steep real effective exchange rate appreciation of more than 30% since end-2016. Real appreciation was driven by persistent high inflation averaging 13.3% in 2017-2019 amid rigid nominal exchange rates. Continued pressures on the naira are illustrated by the drawdown in international reserves, which declined by 9.4% year-to-date, representing a cumulative fall of 22.5% since their peak mid-July.
Reversal of international portfolio inflows in a context of a spike in global risk aversion could magnify the impact of the oil price shock. Nigeria's vulnerability to short-term capital outflows is high given the sizeable stock of portfolio investments in short-term naira debt securities, equivalent to USD27.7billion (6.9% of GDP) at end-2019 and representing around 72% of FC reserves at the time. Of these liabilities, USD14.7 billion was in non-resident investments in the CBN's open-market operation bills that were attracted by high interest rates and hedging instruments offered to non-residents at non-economic costs under the CBN's policy of stabilising the exchange rate.
Continued reluctance to adjust the exchange rate, portfolio outflows and a wide current-account deficit (CAD) will lead FC reserves to fall to 2.5 months of current account payments at end-2020 under our forecasts, well below the historical 'B' median of 3.8 months, and their lowest level since 1994. We estimate that the CAD will widen to a record level of 4.9% of GDP in 2020, exceeding the historical 'B' median of 4.3%, under our assumption of only modest depreciation of the naira. Nigeria's long-standing current account surplus shifted to a deficit of 4.2% of GDP in 2019 on an upsurge in imports, chiefly of equipment goods. We project the CAD to narrow to 1.8% in 2021 reflecting partial recovery of oil prices to USD45/b, import compression and tighter restrictions on FC access.
Nigeria's external finances are highly vulnerable to a further fall in international oil prices below our current forecasts. Despite the expiry of production caps under the OPEC+ agreement, there is little scope to ramp up Nigeria's oil production beyond our current assumption of 2.1 mbpd given capacity constraints and the build-up of a global supply glut on oil markets. Under a stable oil production assumption, a USD10 drop in average Brent benchmark prices below our current projection would cause the CAD to widen by an additional 1.6% of GDP. Furthermore, the domestic oil sector's operational breakeven is around USD25-30/barrel, based on official estimates, meaning production cuts are likely should oil prices continue to hover well below USD30/barrel.
The collapse in oil revenues and the slowdown in economic activity will take a toll on the government's already weak fiscal revenues. This will be partly cushioned by the devaluation of the official exchange rate, which will boost fiscal oil revenues in naira terms. In addition, the fall in international fuel prices will allow the government to eliminate the implicit fuel subsidy. Nigeria's fiscal breakeven oil price is high, at USD133/barrel under our estimates, given particularly low non-oil fiscal intakes.
We project the general government (GG) deficit will widen to 5.8% of GDP (federal government, FGN: 3.1%) in 2020 from 3.8% (FGN: 2.4%) in 2019. There is limited scope for consolidation through spending cuts given fiscal rigidity from payroll and interest outlays, which will represent 150% of the FGN's revenues and two-thirds of its expenditures in 2020. Cuts to other operational outlays and capital expenditures will be largely offset by higher spending on health services and support to sectors affected by the pandemic shock.
Low fiscal revenues present a major challenge to debt sustainability. GG debt will edge up to 511% of revenues (FGN: 1028% ) in 2020 from 371% (FGN: 717%) in 2019, rising by five times in eight years and widening the gap with the historical 'B' median of 214%. Relative to GDP, GG debt will stabilise at 31% (FGN:26%) in 2020-2021 under our projections, its highest level since the restructuring of the Paris Club debt in 2005, but still below the historical 'B' median of 50%.
We expect the government will cover most of its funding needs on domestic markets in 2020, but could still tap emergency funding facilities of multilateral creditors such as the IMF and the African Development Bank. The government had resorted to monetary financing in 2019 with net CBN claims on the FGN soaring to 4% of GDP at end-2019, exceeding annual FGN revenues, from nearly 0% at end-2018.
We expect the pandemic shock to push the Nigerian economy into recession with GDP contracting by 1% in 2020. Non-oil GDP will fall, weighed down by spillovers from the oil sector, tighter FC supply and disruptions to economic activity from measures taken to contain the spread of the coronavirus as regions accounting for nearly half of the national economy were put under a two-week lockdown in March. We expect GDP to bounce back by 4.4% in 2021 assuming a gradual normalisation of economic activity and stable oil production but risks around our baseline are tilted to the downside given uncertainty regarding the spread of the pandemic.
Nigeria's 'B' rating also reflects the following rating drivers:
Materialisation of large contingent liabilities on the government's balance sheet could cause a steeper rise in GG debt than our current forecasts. The collapse in oil prices will pressure already overstretched state and local governments' resources, possibly requiring financial assistance from the FGN. Delays to electricity tariff hikes and to restructuring plans following the pandemic outbreak will raise needs for further support to the ailing electricity sector.
Asset quality in the banking sector is weak, with non-performing loans of 11.7% of total bank loans at end-2018 and an elevated proportion of restructured loans. It is likely to deteriorate given high bank exposure to the oil sector and broad weakening of the operating environment, which could prompt capital injections by the sovereign. This is in addition to contingent liabilities from the debt of the Asset Management Corporation of Nigeria of 3.3% of GDP at end-2018.
Nigeria has an ESG Relevance Score of 5 for both Political Stability and Rights and Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. Lingering insecurity causes disruptions to the economy, while deep regional divisions hinder policy-making.
Sovereign Rating Model (SRM) and Qualitative Overlay (QO)
Fitch's proprietary SRM assigns Nigeria a score equivalent to a rating of 'B' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR.
Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:
Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:
Best/Worst Case Rating Scenario
Ratings of Public Finance issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings https://www.fitchratings.com/site/re/10111579.
We expect global economic trends to develop as outlined in Fitch's most recent Global Economic Outlook. We project Brent oil prices to average USD35/barrel in 2020 and USD45/barrel in 2021. We expect Nigeria's oil production volume to average 2.1 mbpd in 2020-2021, up from 1.96 mbpd in 2019, supported by the coming online of the Egina oilfield.
References for Substantially Material Source Cited as Key Driver of Rating
The principal sources of information used in the analysis are described in the Applicable Criteria.
Nigeria does not publish consolidated fiscal data on a general government basis, which complicates the assessment of fiscal performance. However, Fitch is able to produce its own estimates for general government fiscal metrics that are broadly consistent with and comparable to the data used for other sovereigns, providing sufficient information to maintain the rating. The rating level further mitigates residual uncertainty on the accuracy of the Fitch estimates. These estimates are based on disaggregated data on federal, state and local government revenue, spending and debt published by the Nigerian National Petroleum Corporation (NNPC), the CBN, the Debt Management Office (DMO), the Budget Office of the Federation (BOF) and the National Bureau of Statistics (NBS).
Nigeria has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's Sovereign Rating Model. This is highly relevant to the rating, and a key rating driver with a high weight.
Nigeria has an ESG Relevance Score of 5 for Rule of Law and Institutional and Regulatory Quality, as World Bank Governance Indicators have the highest weight in Fitch's Sovereign Rating Model. This is highly relevant to the rating, and a key rating driver with a high weight.
Nigeria has an ESG Relevance Score of 4 for Human rights and Political Freedoms, as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver.
Nigeria has an ESG Relevance Score of 4 for Creditors Rights as willingness to service and repay debt is a rating driver for Nigeria, as for all sovereigns.