| Reviews & Outlooks |    1829 VIEWS  |
| Reviews & Outlooks | |
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Friday, December 20, 2019 / 03:40 PM / by
Fitch Ratings / Header Image Credit: Archival Institute
Fitch Ratings has revised the Outlook on Nigeria's
Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative from Stable,
and affirmed the rating at 'B+'.
Key Rating Drivers
The Outlook revision reflects the increasing
vulnerability from the current macropolicy setting, raising risks of disruptive
macroeconomic adjustment in the medium term amid continued real appreciation of
the naira. A sharp devaluation of the exchange rate under the current policy
framework would stoke macroeconomic volatility and significantly weaken some of
Nigeria's key credit metrics, including its GDP per capita in US dollars and
its share in world GDP.
The substantial real appreciation of the naira over
the last year appears uncorrelated with macroeconomic fundamentals and is set
to continue, driven by high inflation. Commodity terms of trade have
deteriorated somewhat and will decline further, weighed down by lower oil
prices. However, Nigeria's real effective exchange rate has surged by around
20% since April 2018 and is now close to its high reached in mid-2016, prior to
the exchange-rate devaluation in the wake of the oil-price shock.
Meanwhile, the Central Bank of Nigeria (CBN) is
striving to maintain a stable nominal exchange rate through an array of
unconventional and economically costly policy measures. In particular, risks
stem from the central bank's policy of attracting portfolio investments in its
short-term Open Market Operations (OMO) bills through high yields and hedging
instruments offered to non-resident investors at low cost, despite a wide
spread between the naira and dollar interest rates. As a result, non-resident
holdings of the CBN's OMO bills soared to USD17 billion by end-August,
equivalent to 40% of foreign-currency (FX) reserves at the time.
Challenges to the durability of the current policy
setting are underscored by increasingly complex regulatory measures taken by
the CBN to reconcile its competing objectives of attracting foreign investments
in OMO bills and spurring bank lending. The central bank has recently barred
non-bank residents from participating in the OMO market, and separately imposed
a floor on bank loan-to-funding ratios to support credit growth. Lower OMO
market liquidity due to a narrower range of participants is likely to have
dampened net portfolio inflows, contributing to a 12% drop in FX reserves in
November from end-June to their lowest level in two years.
The current account (CA) balance has shifted to
deficit from a long-standing surplus, pointing to deteriorating macroeconomic
imbalances and adding to external vulnerability. Fitch expects the CA will
record a deficit of 1.6% of GDP in 2019, its second-weakest level in 24 years,
after a surplus of 2.6% in 2018; Fitch forecasts the CA deficit will moderate
to an average of 0.7% of GDP in 2020-2021.
FX reserves will average 4.7 months of CA payments
over 2019-2021, down from 6.1 months in 2018. This will still be much higher
than the forecast 'B' median of 3.5 months, but reliance on short-term
financial inflows - particularly into OMOs - for building reserves and a
significant portion of reserves pledged in swaps mean that Nigeria's liquid foreign
assets offer only a modest liquidity buffer against external shocks.
Nigeria's 'B+' ratings also reflect the following
rating drivers:
General government (GG) debt remains on an upward
path, while particularly low fiscal revenues and structural shortcomings in
public finance management (PFM) constrain the sovereign's ability to support a
rising debt burden. The GG debt/revenue ratio is particularly high, at 333%
(Federal government (FGN), debt: 777%) in 2019, and will rise close to 400%
(FGN debt: 922%) in 2021, well above the forecast 'B' median of 248%. GG debt
will exceed 30% of GDP (FGN debt: 24%) in 2020, trebling in a decade, and up
from 25% (FGN debt: 20%) in 2018 which was already its highest level since the
restructuring of the Paris Club debt in 2004.
Weaknesses in PFM are illustrated by rising monetary
financing, a large and uncertain amount of government arrears, and a multitude
of contingent liabilities on which transparency is poor. Net CBN claims on the
FGN soared to an all-time high of 3% of GDP in August, equivalent to annual FGN
revenues. Significant arrears continue to undermine the viability of the power
sector despite large injections of funds by the CBN and the budget authorities.
Domestic arrears of NGN3.4 trillion (2% of GDP), according to preliminary
estimates, are being cleared through the issuance of promissory notes. This
amount does not capture pension and wage arrears reportedly owed by different
tiers of government.
Litigation with third parties underscoring governance
shortcomings are a source of fiscal risks. This is exemplified by a recent USD9
billion (2.3% of GDP) ruling in the UK against the Nigerian government in a
litigation case with a gas firm, exposing Nigeria to the risk of asset seizure,
although the authorities are contesting the ruling proactively in the courts.
The debt of the Asset Management Corporation of
Nigeria (AMCON) of 3.3% of GDP at end-2018 constitutes a contingent liability
for the sovereign, and could rise in the context of high non-performing loans
in the banking sector of 11.7% of total bank loans and an elevated proportion
of restructured loans.
Low non-oil fiscal revenues are a key credit weakness,
and are unlikely to improve significantly in the medium term in light of the
slow progress on fiscal reforms. Public finances are highly dependent on
hydrocarbon revenues, which account for 45% of GG revenues and are exposed to
risks of disruption to production from vandalism or other force majeure
affecting Nigeria's aging oil infrastructure. Break-even oil prices are high,
at around USD144/barrel on our estimates, and a USD10 change in oil prices
around our baseline would affect the budget balance to the tune of 0.5% of GDP.
Fitch forecasts the GG deficit will deepen to 4.4% of
GDP (FGN: 3.4%) in 2019 and stabilise in 2020, up from 4% (FGN: 3%) in 2018.
Oil revenues will edge down as lower international prices under Fitch's
baseline will offset a rise in production volume and possibly higher royalties
under new legislation.
Fitch forecasts a stable Nigerian oil production
volume of 2.14 million barrels per day (mmbpd, including condensates) over
2019-2021, against a 2019 budget assumption of 2.3 mmbdp and a 2020 budget
assumption of 2.18mbpd. The agency also projects Brent oil prices to average USD65/barrel
in 2019 (FGN budget: USD60), USD62.5/barrel in 2020 (FGN budget: USD60) and
USD60/barrel in 2021.
Inflation is high and poised to accelerate. Fitch
projects it will average 13% in 2020-2021 from 11.3% in 2019, well above the
forecast 'B' median of 5% and inflation rates in Nigeria's main trade partners.
The acceleration will be driven by a host of recently enacted policy measures
which will compound price pressures from exogenous cost-push factors. These
measures include the upcoming raise of the VAT rate, significant salary
increases following the 66.7% hike of the minimum wage in April, as well as the
recent closure of land borders to foreign trade and tightening restrictions on
FX financing for a wide range of imports.
The medium-term economic outlook is subdued. Fitch
projects an average GDP growth of 2.4% in 2019-2021, well below the 'B' median
of 3.4% and the five-year average demographic growth rate of 2.7%. The
prospects for supply-side, fiscal and exchange-regime reforms that could tackle
the major constraints for Nigeria's credit profile are weak, as reflected by
the record in recent years. Emerging rivalries within the ruling APC party,
possibly sparked by early dissensions over the 2023 succession to president
Buhari, could hamper 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.
In accordance with its rating criteria, Fitch's
sovereign rating committee decided not to adopt the score indicated by the SRM
as the starting point for its analysis because the SRM output has migrated to
'B' from 'B+', but in our view this is potentially a temporary deterioration.
Assuming an SRM score equivalent to a rating of 'B+',
Fitch's sovereign rating committee did not adjust the output from the SRM to
arrive at the final LT FC IDR.
Fitch's SRM is the agency's proprietary multiple
regression rating model that employs 18 variables based on three-year centred
averages, including one year of forecasts, to produce a score equivalent to a
LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to
allow for adjustment to the SRM output to assign the final rating, reflecting
factors within our criteria that are not fully quantifiable and/or not fully
reflected in the SRM.
Rating Sensitivities
The main factors that could collectively or individually lead to a rating downgrade are:
Key Assumptions
Commodity prices and global economic trends are
assumed to develop as outlined in Fitch's most recent Global Economic Outlook,
published in December 2019.
Nigeria does not publish consolidated fiscal data on a
general government basis, which complicates the assessment of fiscal
performance. Fitch produces its own estimates for general government fiscal
metrics 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), the National Bureau of Statistics (NBS) and the
Office of the Auditor General for the Federation (OAGF).
ESG Considerations
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. Insecurity causes disruptions to the
economy while deep regional divisions constrain policy-making. 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.
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