Nigeria's Outlook Revised To Negative On Falling Foreign Exchange Reserves


Monday, March 02, 2020 / 11:00 AM / by S& P Global Ratings/ Header Image Credit: The Guardian                  



  • Nigeria's economic growth remains weak, slower than that of several peers at a similar rating level. Weak growth, sizable public debt, and external pressures are all weighing on Nigeria's creditworthiness.
  • Foreign-exchange reserve levels have fallen from $45 billion at mid-year 2019 to $38 billion at end-2019 and $36.5 billion in February 2020.
  • The Central Bank of Nigeria has been issuing Central Bank of Nigeria bills (CBN) bills, which have attracted foreign investors. About a third of foreign-exchange reserves are derived from nonresident holders of these CBN bills, positions we consider to be vulnerable to a change in investor sentiment.
  • Owing to the late passage of the budget in 2019, government funding pressures resulted in increased financing from the central bank through overdraft facilities.
  • As a consequence of these pressures, we are revising the outlook to negative from stable.


Rating Action

On Feb. 28, 2020, S&P Global Ratings revised the outlook on Nigeria to negative from stable. At the same time, we affirmed our 'B/B' long- and short-term sovereign credit ratings on Nigeria. We lowered our long- and short-term Nigeria national scale ratings to 'ngA-/ngA-2' from 'ngA/ngA-1'.



The negative outlook over the next six-to-12 months reflects the balance of the risks from further foreign exchange (FX) pressures, ongoing weak economic performance, as well as rising government domestic and external debt.


We may lower the ratings if Nigeria's international reserves decline markedly, external debt rises significantly faster than our current assumptions, or if our projections of gradual fiscal consolidation do not materialize.


We could raise our ratings if Nigeria's economic performance were to strengthen significantly, FX reserve levels rose, or if fiscal deficits were to reduce faster than we project.



The ratings remain constrained by: falling FX reserves, slow GDP growth, low GDP per capita, and low or negative real GDP per capita growth in dollar terms, increasing public debt (particularly once the CBN bills and Central Bank overdrafts are included) and multiple exchange rates.


Foreign exchange reserves have fallen by US$8.5 billion (or close to 20%) since mid-2019. We estimate the 2019 current account balance turned from a surplus in 2018 to a deficit of 1.5% of GDP in 2019, due mostly to an increase in the goods and services import bill. Reserves declined to about $38 billion in December 2019 and $36.5 billion in February 2020.


In October 2019, Nigerian local nonbank participants were restricted from participating in CBN auctions, which subsequently resulted in a larger portion of CBN bills being held by nonresidents (estimated at about $12 billion or one-third of reserves). These holdings could be subject to changes in foreign investor sentiment and a potential sell-off, thereby creating risks to current reserve levels. Given these risks, we have added CBN bills to general government debt. Therefore, our estimate of general government debt, net of liquid assets, now stands at an average of 39% of GDP in 2020-2023.


In the absence of external funding in 2019 owing to the budget having been passed late, the federal government also turned to the CBN for some direct advances to support expenditures via overdraft facilities. These facilities are likely to be converted into longer-term government securities.


Institutional and Economic Profile: GDP growth continues to be weak, with GDP per capita shrinking in dollar terms

  • Nigeria's growth rates remain low relative to peers with similar wealth levels, and GDP per capita growth has been negative in dollar terms.
  • Nevertheless, we view the approval of the 2020 budget in 2019, prior to the start of the fiscal year, and much earlier than recent years, as favorable for budget execution and capital projects.


Nigeria has established a democratic political system with a tested transfer of power between different political parties and peaceful transitions in recent years. Muhammadu Buhari won the presidency for the second time in March 2019 and his All Progressives Congress coalition party now dominates the national assembly. However, we view government institutions as constrained, with slow decision-making on policy issues. We also view decision-making at the federal level as centralized; nevertheless, the federal system helps to redistribute wealth and spread power, putting a check on the extent of overall centralization.


Nigeria is a sizable producer of hydrocarbons. The oil sector's direct share of nominal GDP is officially estimated at about 10%, but oil and gas account for over 90% of exports and about half of fiscal revenue. Oil production in 2019 was 2.2 million barrels per day (bpd) compared with 1.9 million bpd in 2018. Nigeria's economy is estimated to have expanded 2.2% in 2019 spurred by higher oil production, despite lower oil prices.


Increased foreign currency flows into the market and a relatively stable exchange rate have supported a slight rebound in non-oil sector growth. In fourth-quarter 2019 the economy grew 2.6%, the strongest expansion since the third quarter of 2015. The non-oil sector grew by 2.3%. The extension of bank credit to the private sector is still weak. That said, in its most recent measure to boost credit, the CBN has encouraged banks to increase lending by maintaining a minimum loan-to-deposit ratio of 65%. It has also excluded banks from participating in some auctions of government securities (where they earn a comfortable low-risk margin, which in turn discourages them to lend to the wider economy).


In an environment of low oil prices, boosting non-oil economic growth and associated tax revenue have been priorities for the Buhari government. Nevertheless, economic performance has been weak, while general government debt stocks have risen in recent years. As we have incorporated CBN bills into general government debt stock, debt-servicing costs now consume almost half of general government fiscal revenue, constraining fiscal flexibility.


Absent further structural policy reforms to stimulate economic growth, we forecast real GDP will expand by a modest 2.0%-2.4% over the medium term. In per capita terms, this translates into negative growth over our forecast horizon. Nigeria's per capita GDP remains below that of several peers with income levels at about $2,000 in 2020.


Flexibility and performance profile: CBN bills have been included in our assessment of debt stock

  • Nigeria's current account turned to a deficit in the first three quarters of 2019, while a CBN bills program has resulted in a sizable portion of FX reserves comprising of foreign portfolio investors' funds.
  • Despite moderate public debt levels as a percentage of GDP and relative to peers, Nigeria's fiscal flexibility is constrained by a high interest bill as a percentage of general government revenue.
  • The managed float exchange rate has become more flexible since April 2017, however, there are still several exchange-rate windows and some restrictions.


Increased nonresident participation in domestic markets has been driven by the more-open, liberalized exchange-rate system since April 2017, as well as relatively attractive returns on the CBN's bills. This has in turn helped to boost foreign-currency reserves. However, while issued ostensibly for monetary policy and liquidity management purposes, these holdings could be subject to changes in foreign investor sentiment and pose risks for current reserve levels, which have fallen recently.


There have been some outflows from nonresidents in 2019 in line with other frontier and emerging markets; however, the firm interest rates in the CBN market will likely ensure they remain attractive to nonresidents. If nonresidents remain in the market, central bank reserves should stay broadly around current levels of five months of current account payments. The prompt passage of the 2020 budget--the first time it has been passed before the start of the fiscal year in several years--also provides the government an opportunity to raise external funding through commercial issuances or concessional funding if required, supporting FX reserves.


Although net external debt is still moderate in Nigeria compared with peers, it has been rising sharply over the past few years. Sources of external debt accumulation included substantial Eurobond issuances of close to $10 billion in 2017 and 2018 and the increase in nonresidents active in the local-currency debt markets. The rationale for increased Eurobond issuance is partly related to the government's policy decision to replace expensive domestic debt with potentially cheaper foreign-currency debt.


Although oil revenue supports the economy when prices are high, it exposes Nigeria to significant volatility in terms-of-trade and government revenue. Consequently, the country's balance of payments is affected by swings in global energy markets. The merchandise trade balance is estimated to have slid into a deficit in the first three quarters of 2019, as per the latest CBN data. We estimate a 2019 current account deficit of 1.5%, Nigeria's first deficit since 2015. The country typically runs a deficit on its services and income accounts, but a surplus on its trade account and a substantial surplus on net transfers (largely due to diaspora remittances by Nigerians abroad).


2019 saw a sharp rise in goods imports. For the service account, large outflows were related to travel, medical, and education. Oil exports were fairly firm, despite the fall in oil prices, due to the pick-up in oil production. In 2019, oil production was 2.2 million bpd, compared with 1.9 million bpd in 2018.


Over our forecast period, export revenue could see some upside once production from new oil and gas fields comes on stream. Imports could reduce due to the current crackdown on smuggling of goods across Nigeria's borders with neighboring countries, as well as import substitution measures. This will help the current account move back into a surplus averaging close to 1.8% of GDP over 2020-2023, and thereby reduce downward pressure on reserves.


We estimate narrow net external debt will likely exceed a (still-moderate) 56% of CARs in 2020 (from 40% in 2017) and average 58% until 2023. We estimate gross external financing needs will remain just below 100% of current account receipts (CARs) plus usable reserves during 2020-2023. In 2020, the central government is planning to borrow externally again via Eurobond issuances, and the budget presents a sizable planned external borrowing element.


Although not our base case, if oil prices were to dip significantly below $50 per barrel for a sustained period, this could pose significant downside risk to oil export receipts and the overall economic performance of Nigeria. Since February 2020, oil prices have been under pressure owing to the slowdown in global demand following the coronavirus outbreak.


Unlike some peers, Nigeria publishes an international investment position (external asset and liability position). However, we note that there are discrepancies between changes in external stocks and the balance of payments, which are reflected in errors and omissions in the balance of payments related to unavailable data.


Nigeria's fiscal receipts are still highly dependent on the oil sector, which contributes over half of total revenue. In the current low-oil-price environment, the government is increasing its efforts to boost oil revenue and broaden its overall revenue base. It increased the value-added-tax rate to 7.5% from 5.0% from January 2020 in an effort to increase non-oil revenue. Spending pressures related to capital expenditure, fuel subsidies, and a recent increase in public sector salaries mean that Nigeria will continue to run fiscal deficits. As the 2020 budget has been passed before the start of the fiscal year, the government can undertake a mid-year review (and supplementary budget) if required and adjust the fiscal trajectory. We project the general government deficit, which includes the federal government, states, and local governments combined, will remain at 3.5% of GDP this year and average 3.13% in 2020-2023.


Overall, we forecast that Nigeria's gross general government debt stock (consolidating debt at the federal, state, and local government levels) will average 45% of GDP for 2020-2023, comparing favorably with peer countries' ratios. We include debt of the Asset Management Corporation of Nigeria (AMCON; about 5% of 2018 GDP--created to resolve Nigerian banks' nonperforming loans--in our calculations of gross and net debt, and we now include CBN bill holdings). Excluding CBN bills, gross general government debt as a percentage of GDP averages 27% of GDP for 2020-2023.


General government debt-servicing costs as a percentage of revenue are high, primarily due to low general government revenues to GDP. We have also begun to include interest payments on CBN bills in our calculation to present total interest cost, which has led to them increasing further--we project they will average 48% over 2020-2023 compared with below 10% in 2014. However, we note that currently the interest on CBN bills is being paid by the CBN. Excluding CBN bills, interest costs as a percentage of general government revenues average about 28% in 2020-2023.


The CBN currently operates a few exchange-rate windows. We assess the exchange-rate regime as a managed float and the exchange rate has remained fairly steady (on the main windows) for a few years (especially given inflation differentials). The main exchange-rate windows are the official CBN rate for government transactions, the CBN window for banks and manufacturing companies, and the Nigerian Autonomous Foreign Exchange Fixing Mechanism (NAFEX) window for other transactions. Apart from the official rate, all others have largely converged to the NAFEX window rate.


Although still above the CBN's target of 6%-9%, inflation has been declining. Average inflation was 11.4% in 2019, compared with 12.1% in 2018. We expect inflation will decline again in 2020 to 10% and average about 9% over the medium term. Despite lower food prices last year, compared to 2018, the border closure affected the inflation rate especially toward the second half.


In 2019, the CBN took steps to encourage banks to increase lending by introducing a minimum loan-to-deposit ratio of 65%. As a result, we anticipate higher credit growth of 10%-15% in 2020-2021, stemming both from the CBN's regulatory intervention and a more stable environment, albeit off a low base. The banking sector is exposed to inherently high economic volatility because of Nigeria's reliance on oil and its sensitivity to currency depreciation and high inflation. This leaves banks vulnerable to asset-price shocks and asset-quality problems.


That said, we expect credit losses should normalize at about 2% through 2021. This will in turn support banks' profitability and capitalization. We expect continued regulatory pressures from the CBN in its attempt to support economic growth through financial intermediation, and also strengthen the banking sector following the 2017 naira devaluation. It has been withholding excess naira liquidity over the past two years and increased the cash reserves requirement in January 2020 to 27.5% from 22.5%.

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