| Reviews & Outlooks |    2924 VIEWS  |
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Wednesday, September 02, 2020 / 06:19
PM /by S & P Global Ratings / Header Image Credit: Ecographics
On Aug. 28, 2020, S&P Global Ratings
affirmed its 'B-/B' long- and short-term sovereign credit ratings on Nigeria.
The outlook is stable. At the same time, we affirmed our long- and short-term
Nigeria national scale ratings at 'ngBBB/ngA-2'.
The stable outlook reflects that,
despite the deterioration in economic, fiscal, and external performance,
funding from official lenders will partially alleviate pressures on Nigeria's
FX reserves and support commercial debt-repayment capacity over the next 12
months.
We could raise our ratings if Nigeria
experiences significantly stronger economic performance than we currently
expect, or if external financing pressures prove to be contained, while fiscal
deficits reduce faster than we project.
We could lower the ratings if we saw
increasing risks to Nigeria's capacity to repay commercial obligations, either
because of declining external liquidity or a continued reduction in fiscal
flexibility. This could occur, for instance, if we see significantly higher
fiscal deficits or debt-servicing needs, as well as sharply reduced FX
reserves.
Nigeria's economy has been hit hard by
two shocks--the coronavirus pandemic and the low oil price environment. Given
that Nigeria's reliance on oil revenue is still high, with over 85% of goods
exports and about half of fiscal revenues coming from hydrocarbons, current low
oil prices and volumes in 2020 (with OPEC production quotas capping production)
will impact its external and fiscal positions. The partial lockdown between March
and June, alongside ongoing pandemic-related pressures, will also weigh on the
economy. Furthermore, the manufacturing sector depends heavily on FX for
component imports and is suffering an FX shortage.
We expect real GDP growth to contract by
3.8% in 2020 before growing by a still-lackluster 1.9% in 2021 and averaging
2.1% in 2021-2023. In line with our oil price assumptions (see "S&P Global Ratings Cuts WTI And
Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure,"
published March 19, 2020), our forecast of relatively low oil prices and
volumes in 2020, and consequent low export revenues, will likely see the
current account deficit increasing to 4.3% of GDP this year, despite a fall in
imports. We expect current account deficits to moderate over the medium term
and average 0.5% in 2021-2023. External financing gaps could emerge if economic
assumptions weaken or if funding from official lenders is not as forthcoming as
anticipated.
On the fiscal side, lower oil-related
revenue will keep general government (federal, states, and local government
combined) fiscal deficits elevated at 5.5% of GDP this year, delaying planned
gradual consolidation, before averaging 4.3% in 2021-2023.
In the central government's (excluding
state budgets) amended/supplementary 2020 budget delivered in July 2020,
spending in nominal terms stands at Nigerian naira (NGN) 10.8 trillion, close
to the initial 2020 budgeted figure. However, official revenue projections were
cut by more than one third to NGN5.8 trillion. The revised budget assumes a
relatively conservative oil price at $28/bbl (sharply down from $57/bbl in the
initial budget) and a feasible oil production estimate of 1.8 million barrels
per day (mmbbl/d), leaving some possible upside to revenues if oil prices
remain around the current annual average of approximately $40/bbl. However,
expenditure pressures remain sizable.
Despite the pandemic and oil-price
setbacks, in the medium term the federal government plans to continue trying to
increase non-oil revenue and cutting expenditure. It has removed fuel subsidies
and plans to reduce electricity subsidies, and plans to raise taxes, among
other measures, after having raised VAT. Nevertheless, these measures are not
expected to be enough to compensate for lost oil revenue in 2020.
This year, the government plans to fund
the twin deficits via domestic and concessional multilateral sources. Issuing
eurobonds in the global markets was, at the time of budget planning, viewed as
too difficult given COVID-19-related disruptions globally and risk-averse
investor sentiment (although funding conditions have eased in recent months).
This left the federal government choosing to rely largely on domestic sources
and multilateral debt. The IMF has already disbursed $3.4 billion through its
Rapid Financing Initiative and we expect additional support from the World Bank
and other multilateral lending institutions (MLIs), including the African
Development Bank and Islamic Development Bank, this year. Nigeria is not
planning to apply for debt relief under the G20-led international Debt Service
Suspension Initiative (DSSI)--the amounts of relief that Nigeria is eligible to
obtain under the scheme are relatively small. Relatively low market rates in
the domestic market are currently rendering domestic issuance favorable,
compared to external issuance, and high liquidity in the local market is
leading government auctions to be over-subscribed. This year so far the Debt
Management Office has issued NGN1.8 trillion of its NGN2.2 trillion domestic
borrowing plan.
Relatively low FX inflows tied to low
levels of oil receipts into Nigeria are presenting challenges for the Central
Bank of Nigeria (CBN) in terms of exchange-rate and FX-reserve policies. The
CBN has limited the extent of its FX sales into the Nigerian Autonomous Foreign
Exchange Fixing Mechanism [NAFEX; the main FX market] and the NAFEX is
currently suffering from a dearth of sellers of FX and an estimated backlog of
US$2 billion-US$4 billion in FX demand has built up.
In March the CBN lowered its official
exchange rate (used for some government-related transactions) by about 15%, the
first move on the official rate in over two years, followed by another
devaluation in August of 5%. FX reserves stand at about US$35.6 billion
compared to $38.1 billion at end-2019. The CBN has focused on FX reserve
preservation (arguably at the cost of GDP growth) and we foresee FX reserves
declining relatively slowly to nearly $32 billion by end-2020 but averaging
$35.5 billion in 2021-2023 as the oil price rebounds. FX sales controls,
customs restrictions, and administrative measures to not permit the use of FX
for the purchase of a list of over 40 goods will help the central bank preserve
its FX. Oil companies are also obliged to sell their FX earnings directly to
the central bank.
Nigeria is a sizable producer and
exporter of hydrocarbons, ranking among the top-10 exporters in the world. Oil
production in 2019 was 2.2 mmbbl/d compared with 1.9 mmbbl/d in 2018 and is
estimated at around 1.8 mmbbl/d in 2020--and will most likely be limited by
current OPEC quotas (the result of a June 2020 OPEC-plus-other-countries-wide
deal). Militancy in the Niger Delta has often led to sharp swings in oil
production, but in recent years negotiations led by Nigeria's Vice President
Yemi Osinbajo have led to improved relations and oil flows with fewer attacks
on oil facilities.
The low oil price environment, OPEC+
deal constraints, and measures to contain COVID-19 will weigh on economic
activity this year. Real GDP contracted 5% quarter-on-quarter in the second
quarter of 2020, following a 14.3% quarter-on-quarter contraction in the first
quarter. Year-on-year, the non-oil economy shrank by 6.1% in real terms in the
second quarter, while the oil economy fell 6.6%. Agriculture grew by 1.6%
over-year-ago, down from 2.2% in the first quarter, with lockdowns restricting
agriculture to a lesser degree. Industrial activity fell by 12% over-year-ago
with manufacturing down 8.8% and construction falling by 32%, while services
fell by 6.8%. It is becoming clear that, in addition to effects on the oil
sector, the non-oil economy is also taking a considerable hit from the pandemic
and the knock-on effects of low oil prices and low FX levels.
As a result, we forecast output in 2020
to contract by 3.8% before recovering by slightly under 2.0% next year, with
real GDP recovering to 2019 levels only by 2022. In per capita terms this means
economic contraction over our forecast horizon. Nigeria's per capita GDP
remains below that of several peers, with income levels below $1,800 in
2020-2023, which also reflects its relatively high population growth.
Nigeria has, in the last decade,
established a democratic political system that has seen broadly free and fair
elections and transfers of power between different political parties. However,
there remains a myriad of problems. Police and military forces tend to be
overstretched and forced to deal with a multitude of security crises. The
government is embroiled in conflicts with Boko Haram and Islamic State West
Africa Province (ISWAP) in the northern regions. In the Middle Belt, tensions
persist between farmers and herdsmen, notably over scarce land and water
resources, affecting food supplies, while in the Southern oil-producing states
Delta militants disrupt oil production when conditions do not work in their
favor. The pandemic will also compound tensions among the population and
exacerbate already relatively low living standards. Insufficient resources at
the federal and local levels will also leave vulnerable those affected by the
economic fallout, especially given the very few social safety nets.
President Muhammadu Buhari, with his All
Progressives Congress coalition, is currently serving a second term after
winning a second mandate in March 2019, but the government has been slow on
decision making and structural reform. Nigeria's federal structure helps to
redistribute wealth and spread power and places checks on the extent of overall
centralization, but it also makes reform implementation and tax collection more
difficult.
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. We project the current
account to increase marginally to 4.3% this year, from 4.2% in 2019, because of
the loss of export revenue associated with lower oil prices, before eventually
rising to a small surplus of 0.1% of GDP in 2023. Nigeria's net external debt
has been rising over the past few years. We estimate external debt net of
liquid external assets (our preferred measure of external leverage) will almost
double between 2019 and 2020 to slightly above 60% of current account receipts
(CARs) and stabilize thereafter. More importantly, external liquidity will
remain under pressure with our estimate of gross external financing needs (all
payments to non-residents) averaging 116% of CARs plus usable reserves
during 2020-2023.
We project the general government
deficit, which includes the federal government, states, and local governments
combined, will stand at 5.5% of GDP this year and average 4.3% in 2020-2023.
Overall, we forecast that Nigeria's net general government debt stock
(consolidating debt at the federal, state, and local government levels, and net
of liquid assets) will average 42% of GDP for 2020-2023. We include the Asset
Management Corporation of Nigeria debt (AMCON; created to resolve Nigerian
banks' nonperforming loans) in our calculations of gross and net debt. We also
include CBN bill issuance into our debt stock calculations. In early 2020 the
CBN largely stopped rolling over its bills, reducing its stock sharply, and
therefore our change in net general government debt stands at 1.5% in 2020,
despite a general government deficit of 5.5%.
General government revenue as a
percentage of GDP is very low compared with peers and is forecast to average
only 7% in 2020-2023. This highlights the limited tax generation capacity,
partly explained by high portion of informality in the Nigerian economy. We
nonetheless note the authorities' recent endeavors to increase revenue streams,
especially non-oil revenues. General government debt-servicing costs as a
percentage of revenue are high, primarily due to the low general government
revenue to GDP. We include interest payments on CBN bills in our calculation of
current total interest costs; however, we note that currently the interest on
CBN bills is being paid by the CBN and is therefore not a cost borne by the
Ministry of Finance. Given the sharp reduction in CBN open market operation
(OMO) bills, as well as market conditions, interest cost as percentage of
revenues are sharply lower than projected at our last publication--they will
rise to 31% in 2020, from 27% in 2019 and below 10% in 2014.
The CBN operates a few exchange-rate
windows. We assess the exchange-rate regime as a managed float and note that
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 key government transactions, and the
NAFEX window for other transactions. The current FX shortage in the Nigerian economy
has widened the spread between the NAFEX and the unofficial parallel exchange
rate--the parallel rate stands at around NGN475:$1 compared to the official
rate of NGN380 and the NAFEX rate of about NGN386, highlighting that pressures
remain high.
Average inflation was 11.4% in 2019,
compared with 12.1% in 2018 and rose to 12.8% in July 2020. Low oil prices,
associated naira depreciation, FX shortages, and tensions in the food producing
Middle Belt are likely to fuel inflation. We therefore expect inflation to
remain high this year, increasing to 15%. Thereafter, we anticipate inflation
will decline to an average of about 11% over 2021-2023 as pressures abate
slightly.
The CBN cut rates in May by 100 basis
points to 12.5%, but kept the CRR at 27.5%. The CBN also instructed banks to
provide forbearance on loans and has provided support to various key groups.
The banking sector is facing U.S. dollar shortages while foreign currency loans
account for about half of banks' total loans. Naira liquidity is manageable for
banks and the CBN may have some flexibility to release additional liquidity
through the cash reserve requirement (CRR), which sits at a high 27.5%.
The extension of bank credit to the
private sector is currently subdued, despite the CBN introducing (but not fully
enforcing) a minimum loan-to-deposit ratio of 65% to boost credit growth. We
expect a deterioration of the loan books, with restructured loans increasing
sharply in 2020 from about 10% in 2019. We expect nonperforming loans (NPLs)
will rise again to about 12.0% in 2020-2021 compared with an estimated 6.3% in
2019. We forecast credit losses will increase to about 2.5% in 2020 compared
with a record high of 5.0% following the 2016 crisis.
As a result, the sector's profitability
will be weaker on the back of higher impairments and lower net interest margins
because of lower interest rates and government securities yields. We believe
that the risk of banks breaching minimum capital adequacy ratios could
re-emerge if the naira weakens by more than 20%, which is higher than our
current assumption for 2020.
We believe that banks will be less willing to extend credit to oil and gas companies, especially downstream ones, because these exposures are denominated in U.S. dollars in a context of tight liquidity. The upstream sector's attractiveness will depend on the pace of recovery of oil prices. Single-name and industry concentrations remain high in Nigeria, with most of the large banks serving the same large corporate borrowers.
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