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Federal Republic of Nigeria Ratings Affirmed At 'B-B'; Outlook Stable

Proshare

Monday, September 18, 2017/2:09PM/ S & P Global Ratings

Overview
Oil production in Nigeria has accelerated this year, while the public and financial sectors are now better able to access external financing, in our view, improving external financing and supporting the level of international reserves at the central bank.
We are therefore affirming our 'B/B' ratings on Nigeria.

The stable outlook signals our assessment that the oil sector improvements will support higher economic growth, fiscal revenues, and higher current account receipts over the next 12 months.


Rating Action

On Sept. 15, 2017, S&P Global Ratings affirmed its 'B/B' long- and short-term  sovereign credit ratings on the Federal Republic of Nigeria. The outlook is  stable.


At the same time, we affirmed our long- and short-term Nigeria national scale  ratins at 'ngBBB/ngA-2'.


Outlook

The stable outlook signals our assessment that the oil sector improvements  will support higher economic growth, fiscal revenues, and higher current  account receipts over the next 12 months.


We may lower the ratings if we observe a significant acceleration in the  accumulation of government debt beyond our current forecast, and if external  financing gaps become larger and more difficult to fund. We could also lower the ratings if temporary foreign exchange restrictions remain in place for an extended period.


We could raise our ratings on Nigeria if we see significantly higher economic  growth prospects than our base case.


Rationale

The ratings on Nigeria are constrained by our view of its low level of  economic wealth, weak external position, real GDP per capita trend growth rates below those of peer with similar levels of development, and future policy responses that may be difficult to predict. Following a contraction in the real GDP growth rate of 1.5% in 2016, we now expect Nigeria's economy to expand at a still weak 1% in 2017, supported by rising oil and agriculture production and easing foreign exchange (FX) liquidity conditions.


The ratings are supported by relatively low general government debt but high debt servicing costs and modest fiscal deficits. We expect that improvements  experienced in 2017 with higher crude oil production will help increase foreign currency supply and keep the current account largely in balance. International foreign reserves remain stable as a result.


Institutional and Economic Profile: Economic performance remains weak, with trend growth below peers


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Political decision-making in Nigeria can be unpredictable, as government institutions are relatively weak.

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However, Nigeria is a democratic system with a tested transfer of power between different political parties, most recently experienced in the last 2015 general elections.

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The pace of economic growth remains very low relative to peers with similar wealth levels.

In our view, political decision-making in Nigeria can be unpredictable. We  view government institutions as relatively weak, resulting in mixed messages  being promoted in relation to policies, such as the appropriate exchange rate  regime for the country. Fiscal budgets are frequently passed late in the year, which delays the government's responsiveness to economic challenges.


We also view decision-making as centralized in the person of the president, although we note that the federal system of government helps to redistribute wealth and spread power to some extent. Nevertheless, we view most decision-making as centralized and institutions as relatively weak.


As a result, President Buhari's illness, which has seen him spend several weeks in London in 2017  receiving treatment, has resulted in some domestic political uncertainty. The government has provided executive powers to the Vice President who has acted as president in the absence of Mr. Buhari.


While security risks have abated compared with the last two years, we still see sporadic attacks in the North East owing to Boko Haram, as well as the risk of another escalation of tensions in the Niger Delta.


We note that Nigeria ranks poorly on the World Bank's Regulatory Quality and Rule of Law index, raising concerns regarding the enforcement of contracts.


Nigeria also has a relatively poor ranking on the World Bank's Ease of Doing Business and Ibrahim Index of African Governance (36 out of 54) Indices. Corruption is perceived to be very high in Nigeria; Transparency International ranks Nigeria 136th out of 172 countries in its Corruption Perception Index.


The new administration is nonetheless working on improving broader governance, transparency, and public finance management, but its efforts may take time to bear fruit.


We expect Nigeria's economy to achieve real GDP growth of 1% in 2017 and 3%, on average, over 2017-2020, supported by rising oil and agriculture production and gradually easing foreign currency liquidity conditions.


A gradual increase in foreign currency inflows through rising export revenues, plus bank and government external borrowing, could help reduce foreign currency gaps in the country. Nevertheless, on a per-capita basis, real GDP growth of 0.1% (which we proxy by using 10-year weighted-average growth) remains well below that of  peers with similar wealth levels. Nigeria has significant infrastructure and energy shortfalls and low-income levels, with GDP per capita estimated at US$1,800 in 2017.


Nigeria is a sizable producer of hydrocarbons. The oil sector's direct share of nominal GDP is officially estimated at about 10%, while oil and gas account for over 90% of exports and at least half of fiscal revenues.


Although oil revenues support the economy when prices are high, we view them as exposing Nigeria to significant volatility, in terms of trade and the government, to swings in the revenue base. The government has negotiated with community leaders in the Niger Delta, which led to the resumption of cash payments to militants in that region.


Consequently, disturbances to the oil export pipelines have been significantly reduced this year. Thus oil production continues to rise relative to mid-2016. However, oil production remains subject to sporadic attacks to oil pipelines or output being limited by OPEC.


Nigeria's exemption from the oil production cuts will be reviewed at the next OPEC meeting in September 2017 since oil production has now been restored to normal levels.


The structure of Nigerian National Petroleum Corporation joint venture agreements with international oil companies (IOCs) has resulted in longstanding cash call challenges that have affected the Nigerian oil and gas industry over the years. We expect these upfront cash payments to be reduced by a new funding model whereby all loans will be repaid from project proceeds.


The model creates a special purpose vehicle in relation to a specific project. The project will borrow from banks while the IOCs in the project also lend and provide equity capital. We think this should improve the business environment and attract investment to the oil sector. Existing arrears to IOCs estimated by the oil sector at around US$5 billion will be compensated with incremental production, extra barrels of oil.


Flexibility and Performance Profile: Modest fiscal deficits and low general government debt; high debt servicing costs and still weak external position.


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Nigeria's external position is still weak but we observe improved access to foreign currency, particularly as oil receipts increase.

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The country has a relatively low level of general government debt but high debt servicing costs.

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Nigeria operates multiple exchange rates, which we consider a managed float with a short track record, while foreign exchange restrictions on current account transactions remain.

We consider Nigeria's external position to be weak due to large gross external financing needs above 100% of current account receipts (CARs), plus usable  reserves that emanate from high short-term external debt relative to CARs (about 80%) that have weakened significantly since the fall in oil prices three years ago. Changes in oil prices and production expose Nigeria to significant volatility in terms of trade.


That said, the overall current account posted a small surplus in 2016 of close to 1% of GDP. This is a reversal of the deficit recorded in 2015, caused by compressed goods and services imports, while Nigeria continues to benefit from a large current transfer surplus, which has continued to track historical levels. The compressed payments abroad for goods and services were largely due to shortages of foreign currency experienced in the Nigerian economy over the last two years.


We expect that higher crude production will help increase CARs along with imports of goods and services. Therefore, we now project the current account position to be in near balance over 2017-2020, while gross external financing  needs will average close to 120% of CARs plus usable reserves over the same  period. We expect the government's external financing needs to be covered by a combination of credit lines from the World Bank and the African Development Bank, and from the international capital markets. On a stock basis, narrow net external debt (external debt minus liquid external assets) will average close to 50% of CARs in 2017-2020, in our base-case scenario.


In 2016, government capital budget execution was slow due to delays in the  legislature's approval of the budget and delays in securing external financing to support capital budget spending. The external financing was only sourced in early 2017 and spent under the "2016 budget" after extending the fiscal year into 2017.


At the same time, financial performance of states and local governments were weak, requiring transfers by the federal government to settle salary and supplier arrears. At the same time, revenue collection underperformed budget targets. Thus, the general government deficit estimate (which includes the federal and lower levels of government) weakened to over 4% of GDP.


Despite passing the 2017 budget late in the year (June 2017), we expect budgetary execution will remain similar to 2016, with the fiscal year also likely to be extended into early parts of 2018.


However, we forecast that financial support to states and local governments is likely to be lower than support provided in 2016. We also see increased oil revenues from higher production enabling gradual fiscal consolidation of the fiscal deficit to 3.5% of GDP this year and close to 2% of GDP in 2020. We expect the annual change in general government debt (our preferred fiscal metric because in most cases it is more comprehensive than the reported headline deficit) to average about 2% of GDP over 2017-2020.


The federal government is still in the process of clearing its arrears to lower levels of state, private contractors, and suppliers arrears. The government plans to issue promissory notes that amortize over a 10-year period, which could increase government indebtedness by Nigerian naira (NGN) 3trillion (3%-4% of GDP). We would likely include these promissory notes in the stock of government debt.


Overall, we forecast that Nigeria's general government debt stock (consolidating debt at the federal, state, and local government levels) will average 23% of GDP for 2017-2020, comparing favorably with peer countries' ratios. We also anticipate that general government debt, net of liquid assets, will average 17% of GDP in 2017-2020. We include debt of the Asset Management Corporation of Nigeria (around 5% of GDP)--created to resolve the nonperforming loan (NPL) assets of the Nigerian banks--in our calculation of gross and net debt, in line with our treatment of such entities elsewhere. Over 80% of government debt is denominated in naira.


Despite the relatively low government debt stock, general government debt-servicing costs as a percent of revenues are high and have increased in recent years from below 10% in 2014 to our projection of 21%, on average, in 2017-2020. 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. The government is initiating a process of debt switching: maturing treasury bills--which are costly in the domestic market--will be refinanced by the issuance of dollar-denominated debt, which is currently cheaper. Through this process, the government hopes to reduce debt servicing costs.


While excess demand for foreign currency still prevails in the Nigerian foreign currency market, we see encouraging signs of gradually receding pressures thanks to increasing inflows and some central bank initiatives to support this market.


In April 2017, the Central Bank of Nigeria (CBN) introduced a new exchange rate window, the Nigerian Autonomous Foreign Exchange Fixing Mechanism--commonly known as the New Investors Foreign Exchange(FX) Window--as a softer option relative to outright devaluation, but nevertheless putting downward pressure on the currency by allowing the U.S. dollar/naira exchange rate to move closer to market-determined levels.


Although there are still multiple exchange rates, most FX trading is now predominantly in the interbank market, which trades between 1USD to NGN300-NGN320 and the new foreign investors exchange window, which trades 1USD to NGN340-370.


However, Nigeria still maintains FX controls on both current and capital transactions, including import restrictions on 41 categories of goods.


The Nigerian banking sector faced asset quality, profitability/capitalization, and liquidity pressures in 2015-2016 but has shown signs of resilience despite regulatory headwinds and economic volatility. We have seen improvements in the first half of 2017 in earnings with the improvements in FX supply and central bank actions to stabilize the market.


Credit growth was very high around 20% in 2016, which was supported by naira devaluation. Absent an outright devaluation of the interbank rate, we expect credit growth to be muted in 2017.


Asset quality has deteriorated to 10% in the sector because of the fall in oil prices. In 2017, some banks have been able to pre-emptively restructure their loans and manage their NPL ratio around the 5% regulatory ideal limit.


Our expectation is that asset quality will remain moderate overall, with some  weak outliers (tier 2 banks mostly) and credit losses remaining high around 3% in 2017.


Inflation has risen over the last two years. In December 2016, annual consumer price inflation accelerated to close to 16% compared with 9% in December 2015 or 8% in December 2014. The rising trend has been attributed to the June 2016 devaluation and structural factors such as increases in the cost of food, electricity, transport, and inputs, as well as low industrial activity.


Inflation in 2017 has started trending downwards due to base effects, naira stabilization, and the gradual recovery of non-oil output.



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