Thursday, September 20,
2018 / 09:17
AM / S & P Global Ratings
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 'ngA/ngA-1'.
The stable outlook reflects the balance between risks of heightened domestic political tensions, against the potential for an improving external position.
We may lower the ratings if Nigeria's policymaking and institutional stability weaken significantly, possibly due to election-related disturbances.
We could raise our ratings if Nigeria's external liquidity indicators improve, perhaps due to further accumulation of international reserves or the extension of average external debt maturities.
The ratings on Nigeria are supported by a relatively low general government debt stock. However, debt-servicing costs are high. Moderate exchange rate flexibility and the significant liberalization of Nigeria's exchange restrictions over the past 12 months also support the ratings.
The ratings remain constrained by our view of the country's low economic wealth, weak institutional capacity, lower real GDP per capita trend growth rates than peers at similar development levels, and external risks. Although external indebtedness is relatively modest, significant stock-flow data mismatches raise external risks, in our view.
Institutional and Economic Profile: Weak economic performance, with trend growth below peers'
Nigeria has a democratic political system with a tested transfer of power between different political parties, last witnessed in the 2015 general (presidential and parliamentary) elections. The next general elections are scheduled to take place in February 2019 and state elections are set for March2019.
Following some switching of parties by key leaders from the All Progressives Congress (APC) to the People's Democratic Party (PDP), we expect the forthcoming elections will be hotly contested between the two main political parties. Our base case is that the elections will proceed smoothly, as was the case in the last general election in 2015.
However, there could be downside risks related to subsequent increased tensions and potential political unrest hindering the effective functioning of government institutions. Sitting president Muhammadu Buhari will stand as the APC candidate, whereas the PDP has not yet chosen its presidential candidate. We do not expect any major changes in policy direction as a result of the elections. However, there could be some fiscal slippage.
In our view, political decision-making in Nigeria can be unpredictable and we perceive very high levels of corruption in the country. We view government institutions as relatively weak, with slow decision-making on policy issues. Fiscal budgets are frequently passed well after the year has begun, which impedes the government's responsiveness to economic challenges.
We also view decision-making at the federal level as largely centralized in the office of President Buhari. We note, however, that the federal system of government helps to redistribute wealth and spread power to some extent. While security risks have slightly abated compared with the last two years, we still see sporadic attacks by Boko Haram in the North East, as well as attacks on oil pipelines in the Niger delta.
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 at least half of fiscal revenues. Economic data released by Nigeria's National Bureau of Statistics (NBS) show that, Nigeria's economy grew by 2% year on year in the first quarter of 2018 and by 1.5% year on year in the second quarter.
We therefore estimate that Nigeria's economic performance in full-year 2018 is likely to be weak at 1.8% in real terms (compared with our previous forecast of 2.4%, see "Nigeria Ratings Affirmed At'B/B'; Outlook Stable," published March 17, 2018, on Ratings Direct).
The weaker economic performance than anticipated primarily stems from lower agriculture and oil production. NBS data show that Nigeria produced an average of 1.84 million barrels of oil per day in the second quarter of 2018 compared with 2 million barrels per day produced in the first quarter of 2017. As some pipelines shutdown due to vandalism have been repaired, we expect oil production for the full year to average 1.9 million barrels per day.
In the medium term, we expect non-oil-sector improvements will support our forecats for higher economic growth of at least 2% in real terms. However, real per capita GDP growth of negative 0.2% (which we estimate by using 10-year weighted-average growth) remains well below that of peers with similar wealth levels. Nigeria has significant infrastructure shortfalls and low income levels, with GDP per capita estimated at US$1,800 in 2018.
Flexibility and Performance Profile: External position will improve and
stabilize by 2021, but the current fiscal consolidation path will not improve the net debt position or financing costs
Although oil revenues support the economy when prices are high, they expose Nigeria to significant volatility in terms of trade and government revenues. The Central Bank of Nigeria (CBN) has continued to build its external buffers and gross foreign currency reserves over the last 12 months. Sources are varied: rising oil prices, federal government external debt issuance, and portfolio inflows from non-residents.
Portfolio flows are subject to changes in sentiment or global volatility related to increased interest rates in advanced markets, emerging market sentiment, or Nigeria's upcoming political calendar.
As a result, we expect that the amount of reserves accumulated may have already peaked and will likely decline mildly over the next six months. We estimate the CBN's external buffers will remain at about seven months' import cover through 2021, compared with five months' cover three years ago in 2015.
We estimate that Nigeria will remain in a small current account surplus over 2018-2021. This year, the current account surplus could exceed 3% of GDP thanks to the recovery in oil prices, which are helping to strengthen the trade balance. In May 2018, we revised our oil price assumptions (see "S&P Global Ratings Raises 2018 Brent And WTI Oil Price Assumptions And 2019 Brent Price Assumptions," May 8, 2018). We assume lower oil revenues for 2019-2021, and gradually rising imports, which leads us to expect a marginally weakening current account position over the same period.
Modest current account surpluses and the rise in foreign currency reserves have led us to forecast relatively stable ratios of narrow net external debt to current account receipts (CARs) and of gross external financing needs to CARs plus usable reserves. We now estimate gross external financing needs will average close to 105%of CARs plus usable reserves during 2018-2021.
We expect the government's external financing needs to be covered by a combination of credit lines from multilateral partners, and from the international capital markets. We estimate narrow net external debt (external debt minus liquid external assets) will remain well below 50% of CARs over 2018-2021. Although Nigeria produces an International Investment Position (external asset and liability position), we note that there are discrepancies of on average 20% of CARs, between changes in the external stocks and changes in the balance of payments, which we think hampers our analysis of Nigeria's external accounts.
We expect the higher oil revenues in 2018 to be largely offset by weak non-oil revenue growth, faster implementation of capital expenditures ahead of the February 2019 elections, and the deficits of state and local governments (average 0.8% of GDP in 2018-2021). As a result, we project the general government deficit, which includes that of the federal government, states, and local governments combined, will remain close to 4% of GDP this year.
We expect oil prices to moderate, along with capital spending after the elections, while non-oil economic activity picks up. This should help grow non-oil revenues. We believe these factors will help Nigeria consolidate its fiscal position, as headline deficits decline closer to 2% of GDP by 2021. We estimate the annual change in net general government debt will average 3.1% of GDP in 2018-2021.
Our overall general government deficit projections exclude the clearance of yet-to-be reconciled fiscal arrears to contractors, suppliers, and lower levels of government. If a proposed plan to clear fiscal arrears, estimated between 2% and 3% of GDP, is approved by the national assembly in 2018, through the issuance of Nigerian naira (NGN)-denominated debt securities, it could increase our deficit and debt projections by the same margin.
Overall, we forecast that Nigeria's gross general government debt stock (consolidating debt at the federal, state, and local government levels) will average 26% of GDP for 2018-2021, comparing favorably with peer countries' ratios. We also anticipate that general government debt, net of liquid assets, will average close to 20% of GDP in 2018-2021. We include debt of the Asset Management Corporation of Nigeria (AMCON; around 5% of 2018 GDP)--created to resolve the nonperforming loan assets of the Nigerian banks--in our calculations of gross and net debt. Over 70% of government debt is denominated in naira, which limits exchange rate risk.
Despite the relatively low government debt stock, general government debt-servicing costs as a percentage of revenues are high, due to the coupon on local currency treasury bills and bonds. Debt-servicing costs have increased in recent years to our projection of over 20%, on average, in 2018-2021, from below 10% in 2014.
The central government alone has debt-servicing costs of nearly 50% of revenues, which in our opinion limits fiscal flexibility. The steep increase in the ratio stems from a combination of lower oil revenues compared with 2014 and higher borrowing costs in the domestic market. The government has borrowed externally to fund maturing short-term domestic debt obligations, as a way to reduce borrowing costs.
We assess the exchange rate regime as a managed float. The CBN currently operates multiple exchange rate windows. The main exchange rate windows are the official CBN rate for government transactions, the interbank rate for banks, and the Nigerian Autonomous Foreign Exchange Fixing Mechanism (Nafex) window for all other autonomous transactions.
The interbank market window trades at around $1 to NGN326-NGN345, while the new foreign investors exchange window trades at around $1 to NGN363. We do not expect any policy decision to merge the various exchange rate windows, at least not before the elections in February 2019.
That said, the spread between the interbank window, the Nafex window, and the parallel markets has been substantially reduced. Additionally, the exchange restrictions arising from the rationing of foreign currency and its allocation based on the CBN's determination of priority categories of transactions is no longer the main driver of the market, as the CBN has permitted trading via the Nafex window, which allows market participants to access foreign currency at market rates. Therefore, we no longer consider Nigeria's exchange restrictions as extensive.
Inflation is still high and above the CBN's maximum target of 9%. However, it is on a declining trend and the latest figures show 11.14% in July 2018. We see risks of inflation on a rising trend, mainly as regards food inflation owing to weaker agricultural performance and because of potentially higher election-related government spending.
Following years of heightened risks, operating conditions for the Nigerian banking sector are improving thanks to the gradual economic recovery, rising oil prices, increasing U.S. dollar supply in the banking system, and Nigeria's successful tapping of the Eurobond market.
The majority of banks has overcome the short-term liquidity challenge. We expect muted loan growth, as well as gradual improvements in asset quality and profitability, with top-tier banks faring better than the sector average. Capital adequacy remains exposed to unexpected weakening of the naira and weak internal capital generation. This
is because of the potential provisioning shortfalls and pressure on net interest margins after the federal government converted part of its short-term debt into longer-dated U.S. dollar-denominated debt.