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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