Culled–Proshare

March 27, 2020

By S & P Global Ratings  

Overview

• Significantly lower international oil prices following the collapse of the OPEC+ deal on March 6, and lower demand tied to the coronavirus pandemic, have led us to sharply revise down our forecast for oil prices.
• Lower oil prices will hurt Nigeria’s external and fiscal positions in the near term, and the administration’s policy responses are unlikely to be enough to mitigate the decline in oil revenue, and foreign-exchange reserve levels are likely to come under pressure.
• We are therefore lowering our long-term sovereign credit rating on Nigeria to ‘B-‘ from ‘B’.
• The outlook is stable.
  

Rating Action

S&P Global Ratings lowered its long-term foreign and local currency sovereign credit ratings on Nigeria to ‘B-‘ from ‘B’. At the same time, we affirmed our ‘B’ short-term sovereign credit ratings on Nigeria. We lowered our long-term Nigeria national scale rating to ‘ngBBB’ from ‘ngA-‘ and affirmed the ‘ngA-2’ short-term Nigeria national scale rating.

As a “sovereign rating” (as defined in EU CRA Regulation 1060/2009 “EU CRA Regulation”), the ratings on Nigeria are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar.

Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is S&P Global Ratings’ revision of its hydrocarbon price assumptions for 2020 and beyond. The next scheduled rating publication on the sovereign rating on Nigeria will be on Aug. 28, 2020. 

Outlook

The stable outlook reflects that, at this lower rating level, risks to the ratings on Nigeria will be balanced over the next six-to-12 months.

We could raise our ratings if Nigeria experiences much stronger economic performance than we currently expect, or if external financing pressures prove to be temporary, 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 due to declining external liquidity or a continued reduction in fiscal flexibility. This could occur, for instance, if we see significantly higher debt-servicing costs, sharply reduced foreign-exchange (FX) reserves, or if our projections for gradual fiscal consolidation do not materialize. 

Rationale

On March 19, 2020, S&P Global Ratings materially lowered its oil price assumption for 2020. This follows an earlier significant downward revision of its price assumptions on March 9, 2020. Prices for crude oil in spot and futures markets are more than 55% lower than levels observed during the summer of 2019 when prices increased due to rising geopolitical tensions in the Middle East. When we last reviewed Nigeria (see “Nigeria Outlook Revised To Negative On Falling Foreign Exchange Reserves; ‘B/B’ Ratings Affirmed,” published Feb. 28, 2020, on RatingsDirect), we expected Brent oil prices to average $60 per barrel (/bbl) in 2020 and to gradually decline to $55/bbl from 2021. We now assume an average Brent oil price of $30/bbl in 2020, $50/bbl in 2021, and $55/bbl from 2022 (see “S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure,” published March 19, 2020).

Related Link: Nigeria’s Outlook Revised To Negative On Falling Foreign Exchange Reserves

Oil prices plummeted following OPEC’s failure to agree on further production cuts during meetings on March 6. OPEC+ did not agree to a proposed reduction of 1.5 million barrels per day (mmbbl/d) to address an expected significant drop in global demand partly due to the spread of the coronavirus. The proposed reduction would have been in addition to the current 2.1 mmbbl/d production cut. Shortly after the meetings, Saudi Arabia announced that it was immediately slashing its official selling price and would increase its production to over 12 mmbbl/d in April after the current production cut expires. These actions possibly signal that, despite a collapse in global demand and shrinking physical markets, Russia and Saudi Arabia may engage in a price war to try and maintain market share and market relevance. Oil markets are now heading into a period of severe supply-demand imbalance in second-quarter 2020. In line with our economic outlook (see “Economic Research: COVID-19 Macroeconomic Update: The Global Recession Is Here And Now,” published March 17, 2020), we anticipate a recovery in both GDP and oil demand through the second half of 2020 and into 2021 as the most severe effects from the coronavirus outbreak moderate.

Given that Nigeria’s reliance on oil revenue is still high– over 85% of goods exports and about half of fiscal revenues–lower oil prices in 2020 will significantly hurt its external and fiscal positions. We estimate the economy will grow about 1.5% in 2020 (our previous estimate was 2.2%) and average 2.0% in 2020-2023. Our forecast for a sharp decline in oil prices, and consequent lower export revenues, are likely to result in the current account deficit increasing to 3.3% of GDP this year before moderating over the medium term and averaging -1.1% in 2020-2023.

On the fiscal side, lower oil-related revenue will keep general government (federal and state government combined) fiscal deficits elevated at about 5% of GDP this year, delaying planned gradual consolidation, before averaging 4.2% in 2020-2023. The federal government has and will continue to make efforts to increase nonoil revenue, including the increase in value-added tax to 7.5% from 5.0%, reducing fuel subsidies, and raising electricity tariffs among other administrative measures. In addition, adjustments to the exchange rate should also yield the federal government higher naira revenues. Nevertheless, these measures are not expected to be enough to compensate for the forecast reduction in oil revenue. In addition, COVID-19-related spending is likely to affect expenditure.

Funding the twin deficits this year is also likely to be more challenging. This is because issuing in the global markets will be difficult amid global disruption stemming from the coronavirus pandemic, leaving the federal government relying largely on domestic sources and multilateral debt.

Lower FX inflows tied to lower oil receipts into Nigeria are also likely to present policy challenges for the Central Bank of Nigeria (CBN) in the near term with regard to exchange-rate and foreign-exchange-reserve policy. In the face of declining foreign-currency reserves and global risk aversion, nonresident investors holding CBN bills may choose to reduce their holdings and exit, leading to a fall in FX reserves. In addition, the turmoil in global markets is likely to delay the government’s international issuance plans in the near term, further starving the country of FX inflows.

Since partially liberalizing the Nigerian naira (through the Nigerian Autonomous Foreign Exchange Fixing Mechanism [NAFEX]) in April 2017, the exchange rate has depreciated only marginally and the CBN has tried to stem depreciation. In March the central bank lowered its official exchange rate by about 15%, the first move on the official rate in over two years. We now see FX reserves further declining to close to $32 billion in 2020, but averaging $34 billion in 2020-2023 as the oil price rebounds in the later years.

All in all, given the sharp fall in the oil price, and that Nigeria has little room to increase oil production, any policy responses will fall short of mitigating the effects of the oil-price decline, in our view. The ratings remain constrained by slower real GDP growth than several peers, low GDP per capita, sizable fiscal deficits, and external imbalances. 

Institutional and economic profile: GDP growth is weak, with GDP per capita declining in dollar terms

• Nigeria’s established democratic and federal system helps distribute wealth and power, but reform momentum has been lackluster.
• Nigeria’s growth rates remain low relative to peers with similar wealth levels, and GDP per capita growth has been negative in dollar terms.

Nigeria has an established democratic political system with a tested transfer of power between different political parties and peaceful transitions in recent years. President Muhammadu Buhari, with his All Progressives Congress coalition party, is currently serving a second term after winning the election in March 2019. 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 structure helps to redistribute wealth and spread power, putting a check on the extent of overall centralization.

Nigeria is a sizable producer of hydrocarbons. Oil production in 2019 was 2.2 mmbbl/d compared with 1.9 mmbbl/d in 2018. We estimate Nigeria’s economy expanded 2.2% in 2019, the strongest expansion since 2015, spurred by higher oil production (and despite lower oil prices) and broadening nonoil sector growth. This year, we forecast economic growth at about 1.5% only, since the effects of lower oil revenue will filter through to the nonoil real sector. We forecast real GDP will expand by a modest 2% over 2020-2023. In per capita terms, this translates into economic contraction over our forecast horizon through 2023. Nigeria’s per capita GDP remains below that of several peers, with income levels below $2,000 in 2020. 

Flexibility and performance profile: Twin deficits are likely to remain over the medium term given oil-price pressures

• Nigeria’s current account turned to a deficit in 2019, and, given lower oil prices, we forecast deficits in 2020-2021 before a move back to surpluses.
• Nigeria’s fiscal flexibility is constrained by a high interest bill as a percentage of general government revenue, and government revenue as a percentage of GDP remains very low compared with peers.

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. After Nigeria posted a current account deficit of 1.5% in 2019, we estimate that it will more than double to nearly 3.3% this year, due to loss of export revenue associated with lower oil prices, before eventually rising to a small surplus of 0.4% of GDP in 2023.

Nigeria’s net external debt has been rising sharply over the past few years. This year, we estimate narrow net external debt will likely exceed 75% (our previous estimate was 56%) of current account receipts (CARs), and average 74% until 2023. We estimate gross external financing needs will exceed 113% 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 remain at 5.0% of GDP this year and average 4.2% 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 Asset Management Corporation of Nigeria debt (AMCON; about 5% of 2018 GDP–created to resolve Nigerian banks’ nonperforming loans) in our calculations of gross and net debt. Also, as of February 2020, we have started to include CBN bill issuance. General government revenue as a percentage of GDP is very low compared with peers and is forecast to average 6.5% of GDP in 2020-2023.

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, which has led these costs to increase further–we project they will average 55% 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.

As mentioned, 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 government transactions, the CBN window for banks and manufacturing companies, and the NAFEX window for other transactions.

Average inflation was 11.4% in 2019, compared with 12.1% in 2018. However, the decline in oil prices and the associated naira depreciation are likely to lead to exchange rate pass-through to inflation. We therefore expect inflation to remain high this year, increasing to 12%. Thereafter, we anticipate inflation will decline to average about 9% over the medium term.

In 2019, the CBN took steps to encourage banks to increase lending by introducing a minimum loan-to-deposit ratio of 65%. 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.

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