August 4, 2023/Source: S&P Global Ratings

Overview

• On May 29, 2023, Nigeria inaugurated former Governor of Lagos State, Bola Tinubu, as its 16th president, after he won the presidential elections.
• The new administration has announced reforms, including exchange-rate liberalization and the end of fuel subsidies, which will benefit public finances.
• In early May, the ministry of finance and central bank agreed to securitize long-standing central bank financing, which will reduce interest expenses, further supporting fiscal consolidation.
• Nevertheless, planned fiscal spending remains elevated and inflation is high.
• Remaining challenges include relatively low (albeit rising) oil production, continued weak fiscal revenue mobilization, and high local and foreign currency borrowing costs.
• The West African region could face heightened geopolitical risks tied to the recent coup in neighboring Niger.
• We revised our outlook on our ‘B-/B’ long- and short-term ratings on Nigeria to stable from negative on increased reform momentum. We also raised our national scale ratings to ‘ngBBB+/ngA-2’ from ‘ngBBB-/ngA-3’.
  

Rating Action

On Aug. 4, 2023, S&P Global Ratings revised the outlook on Nigeria to stable from negative. At the same time, we affirmed our ‘B-/B’ long- and short-term foreign and local currency sovereign credit ratings on Nigeria.

We also raised our long- and short-term Nigeria national scale ratings to ‘ngBBB+/ngA-2’ from ‘ngBBB-/ngA-3’. The higher national scale rating reflects the improving reform momentum as well as our view of the sovereign as the most creditworthy entity in the domestic markets.

The transfer and convertibility assessment remains ‘B-‘.

Outlook

The stable outlook indicates balanced risks to the rating. Relatively low oil production and modest revenue mobilization pose risks to public finances and external liquidity. However, the new government is moving ahead with a series of reforms that could, if delivered, benefit growth and fiscal outcomes.

Downside scenario

We could lower the ratings over the next 12 months if we see increasing risks to Nigeria’s capacity to repay commercial obligations, either because of declining external or domestic liquidity. This could arise, for instance, from much higher fiscal deficits or debt-servicing needs alongside significantly reduced net foreign currency (FX) reserves, or because domestic financial markets are unwilling to absorb additional local currency debt issuance.

Upside scenario

We could raise our ratings over the next 12 months if economic performance significantly exceeds our forecasts, and fiscal and external imbalances improve significantly.

Rationale

In February of this year, former Lagos State Governor, Bola Tinubu, won the presidential elections. Upon assuming office on May 29, 2023, the new administration announced a series of reforms including the removal of fuel subsidies, the liberalization of the exchange rate regime, and governance changes at the Central Bank of Nigeria (CBN). Earlier in May, the previous national assembly had already signed into law the securitization of Ways and Means advances (direct central bank lending by the central bank to the government to finance deficits) into long-term, lower-cost instruments. We believe these measures will gradually benefit Nigeria’s public finances and its balance of payments.

However, challenges remain. Inflation is high and despite the recent introduction of offsetting measures to counterbalance the removal of fuel subsidies, labor unions have ramped up protests against their elimination. Interest costs on government debt are elevated and absorb a large share of government spending (over 30% of revenue last year, although we project this will gradually fall toward 23% by 2026). At the same time, government tax revenue collection, as a percentage of GDP, remains very low when compared with peers.

Institutional and economic profile: Despite short-term inflation-related obstacles, the new government’s reform initiatives should support medium-term growth

• After being sworn into power in late May, the new president’s administration has delivered a series of reforms.
• We expect the oil sector to pick up over 2023-2026 as crude oil production levels improve slightly, while significant oil refining (and petrochemical) capacity is launched.
• In the medium term, exchange-rate liberalization should benefit the non-oil sector as domestic goods become more competitive.

Nigeria’s newly elected government has moved quickly to implement a series of fiscal and monetary reforms, which we believe will gradually benefit public finances and the balance of payments. New measures include the decision to eliminate untargeted fuel subsidies, in an effort to contain spending pressures, and reduce the regressivity of fuel policy (where the majority of spending on fuel subsidies has historically benefited middle and upper income groups).

Despite the clear fiscal benefits of fuel subsidy reform (which has been attempted in the past), labor unions have threatened to strike in protest against their removal. The risk of such protests is likely to increase during periods of exchange rate depreciation or rising international oil prices. In order to mitigate inflationary pressures, in late July, the new government passed a supplementary fiscal package of “palliative measures,” which is also being supported by World Bank funding. With this package, the government aims to offset the effect of subsidy elimination on lower-income households, by providing them with cash transfers tied to their incomes. Via this targeted support, the government is attempting to ensure that the fuel subsidy removal does not impact the poorest sections of society.

S&P Global Ratings projects considerable fiscal savings from the elimination of fuel subsidies, and other recent reforms. Taken together, the elimination of subsidies and the securitization of the Ways and Means advances will generate fiscal savings of around 2.5% of GDP in 2023. We also believe the government will gradually improve tax intake: by as much as 2 percentage points of GDP by 2026, according to our forecasts.

Nigeria is the most populous economy in Africa. It is a sizable producer and exporter of hydrocarbons, ranking among the world’s top 15 exporters. However, most Nigerians work in the non-oil economy, with 45% of the labor force employed in relatively low productivity agriculture, which accounts for an estimated 26% of total output. According to IMF data, another 37% of the labor force works in household enterprises outside of the agricultural sector, with just 11% of Nigerian workers engaged in wage employment, primarily in the public sector. Given the composition of the labor force, and high informality, increasing tax pressure is a key fiscal challenge, and explains the relative dependency on hydrocarbon production for tax revenue.

Complicating this fiscal challenge, Nigeria has struggled to maintain hydrocarbon production levels over the past several years. During 2022, due to technical and security issues, oil production (including about 230,000 barrels per day [b/d] equivalent of condensates) averaged about 1.3 million barrels per day (mbpd), down from 1.6 mbpd in 2021. Militancy in the Niger Delta and high incidents of theft and vandalism are the primary causes of dips in oil production. Technical and regulatory issues, as well as divestments by some large international oil companies, tied to environmental considerations, are also deterring new investments. However, a series of projects are in the pipeline and the Nigerian National Petroleum Company (NNPC) is confident that volumes will increase in the near future.

Crude oil production levels improved to 1.2 mbpd (excluding condensates) in May 2023, partly due to improved security surveillance tied to the establishment of a new security task force. Via the task force, oil producers have enhanced collaboration with government and defense forces, who are taking a more zero-tolerance stance to theft. Moreover, oil producers are also beginning to work on alternative evacuation methods and shutdown optimization, to reduce the loss of oil during episodes of pipeline and facility breaches. As a result of these efforts, we expect oil production to slowly recover but remain below Nigeria’s OPEC quota of 1.74 mbpd. An overhaul of the governance structure and fiscal terms in the oil sector under the Petroleum Investment Act, should, over time, unlock further investment in the hydrocarbon sector, despite environmental considerations.

We also anticipate that refining capacity will substantially increase as a large refinery (and petrochemicals facility), owned by the private-sector Dangote group, with capacity of 650,000 b/d, starts large-scale production by late 2023. In addition, several other refineries–such as at Port Harcourt, Warri, and Kaduna–are being rehabilitated, which will significantly contribute to the country’s refining capacity in the next few years. This new refining capacity made it easier for the new president to stick to the removal of the petroleum subsidies as pledged in the 2023 budget.

Given recent reforms and exchange rate liberalization, we now expect Nigerian economic growth to average 3.5% over 2023-2026, up from our previous estimate of average 3%. Growth in terms of GDP per capita will, nevertheless, remain low, partly reflecting the country’s high population growth as well as the recent depreciation of the Nigerian naira (NGN). Increasing digitization tied to the pandemic boosted growth rates in sectors like insurance, finance, and information and communication; innovation and entrepreneurship is relatively high in these areas. However, severe floods in large parts of the country constrained growth within the agriculture sector (which contributes around 20% of nominal GDP) in the second and third quarters of 2022. The economy expanded slowly in the first quarter of 2023 as a CBN-imposed change to the naira notes in circulation (whereby old notes were replaced with higher denomination new ones, and old notes were no longer permitted as legal tender) led to a severe cash shortage, while the oil sector contracted.

The recent Nigerian elections were the first in Nigeria’s history where electronic voting machines were used. This led to significant issues, with many voters denied a vote because they did not possess a voter card. Consequently, the turnout was exceptionally low at 27% of the 93 million eligible voters. This resulted in the president being elected with the support of only 8.8 million votes in a country with a population of over 220 million. Legal challenges to his win are still going through the courts, but, in our view, are unlikely to lead to significant changes to the overall outcome. The new president has not yet named his cabinet, but has submitted a list of names to be vetted and approved by the senate, and the cabinet, including the new finance minister, is likely to be announced soon.

Nigeria’s internal security has deteriorated over the past several years, with banditry, kidnappings, and general instability having increased. Police and military forces tend to be overstretched and forced to deal with a multitude of security crises. The militant groups Boko Haram and Islamic State West Africa Province (ISWAP) are active in the northern regions. In the Middle Belt, tensions between farmers and herdsmen have increased, notably over scarce land and water resources, which is affecting food supplies. In the southern oil-producing states, Niger Delta militants have disrupted oil production when conditions have not worked in their favor. The security situation worsened in the run up to the elections, but reforms pledged by the new government should help improve the situation somewhat, and the new president has appointed a new Chief of Army Staff, other service chiefs, and a national security advisor. Nevertheless, we do not expect the overall security situation to immediately improve, as high unemployment, inflation, and rising poverty levels have stagnated social development, fueling militancy.

Nigeria’s president currently holds the rotating position of chairperson for a regional body, the Economic Community of West African States (ECOWAS). ECOWAS has imposed sanctions and warned of possible military intervention against Nigeria’s northern neighbour, Niger, if, following a military coup in Niger on July 26, the former democratic government is not reinstated. ECOWAS has also suspended Niger’s membership. If ECOWAS intervenes, it would likely involve Nigerian troops alongside other ECOWAS troops, and could complicate anti-militancy efforts already underway in Northern Nigeria. The issue is further complicated by Niger being a large uranium producer and hosting anti-insurgency military forces from both France and the U.S., and the coup follows four other coups in the region, with some regimes supported by Russia’s Wagner mercenaries.

Flexibility and performance profile: Fiscal and external metrics have deteriorated in recent years, but liberalization efforts should support fiscal consolidation

• We forecast increased oil volume production and higher oil prices, improved collection of non-oil revenue, and exchange rate liberalization, which lead us to expect some modest fiscal consolidation over the next few years.
• We expect interest payments will still consume about a quarter of general government revenue over 2023-2026.
• We project usable foreign currency reserves (gross reserves minus encumbered reserves and FX borrowed from domestic residents) will remain around $28 billion over 2023-2026, covering over three months of current account payments, which is sufficient to cover external debt repayment needs.

Over 2023-2026, we project modest fiscal consolidation to continue. Consolidation will be supported by savings via the elimination of the petroleum subsidies and an increase in collection of non-oil taxes and other revenue owing to ongoing digitization and improved compliance, savings on interest costs due to the securitization of the central bank’s Ways and Means advances, as well reasonably strong oil prices. There could also be an upside to oil revenue projections if oil production meets NNPC’s expectations over the next two-to-three years. We project the general government deficit–which includes the federal government, states, and local governments combined–will stand at 5.4% of GDP in 2023 and average 4.6% in 2024-2026.

After running a very tightly managed exchange-rate regime, the new government cited a long-standing policy of a misaligned exchange rate, announced the suspension of the governor of the central bank (with one of the deputy governors, Folashodun Shonubi, taking the role of acting governor), and permitted the liberalization of the FX market. The CBN ended trading band limits and permitted a move to a “willing buyer-willing seller” model at the investor and exporter window, which soon led to a significant depreciation of the currency to N780/US$1 from N460/US$1. While the exchange rate is now trading significantly more in-line with market demand and supply fundamentals, the regime still more closely resembles a managed-float rather than a full free floating currency.

Given that roughly half of the federal budget revenue reflects dollar-denominated crude oil export revenue, converted into naira, the exchange rate and monetary policy have historically had a material impact on Nigeria’s fiscal performance. The naira’s fall from its official rate of N460/US$1 in early June to close to N780/US$1 currently, has improved the outlook for tax receipts over the next few years. Following the liberalization, the Ministry of Finance’s Budget Office has adopted an exchange rate of N700/US$1 for its accounts for the second half of the year (compared to the initial budgeted exchange rate of N460/US$1) thereby boosting revenue in naira. In April, S&P Global Ratings also revised upward its Brent oil price forecast to an average $83 per barrel (/b) in 2023, and $85/b in 2024-2026 (compared with our forecast of $90/b in 2023, $80/b in 2024, and $55/b in both 2025 and 2025) pointing to improving oil-related revenue in dollar terms as well, in particular in 2025 and 2026.

The 2023 federal budget (central government; excluding state budgets) has planned for a fiscal deficit of NGN11.34 trillion, which represents 5% of GDP. The budget is based on a reasonable oil price estimate of $75/bbl, but an ambitious oil production volume target of 1.69 mbpd. The 2023 budget assumed the removal of refined petrol subsidies by mid-2023, which cost around NGN4 trillion (2% of GDP) in 2022, and the new president followed through on his pledge to remove them. The removal of fuel subsides from late June, savings on debt service on Ways and Means, as well as the liberalization of the exchange rate, will compensate for lower-than-budgeted oil receipts achieved during the first half of the year.

The government is currently reforming the Federal Inland Revenue Service, which should engender more transparency and improvement in fiscal governance. Nevertheless, general government revenue as a percentage of GDP in Nigeria average only about 8%–very low even by African and frontier market standards. This highlights the limited tax-generation capacity, partly explained by the high level of informality in the economy, and partly by the two-tiered federal and state tax system in which the states lack the institutional capacity to garner taxes. Nevertheless, the authorities have made recent efforts to increase revenue streams, especially non-oil revenue. The new administration has approved the establishment of a Presidential Committee on Fiscal Policy and Tax Reform. This will be chaired by a tax specialist and will comprise experts from both the private and public sectors. It will have the responsibility to push tax law reform with a view to increasing the tax take. We forecast fiscal revenue to GDP to increase to 10% by 2026 due to the aforementioned efforts and continued strong collection of VAT and corporation income tax. Nevertheless, high debt-servicing costs and security-related spending will continue to weigh on fiscal dynamics, leaving reduced funds for capital investment, infrastructure development, or social safety nets.

Nigeria benefits from its relatively deep domestic financial markets. For the remainder of 2023, the government plans to issue domestic naira-denominated Federal Government of Nigeria (FGN) bonds to finance over 75% of the 2023 deficit, with the rest in foreign financing split between concessional multilateral and bilateral external financing, and commercial borrowing. Between January and June 2023, the Debt Management Office managed to raise NGN3.59 trillion of the annual budgeted NGN7.04 trillion in FGN bonds, largely at rates between 13.9% and 16.0%, below the central bank’s Monetary Policy Rate (MPR), with subscription levels remaining high. On the external front, the government will likely only issue Eurobonds if market conditions change, due to the current prohibitively high yields demanded in the international markets, and may opt for either syndicated loans or more multilateral funding, if available. On July 12, 2023, the government repaid its $500 million Eurobond in full and on time and the next Eurobond maturity (of $1.1 billion) is due in 2025; the external commercial debt repayment profile is relatively low compared with FX reserve levels.

The government restructured several years of debt amassed via borrowing from the central bank (under the Ways and Means facility) amounting to NGN22.7 trillion (12% of GDP). The Ministry of Finance and CBN agreed to the securitization of this debt into an instrument with 40 years tenure, with a moratorium on principal repayment for three years and a 9% interest rate. The government was previously amassing dues at an interest rate of about 20% on this debt (MPR + 1%-3%). We incorporate the impact of this securitization deal in our interest expenditure, which along with the projected revenue increase, reduces interest cost as a percentage of revenue to 20% of general government revenue in 2023, compared with 31% in 2022. We do not consider the securitization of the obligations to the central bank as a default under our criteria, as our ratings speak to the timely repayment of commercial debt obligations–and we classify borrowing from the central bank as inherently noncommercial.

We forecast Nigeria’s net general government debt stock (consolidating debt at the federal, state, and local government levels, and net of liquid assets) will average 40% of GDP for 2023-2026. This level of indebtedness is relatively low compared with what we typically observe for ‘B’ category rated peers. We include the Asset Management Corporation of Nigeria (created to resolve Nigerian banks’ nonperforming loans) debt in our calculation of gross and net debt. We also include CBN open-market-operation (OMO) bill issuance, as well as central bank lending to the federal government (via the Ways and Means advances), in our debt stock calculations. From 2020, the CBN sharply reduced the number of OMO bills that it rolled over, but this was partly counterbalanced by the increase in the Ways and Means advances. The depreciation of the naira has continued to inflate foreign currency debt, which makes up approximately 40% of the total debt stock. We include interest payments on CBN bills and Ways and Means in our calculation of current total interest costs, with the latter having fallen due to the recent securitization deal.

Despite being a sizable hydrocarbon exporter (close to 90% of exports receipts are from crude oil and gas exports), we project that Nigeria will post only small current account surpluses for 2023-2026 due to uncertainties regarding oil production volumes, alongside high demand for imports. Relatively high oil prices (we revised our forecast Brent oil prices for 2025 and 2026 upward to $85/b), and robust remittances will support current account receipts (CARs) while the country’s increase in refining capacity will help to reduce the import bill from 2024 onward, in our view. Overall, we now project current account surpluses averaging 0.6% of GDP, following a small surplus of 0.2% in 2022.

Under our projections, costlier imports and the clearance of FX arrears will limit the rise in FX reserves. We also deduct $10 billion from gross FX reserves to account for reserves held for forward sale, which makes them unavailable for meeting external financing needs. We project usable reserves (gross reserves minus reserves held for forward) to remain steady at around $28 billion over 2023-2026. Relatively high imports and the reduced level of usable reserves will keep our estimate of gross external financing needs (all payments to nonresidents) averaging 106% of CARs plus usable reserves during 2023-2026.

Surging fuel, utility, and food prices caused inflation to hit 18.8% year-on-year in 2022, versus the CBN’s 6%-9% target. Due to fast-paced increase in consumer price index (CPI) inflation, CBN raised its benchmark rate by a cumulative 500 basis points in 2022 to 16.5%, followed by further rises to 18.75% currently. The removal of fuel subsidies and the exchange rate depreciation, alongside global inflationary pressures, will ensure that double-digit headline inflation will persist in 2023, but will gradually decline to 15% by 2026 owing to the monetary tightening and improvement in supply of refined crude products in line with increasing refining capacity.

The banking sector’s sensitivity to oil prices and currency depreciation exposes it to short credit cycles and high credit risks. The sector has a material exposure to the oil and gas sector, averaging about 30% of total loans, which leads to concentration and exposure to energy transition risks. Banks have converted part of their foreign currency loans to naira loans amid U.S. dollar scarcity that affected manufacturers. That said, the naira depreciation will result in an increase of the sector exposure in foreign currency loans, estimated at about 40% in 2022.

High inflation and interest rates will likely constrain real lending expansion, as will banks’ high cash reserve ratios (CRRs). The CBN’s CRRs imposed on banks stand at a high statutory minimum of 32.5%, but for some banks these are significantly higher at around 45% of deposits. These elevated CRRs have also constrained lending. We expect credit losses will average 2% in 2023, while the nonperforming loan ratio deteriorates to 5.7% in 2023, above the 5.0% regulatory limit, amid high inflation and interest rates.