Moody’s Investors Service has today changed the outlook on the government of Nigeria’s ratings to negative from stable. Concurrently, Moody’s has affirmed the B2 long-term local and foreign currency issuer ratings, the B2 foreign currency senior unsecured ratings, and the (P)B2 foreign currency senior unsecured MTN programme rating.
B2 Ratings Explained
Moody’s decision to affirm the rating at B2 recognizes a combination of credit strengths including the country’s large and diversified economy supported by vast oil and gas endowments, notwithstanding persistent credit weaknesses such as its very weak institutions and governance framework and in particular poor public finance management.
The negative outlook reflects Moody’s view of increasing risks to the government’s fiscal strength and external position. Already weak government finances will likely weaken further given an extremely narrow revenue base and persistently sluggish growth that hinders fiscal consolidation. As pressures mount, there is a risk that the government resorts to increasingly opaque and costly options to finance a moderate but rising debt burden. Moreover, vulnerability to an adverse change in capital flows is building in light of Nigeria’s increasing reliance on foreign investors to fund the country’s foreign exchange reserves.
Concurrently, Moody’s has maintained Nigeria’s country risk ceilings at their current levels: Foreign Currency bond ceiling at B1, Foreign Currency deposit ceiling at B3, and Local Currency bond and deposit ceilings at Ba1.
The central bank’s stock of so-called open-market operation bills has risen to 17.4 trillion naira ($48 billion) from 5 trillion naira in 2017, according to Moody’s. Around a third are held by foreigners, it said, many of which are carry traders enticed by yields of about 13%.
“To attract foreign investors, the Central Bank of Nigeria is paying high interest rates on these certificates,” Moody’s analysts Samar Maziad and Marie Diron said in a statement. “This policy is very costly, and has a consequent impact on the yields of other government financing instruments.”
Rationale For The Negative Outlook: Nigeria’s Public Finances Are Increasingly Fragile In A Sluggish Growth Environment. The change of outlook to negative is informed by the increasing fragility of the country’s public finances and sluggish growth prospects.
The increasing fragility of Nigeria’s public finances is evident in the greater reliance by the government on financing from the Central Bank of Nigeria (CBN) over the last three years to cover persistently large fiscal deficits, with CBN cash advances reaching 2.5% of GDP on a net basis at the end of September 2019, in addition to government debt instruments held by the CBN worth 1.4% of GDP. In particular, CBN advances are more expensive than debt funded on the domestic capital market as the CBN applies a penalty rate on top of its monetary policy rate currently at 13.5%.
Moody’s expects general government revenues to remain very low at around 8% of GDP until 2022, despite measures to such as the VAT rate increase to 7.5% from 5% in 2020. Consequently, debt affordability will remain weak, with general government interest payments at around 25% of revenues in the next few years.
The administration’s focus on increasing infrastructure spending from very low levels will further exert pressure on fiscal deficits even if it is likely that much-needed capital expenditure will continue to be under-realised compared to the budgets, as capex is curtailed in order to contain the overall budget deficit.
In general, Moody’s expects real growth to remain weak, at just over 2% over the next few years. The economy has yet to fully recover from the oil price shock of 2015 and the subsequent recession in 2016; real growth remains below population growth, denoting an erosion in incomes from already low levels. This low growth environment makes achieving the government’s objectives of job creation, improvement in social indicators, and fiscal consolidation via increased revenue collection highly challenging. The implementation of economic policies to sustainably boost real GDP growth would alleviate some of the negative credit pressures. However, the continuation of the current policy mix – including the rationing of the supply of US dollars in the economy while suppressing part of the demand for foreign currency (via the list of items banned from accessing dollars from official channels, for example) – aimed at supporting domestic production and job creation over the long term, will constrain economic growth over the short to medium term.
Overall, given Moody’s expectation that general government fiscal deficits are likely to remain around 4% of GDP (50% of revenues) and growth subdued over the coming years, rapid debt accumulation will continue. Moody’s expects debt to GDP to reach N49 trillion by the end of 2021, or 27% of GDP. While still at moderate levels, debt has accumulated quickly over the last four years, almost tripling to an estimated NGN33 trillion (23.2% of GDP) in 2019 from NGN12.6 trillion (or 13.2%) in 2015. This number includes the debt of the federal government, the states and the municipalities, the net cash advances from the CBN, as well as the stock of promissory notes issued to clear past arrears.
External Vulnerability Is Increasing
The negative outlook is also underpinned by rising vulnerability to an adverse change in external capital flows.
Official foreign exchange reserves at around $40 billion at the end of October, or 5-6 months of import cover, at first appear to be relatively comfortable. However, Nigeria’s external position is increasingly dependent on foreign capital inflows in the form of portfolio investments, which by definition are volatile and susceptible to reversal.
In order to maintain price and exchange rate stability, the CBN has issued domestic certificates (via Open Market Operations) to mop up naira liquidity, which has been boosted following the creation of the import-export windows by the central bank in 2017. The stock of certificates has grown very quickly to reach NGN17.4 trillion in September 2019 from NGN5 trillion in 2017, of which around NGN5.8 trillion ($16 billion) are currently held by foreign investors.
In order to attract foreign investors, the CBN is paying high interest rates on these certificates. This policy is very costly, and with consequent impact on the yields of other government financing instruments. Importantly, the large holdings of foreign investors make Nigeria’s external position vulnerable to an adverse change in investor sentiment that could quickly materialize given the short-term nature of the instruments.
Rationale For Affirming The B2 Ratings
The affirmation reflects credit strengths supporting the B2 rating, balancing significant credit weaknesses. Nigeria’s economic strength is supported by the diversification of economic activity and very large oil and gas endowments. Moreover, Nigeria benefits from deep domestic capital markets to finance a still moderate debt burden at relatively long maturities. In turn, long average maturity of debt contributes to moderate borrowing requirements for the government.
Nevertheless, very weak institutions and governance strength, and in particular poor public finance management, remain a constraint to Nigeria’s credit profile. Meanwhile, only a durable and significant increase in non-oil revenue would improve the sovereign’s resilience to oil price volatility and provide scope to realize ambitious capital spending plans on the large infrastructure projects that are crucial to economic development. In the meantime, the fiscal deficits will remain elevated, debt affordability will remain weak and the government’s balance sheet will remain exposed to further shocks.
Environmental, Social, Governance Considerations
Environmental considerations are not material to the rating. While Nigeria is potentially exposed to carbon transition, under a baseline assumption of a relatively gradual transition, global demand for oil and prices seem likely to remain sustained over the next few decades.
Social considerations are material for Nigeria’s credit profile given the country’s very low average income levels, high levels of poverty, and growing income equalities. Nigeria ranked 157 out of 189 countries in the 2018 UN’s Human Development Index, with particularly low rankings (last decile) in infant mortality rate and in measures of inequality in income, education and health.
Despite vast natural resources wealth, 53.5% of people live on less than PPP$1.9 a day. Over time, there is a risk of social unrest potentially affecting growth and the government’s finances. Prolonged and severe unrest could also dampen foreign investors’ willingness to purchase Nigerian assets, threatening the country’s external position.
Governance factors are a material driver of the rating and are captured in Moody’s assessment of Nigeria’s institutions and governance strength. Institutional capacities remain limited and the management of public resources remains opaque and lacking in effectiveness.
Factors That Could Lead To An Upgrade
An upgrade is unlikely in the short to medium term given the negative outlook. A return to a stable outlook would likely be prompted by some of the following developments:
(1) a lasting reduction in reliance on foreign portfolio investors to sustain the level of foreign exchange reserves;
(2) prospects of effective implementation of structural reforms, particularly with respect to public resource management and a broadening of the revenue base; and/or,
(3) over the longer term, signs that economic policies are likely to foster stronger GDP growth on a sustained basis.
Factors That Could Lead To A Downgrade
Â· Nigeria’s rating would likely be downgraded if the sovereign’s vulnerability and exposure to a financing shock increased to an extent no longer considered consistent with the current rating level, potentially because of:
(1) an increase in external vulnerability risk as foreign investor sentiment weakened putting pressure on foreign exchange reserves;
(2) signs of a more rapid erosion in fiscal strength than Moody’s currently assumes, in particular if the revenue base seems likely to narrow further; or
(3) materially weaker medium-term growth prospects than Moody’s currently expects.
Â· GDP per capita (PPP basis, US$): 6,027 (2018 Actual) (also known as Per Capita Income)
Â· Real GDP growth (% change): 1.9% (2018 Actual) (also known as GDP Growth)
Â· Inflation Rate (CPI, % change Dec/Dec): 11.4% (2018 Actual)
Â· Gen. Gov. Financial Balance/GDP: -4.5% (2018 Actual) (also known as Fiscal Balance)
Â· Current Account Balance/GDP: 1.3% (2018 Actual) (also known as External Balance)
Â· External debt/GDP: 11% (2018 Actual)
Â· Level of economic development: Low level of economic resilience
Â· Default history: No default events (on bonds or loans) have been recorded since 1983.
On 27 November 2019, a rating committee was called to discuss the rating of the Nigeria, Government of. The main points raised during the discussion were: The issuer’s fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks. Other views raised included: The issuer’s economic fundamentals, including its economic strength, have not materially changed. The issuer’s institutional strength/ framework, have not materially changed. The issuer’s governance and/or management, have not materially changed.