S&P Affirms Nigeria ‘B/B’ and ‘ngA/ngA-1 rating, calls for fiscal consolidation to strengthen economic policy

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FILE PHOTO: People crowd a street at the central business district in Nigeria's commercial capital Lagos ahead of Christmas December 23, 2016. REUTERS/Akintunde Akinleye/File Photo

Nigeria’s economic performance remains weak and its external debt moderate. We consider fiscal consolidation will be key in the period
ahead. President Buhari has secured a second term, which provides his government with another opportunity to strengthen economic policy
framework and consolidate public finances.
We are therefore affirming our ‘B/B’ sovereign credit ratings and ‘ngA/ngA-1’ Nigeria national scale ratings on Nigeria.
The outlook is stable.

A Global rating agency, S&P Global Ratings has 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′.

OUTLOOK
The stable outlook balances the risks associated with Nigeria’s still-weak economy against its moderate external debt and external buffers.

We may lower the ratings if Nigeria’s international reserves were to decline markedly and at the same time its external debt rose much faster than we
currently expect.

We could raise our ratings if Nigeria’s economic performance were to improve markedly more than our base case–for example, if it saw positive real per
capita growth, or it consolidated its fiscal deficits more quickly.

RATIONALE
The ratings on Nigeria are supported by its relatively low general government debt stock, the country’s moderate external indebtedness, and its moderate
international reserves.

The ratings remain constrained, in our view, by the country’s low economic wealth, weak institutional capacity, and lower real GDP per capita trend
growth rates than peers at similar development levels.

Institutional and Economic Profile: Weak economic performance, with slower trend growth than peers

By securing a second term as leader of Nigeria, Mr. Buhari has gained another opportunity for his government to improve the economy and
stabilize public finances.
The economy is growing more slowly than that of peers that have similar wealth levels.

Nigeria has a democratic political system and has tested its ability to transfer power between different political parties. However, we regard its
institutions as weak and policy predictability as low. Fiscal budgets are frequently passed well after the year has begun, which impedes the government’s responsiveness to economic challenges.

Decision-making at the federal level has largely been centralized in the office of President Buhari, although we consider that his government’s federal
system does help to redistribute wealth and spread power, to some extent.
Security risks from Boko Haram in the northeast have abated slightly, compared with the past three years, but there are still sporadic attacks on oil
pipelines in the Niger delta.

In the general elections held on Feb. 23, 2019, Mr. Buhari won a second term with 56% of the votes. His nearest challenger, Mr. Atiku Abubakar, garnered
41% of the votes and is contesting the election outcome in courts. State and local elections were held on March 9 and the final results are still being
collated. Our base case is that Mr. Buhari and the APC coalition he has so far led will form a new government within the next few weeks, and that the policy
framework will not change significantly. The result of the presidential elections provides Mr. Buhari’s government with another opportunity to
strengthen the economic policy framework and consolidate public finances.
Nigeria’s economic performance has been weak–GDP per capita has been negative and debt-servicing costs absorb at least 30% of the country’s fiscal revenues,
which constrains its fiscal flexibility.

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 show that Nigeria’s
economy grew by 1.9% during 2018, based on improving performance in non-oil sectors as well as rising oil prices.

Agriculture, manufacturing, and services (which comprise the transport, information, communication, and technology sectors) have helped the economy
grow faster in 2018 than the 1% it achieved in 2017. In our view, the increase in the availability of foreign currency and the flexible exchange rate have
helped the non-oil sector grow.

That said, average oil production is close to 2 million barrels per day and we forecast that oil prices will decline over 2019 and 2020 (see “S&P Global
Ratings Lowers Brent And WTI Oil Price Assumptions For 2019 Through 2020; Natural Gas Price Assumptions Are Unchanged,” published on Jan. 3, 2019). Low
oil prices are likely to present fiscal pressures and limit growth, stimulating government expenditure.

In the medium term, we expect improvements in the non-oil sector to support our forecast of economic growth rising to at least 2% in real terms. However, when we use 10-year weighted-average growth rates to estimate real per capita GDP growth, we calculate that the real economy is shrinking by 0.7% a year, well below the economic performance of peers that have 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: The post-election period provides an opportunity for the government to pursue fiscal consolidation

Net external debt is likely to increase over 2019-2022 if fiscal financing remains externally funded and external buffers stay at current levels.
After the elections, Nigeria could consolidate its fiscal position if it increases non-oil revenues while moderating capital spending.

Although oil revenues support the economy when prices are high, they expose Nigeria to significant volatility in terms of trade and government revenues.
Consequently, Nigeria’s trade balance is significantly affected by changes in the price of oil. Nigeria also consistently runs substantial deficits on the service and income balances.

The most consistently supportive feature of Nigeria’s current account is the surplus on net transfers, largely based on diaspora remittances by Nigerians living abroad.
In 2018, oil prices increased by close to 30%, boosting Nigeria’s export revenues. However, imports of goods and services surged at
the same time. We estimate that the current account surplus in 2018 may be only 2% of GDP; in 2017, when oil prices were lower and imports were compressed, it reached 3% of GDP.

Over 2019-2022, we assume that oil prices will decline, which will reduce export revenues. We also expect imports to moderate, albeit more slowly.
Our overall forecast of the current account is a near balance, averaging -0.4% over 2019-2022. We now estimate gross external financing needs will average close to 100% of current account receipts (CARs) plus usable reserves during
2019-2022.

The government is likely to cover its external financing needs through a combination of concessional credit lines and the international capital markets. As part of exchanging expensive domestic debt for cheaper foreign currency debt and general external financing needs, the government last year issued Eurobonds worth about $6 billion. The impact of rising net external debt in 2018 was moderated by improving foreign exchange reserves at the Central Bank of Nigeria (CBN).

In 2019, we expect Nigeria’s government to issue further Eurobonds before moderating issuance levels in 2020-2022. We assume central bank reserves will remain at the current levels. The government drew down some of its savings in 2018 from the excess crude account (ECA). It was above US$2 billion at the start of 2018, and is now estimated to be close to US$1 billion.

We add government savings from the ECA plus the Nigeria sovereign wealth fund (which stands at about US$2 billion in 2019) to calculate public sector liquid external assets. We expect a reduction in external assets, combined with rising external indebtedness, to weaken Nigeria’s net external position.
Therefore, we estimate narrow net external debt (external debt minus liquid external assets) will likely rise from an average of about 30% of CARs in 2018 to 45% over 2019-2022.

Although Nigeria produces an international investment position (external asset and liability position), our analysis of Nigeria’s external accounts is hampered by discrepancies in the data that average 20% of CARs.

The discrepancies occur between changes in the external stocks and changes in the balance of payments.

Higher oil prices in 2018 have helped increase government revenue, largely offsetting weak non-oil revenue growth. However, projects requiring capital expenditure have been implemented more quickly and deficits remain at the state and local government levels. As a result, we project the general government deficit (which combines deficits at the federal, state, and local government levels) will remain above 3% of GDP this year.

Our forecast shows oil prices declining and capital expenditure moderating after the election cycle. At the same time, a pick-up in non-oil economic activity should help grow non-oil revenues. These factors should help Nigeria consolidate its fiscal positon, as headline deficits decline closer to 2% of GDP by 2022. We estimate the annual change in net general government debt will average 2.65% of GDP in 2019-2022.

In projecting the overall general government deficit, we exclude the clearance of fiscal arrears to contractors, suppliers, and lower levels of government that have yet to be reconciled. Fiscal arrears are estimated at 2%-3% of GDP.
A plan to clear them by issuing debt securities denominated in Nigerian naira
(NGN) in 2019 has been proposed–if the national assembly approves the plan, our deficit and debt projections could increase 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 2019-2022, which compares favorably with peer countries’ ratios. We also anticipate that general government debt, net of liquid assets, will average close to 20% of GDP in 2019-2022.

The government created the Asset Management Corporation of Nigeria to resolve the nonperforming loan assets of Nigerian banks. We include its debt, which comprised about 3% of GDP in 2019, 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 amount of government debt, the cost of servicing it is relatively high, as a percentage of revenue, because of the high coupon on local currency treasury bills and bonds. In our view, the high debt-servicing costs–projected to remain over 40% of revenue at the central government level–limit fiscal flexibility.

We project average debt-servicing costs for 2019-2022 of 30% of general government revenues. This represents a steep increase from just 10% in 2014.
Not only are oil revenues lower than they were in 2014, borrowing costs in the domestic market have also risen. To reduce its borrowing costs, the government has borrowed externally to fund maturing short-term domestic debt obligations.

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, CBN window for banks and manufacturing companies, and the Nigerian Autonomous Foreign Exchange Fixing Mechanism (Nafex) window for all other autonomous transactions. Apart from the official rate, all other rates have converged to the Nafex window, averaging NGN362 to US$1 in 2018. We do not expect any policy decision to merge the various exchange rate windows.

Inflation is declining in Nigeria, although it remains high. It averaged 12% in 2018, down from 16.5% in 2017. We anticipate that it will fall further to
10% in 2019, and average around 9% over the medium term. Good performance in agriculture has helped by increasing crop outputs and the food supply. Lower
food prices, combined with lower oil prices and a stable exchange rate, has kept import costs stable and relatively low.

The banking sector has been operating under difficult economic and regulatory circumstances. We still consider the Nigerian banking sector to be in a correction phase. It suffered high credit losses of 2.5%-3% over the past two years and we expect flat or negative credit growth in 2019-2020. That said, the banking sector has stabilized since the 2016 oil price shock–we think material change unlikely in the next 12-24 months. We also expect profitability at the top-tier banks to remain resilient to the credit cycle.
In 2018, Nigerian banks implemented International Financial Reporting Standards (IFRS) 9 using their regulatory risk reserves, thus shielding their capital ratios from breaching the minimum capital requirements.

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Godwin Okafor is a Financial Journalist, Internet Social Entrepreneur and Founder of Naija247news Media Limited. He has over 16 years experience in financial journalism. His experience cuts across traditional and digital media. He started his journalism career at Business Day, Nigeria and founded Naija247news Media in 2010. Godwin holds a Bachelors degree in Industrial Relations and Personnel Management from the Lagos State University, Ojo, Lagos. He is an alumni of Lagos Business School and a Fellow of the University of Pennsylvania (Wharton Seminar for Business Journalists). Over the years, he has won a number of journalism awards. Godwin is the chairman of Emmerich Resources Limited, the publisher of Naija247news.

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