Moody’s Changes Nigeria’s Economic Outlook to Stable, Affirms B2 Ratings

0
186

Moody’s Investors Service (“Moody’s”) has today changed the outlook on the Government of Nigeria to stable from negative and affirmed its long-term issuer and senior unsecured ratings at B2. Moody’s also affirmed the Government of Nigeria’s (P)B2 senior unsecured medium-term note program rating.

The change of outlook to stable reflects Moody’s expectation that higher oil prices and some measures taken by the government will help stabilize the sovereign’s credit metrics and support its external position. The ongoing improvements in the macroeconomy and the external position are likely to continue in the next few years, supported by the oil price environment, Nigeria’s new Petroleum Industry Act legislation and the opening of the Dangote refinery that will structurally reduce demand for US dollars. At the same time, Moody’s expects Nigeria’s fiscal deficit to narrow very slowly, with ongoing efforts to increase non-oil government revenue, although weak governance and institutional capacity are likely to hamper execution. General government debt (including central bank funding and promissory notes) is projected to rise gradually, towards 35% of GDP by 2025, stabilizing above 400% of revenue.

The affirmation of the ratings reflects Nigeria’s significant credit constraints, balanced by some credit strengths supporting the B2 ratings. The credit constraints include fiscal and external reliance on the hydrocarbon sector as well as its very weak institutional framework and governance, reflected in extremely low revenue generation. Susceptibility to event risk remains mainly driven by political risk.

Over the medium to long term, environmental and social risks represent significant rating constraints for Nigeria. Weak institutions indicate low capacity to adjust to rising social demands from a fast-growing population earning very low incomes and/or to the transformation of the government’s revenue and foreign-currency generation capacity implied by carbon transition. In particular, compared to historical experience, Moody’s expects oil exports to produce less robust revenues at peak oil prices and weaker revenues at trough oil prices because global initiatives to limit the adverse impacts of climate change will increasingly constrain the use of hydrocarbons and accelerate the shift to less environmentally damaging energy sources.

Balancing these factors, the scale of the economy that is relatively diverse, with services accounting for approximately 50% of the economy, supports the rating. Moreover, liquidity risk appears manageable with borrowing requirements around 8% of GDP (although relatively much higher as a proportion of revenue) over the next few years.

Nigeria’s local currency (LC) and foreign currency (FC) country ceilings remain unchanged. The LC country ceiling at Ba3, two notches above the sovereign issuer rating, incorporates some degree of unpredictability of government actions, political risk and the reliance on a single revenue source for the government. The FC country ceiling at B2, two notches below the LC country ceiling, reflects transfer and convertibility risks, given the track record of imposition of capital controls during oil price shocks.

Ratings Rationale

Rationale for the Change of Outlook to Stable from Negative

Nigeria’s Slow Economic Recovery Likely to Continue over the Next Few Years

Moody’s expects Nigeria’s economy to grow by 2.8% in 2021 and by 3.5% per year on average until 2025. This economic recovery is mainly due to low base effects, but also to improved dollar liquidity which has been facilitated by higher oil prices and the support of International Financial Institutions (IFIs) such as the IMF. While growth prospects are better than pre-pandemic levels, they remain weaker than before the 2016 oil price shock and insufficient to significantly lift living standards given population growth.

Moody’s expects that oil production (including condensate) will slightly increase in 2022 to reach 1.8 million barrels per day (mbpd) against an estimated 1.7 mbpd in 2021. Further out, the recent adoption of the Petroleum Industry Act (PIA) has reduced uncertainties that, over more than a decade, significantly weighed on investment in the Nigerian oil and gas sector. Over the next few years, other sectors including agriculture and services are also likely to perform well because of ongoing government support and improved dollar liquidity respectively.

Weak But Stable Fiscal Strength; Liquidity Risk Contained

Nigeria’s public finances have been deteriorating since 2016 due to successive oil prices shocks. The government’s inability to significantly expand the non-oil revenue base means that its balance sheet is exposed to further shocks. In the next few years, deficits will narrow with the recovery in oil prices, production and some fiscal measures, albeit remaining substantial to average 4.5% of GDP over 2021-2025. Debt affordability will remain very weak and debt levels will increase slightly towards 35% of GDP and stabilize above 400% of revenue.

Moody’s expects general government revenue to be around 6.8% of GDP in 2021, slightly higher than in 2020 at 6.3%; and to gradually increase to reach 8% in 2024-25. The government’s goal for revenues to reach 15% of GDP by 2025 is unlikely to be achieved or even approached, given the institutional capacity constraints and lack of track record in improving public finance. While the IMF has identified a number of fiscal measures to raise revenue, based on Nigeria’s track record, Moody’s expects only few of the reforms to be fully implemented over the period. The phasing out of oil subsidies, currently planned by the authorities in 2022, would potentially raise revenue by 1% of GDP, if fully implemented; Moody’s assumes that only some of these fiscal benefits will be realised in the foreseeable future.

In this context of very gradual fiscal consolidation, Moody’s expects liquidity risk to remain contained with gross borrowing requirements around 8% of GDP in the future after they peaked at 9% of GDP in 2020. Although the government has relied on the central bank funding to finance its deficits since 2018, it has also been able to increasingly rely on its domestic capital markets, which have continued to develop rapidly. Meanwhile, external government liquidity risk remains limited. External debt service remains manageable, with an average maturity at around 14 years. Slightly more than half of government external debt is on concessional terms, with 55% owed to multilateral development banks. Overall, Nigeria’s average external debt service (principal and interest) is relatively small at around $3.2 billion (0.7% of GDP) per year over the next five years. The government is likely to continue to favor official sector external borrowing and opportunistic long-term issuance on the international markets.

Nigeria’s External Position to Strengthen in the Coming Years

An increase in oil production and the commissioning of the Dangote refinery in 2022, with full production expected in 2023, will raise exports and lower imports, and strengthen Nigeria’s external position in the next few years.

Moody’s expects the current account deficit to be around 1.1% of GDP for 2021 compared to 3.9% in 2020 and it is likely to turn into surplus from 2022 onwards averaging 1% of GDP over 2022-25 period. Oil-related products such as fertilizers and petrochemicals currently make up 35%-40% of the import bill. As the refinery ramps up, local production will substitute imports.

Official foreign reserves stood at $42 billion at the end of October 2021, back to pre-pandemic levels after reaching a low of $33 billion in April 2021. A range of factors have supported reserves. The IMF disbursed $3.4 billion in April 2020 and another $3.35 billion in the form of SDR allocation in August 2021. Nigeria also issued $4 billion of Eurobonds in September 2021. Lastly, the government devalued the naira twice in 2020 and 2021, by 23% in March 2020 (to NGN379 from NGN306 to the dollar) and further 8% in June 2021 (to NGN411 from NGN379 to the dollar).

Given the anticipated small increase in oil production, sustained oil prices and lower imports, combined with continued debt issuance on international markets and official support, Moody’s expects foreign exchange reserves to continue to increase to $45 billion and $48 billion in 2022 and 2023 respectively. This will help reduce the pressure on naira and improve dollar liquidity in the economy.

Rationale for Affirming the B2 Ratings

The affirmation of the ratings reflects Nigeria’s significant credit constraints, balanced by some credit strengths supporting the B2 ratings.

On the negative side, Nigeria’s credit profile is vulnerable to oil price volatility which is a structural credit constraint given the country’s significant fiscal and external reliance on the hydrocarbon sector. Another key credit constraint arises from the sovereign’s very weak institutional framework and governance, reflected in particular in extremely low revenue generation. Susceptibility to event risk remains mainly driven by political risk.

Over the medium to long term, environmental and social risks represent significant rating constraints for Nigeria. Weak institutions indicate low capacity to adjust to rising social demands from a fast-growing population earning very low incomes, and to the transformation of the government’s revenue and foreign-currency generation capacity implied by carbon transition.

Balancing these factors, the scale of the economy that is relatively diverse, with services accounting for approximately 50% of the economy, supports the rating. Public sector debt remains moderate as percentage of GDP compared to peers and Nigeria benefits from increasingly deep capital markets. Liquidity risk appears manageable with long average maturity of debt that contributes to moderate borrowing requirements for the government.

Environmental, Social, Governance Considerations

Nigeria’s ESG Credit Impact Score is very highly negative (CIS-5), reflecting very high exposure to environmental risk and social risk and very weak governance that, with low wealth levels, leads to low resilience to E and S risks.

For Nigeria, exposure to environmental risks carries very high credit risks, reflected in its E-5 issuer profile score. Exposure to carbon transition risk is very high, given the very significant reliance on oil. Oil accounts for around 50% of government revenue on average and more than 80% of merchandise exports. Nigeria’s credit profile would face downward pressure in a scenario of more rapid global carbon transition than Moody’s currently assumes — and than implied by stated policies internationally. Water risk and physical climate risk are also high, driven by the high share of the population exposed to unsafe drinking water, risks of flooding and heath stress, as well as risks from waste and pollution respectively.

Exposure to social risks is very highly negative (S-5 issuer profile score), mainly related to poverty, low education outcomes, and poor health and safety indicators and access to basic services. Infant mortality is one of the highest in Sub-Saharan Africa and poverty is widespread, with close to 40% of the population living on less than PPP$1.90 a day despite vast natural resources wealth. The successive oil shocks and the pandemic have exacerbated the exposure to social risk. GDP per capita remains well below 2015 figures, with growing inequality due to the most vulnerable households carrying a disproportionate part of the burden of successive shocks.

Nigeria has a very highly negative governance profile score (G-5 issuer profile), reflecting weak control of corruption and rule of law as well as limited fiscal and monetary policy effectiveness and opaque management of public resources.

GDP per capita (PPP basis, US$): 5,186 (2020 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -1.8% (2020 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 15.8% (2020 Actual)

Gen. Gov. Financial Balance/GDP: -5.8% (2020 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -3.9% (2020 Actual) (also known as External Balance)

External debt/GDP: 8.2% (2020 Actual)

Economic resiliency: b2

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 24 November 2021, 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 economic fundamentals, including its economic strength, have not materially changed. The issuer’s institutions and governance strength, have not materially changed. The issuer’s fiscal or financial strength, including its debt profile, has not materially changed. The issuer’s susceptibility to event risks has not materially changed.

Factors That Could Lead to an Upgrade or Downgrade of the Ratings

Moody’s would likely upgrade the ratings if the implementation of structural reforms looked likely to be faster and more effective than it currently assumes, particularly with respect to public resources management and a broadening of the revenue base; and/or there were signs that economic policies were likely to foster stronger GDP growth on a sustained basis which will improve key credit metrics.

Moody’s would likely downgrade the ratings 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) a significant increase in external vulnerability risk indicated by prospects of a significant decline in foreign exchange reserves; (2) signs of a deterioration in fiscal strength, in particular if the revenue base did not increase gradually as Moody’s currently expects; or (3) materially weaker medium-term growth prospects than Moody’s currently assumes.