Monday 20, March 2017 by Matthew Amlôt

S&P: Federal Republic of Nigeria ratings affirmed at 'B/B'; outlook stable

On March 17, 2017, S&P Global Ratings affirmed its 'B/B' long- and short-term sovereign credit ratings on the Federal Republic of Nigeria. The outlook is stable.

“At the same time, we affirmed our long- and short-term Nigeria national scale ratings at 'ngBBB/ngA-2'. We also maintained our transfer and convertibility (T&C) assessment on Nigeria at 'B'.

“The ratings on Nigeria are constrained by our view of its low level of economic wealth, real GDP per capita trend growth rates below those of peers with similar levels of development, and future policy responses that may be difficult to predict because of the highly centralized political environment. The ratings are supported by relatively low general government debt and modest fiscal deficits.

“We expect Nigeria's economy to achieve real GDP growth of 1.5 per cent in 2017 and 3.4 per cent on average over 2017-2020, supported by improvements in the oil sector and improved government budget execution under its recently released Economic Recovery and Growth Plan 2017-2020. A gradual increase in foreign currency inflows through rising export revenues and government external borrowing could help reduce foreign currency shortages in the non-oil sector and allow industry and financial sectors more leeway to contribute to economic growth. Nevertheless, on a per-capita basis, real GDP trend growth of 0.4 per cent (which we proxy by using 10-year weighted-average growth) remains below that of peers with similar wealth levels. Nigeria has significant infrastructure and energy shortfalls and low income levels, with GDP per capita at $1,800 in 2017.

“Nigeria is a sizable producer of hydrocarbons. The oil sector's direct share of nominal GDP is officially estimated at about 10 per cent, while oil and gas account for over 90 per cent of exports and at least half of fiscal revenues. Although oil revenues support the economy when prices are high, we view them as exposing Nigeria to significant volatility in terms of trade and the government to swings in therevenue base. Oil's relatively small contribution to GDP results from the country's large and growing population, estimated at about 192 million people in 2017, which has resulted in the emergence of other large sectors, such as agriculture (22 per cent of GDP), trade (18 per cent), and information and communication (12 per cent). Nevertheless, the oil sector has a significant indirect impact on the economy. A marked contraction in oil production, slower implementation of fiscal policy, and a restrictive exchange-rate regime resulted in Nigeria's economy contracting, in real terms, by 1.5 per cent of GDP in 2016. Since then, oil production has increased back above two million barrels per day (bpd) in early 2017 (against the about 1.6 million bpd reported at times in the second half of 2016). Oil production has been supported by reduced incidents of sabotage in the Niger Delta as the government's engagement with community leaders appears to have borne fruit, while repairs are being completed on key export pipelines. We have marginally increased our oil price assumptions to an average $53 per barrel (/bbl) over 2017-2020, compared with $51/bbl at the time of our previous review in September 2016.

“In 2016, government budget execution was slow due to delays in the legislature's approval of the budget and delays in securing external financing to support capital budget spending. Thus, the general government deficit estimate (which includes the federal and lower levels of government) improved to three per cent of GDP from four per cent. We expect the 2017 budget to be passed in March 2017, and improved budgetary execution to result in higher spending. However, increased oil revenues should allow the government to maintain its deficit at around three per cent of GDP this year, and enable gradual fiscal consolidation over the medium term. We expect the annual change in general government debt (our preferred fiscal metric because in most cases it is more comprehensive than the reported headline deficit) to average about two per cent of GDP over 2017-2020.

“However, the federal government is working through a process to verify the amount of arrears it has to lower levels of state and to private contractors and suppliers. This could increase government indebtedness by Nigerian naira (NGN)2 trillion (2 per cent-3 per cent of GDP) which could worsen our assessment of Nigeria's fiscal risk. The government plans to clear its arrears through the issuance of promissory notes that amortize over a 10-year period. We would likely include these promissory notes in the stock of government debt. At the same time, the states that have received financial assistance over the last two years are still running salary and supplier arrears that require further federal government assistance. Such assistance may be subject to states meeting conditions and financial reforms agreed with the federal government. Apart from arrears, deficits at the state level are largely contained by states' limited ability to borrow from the markets--they remain largely reliant on constitutionally mandated transfers of funds from the federation's revenue pool.

“Overall, we forecast that Nigeria's general government debt stock (consolidating debt at the federal, state, and local government levels) will average 23 per cent of GDP for 2017-2020, comparing favorably with peer countries' ratios. We also anticipate that general government debt, net of liquid assets, will average 16 per cent of GDP in 2017-2020. We include debt of the Asset Management Corporation of Nigeria (around five per cent of GDP)--created to resolve the nonperforming loan assets of the Nigerian banks--in our calculation of gross and net debt, in line with our treatment of such entities elsewhere. Over 80 per cent of government debt is denominated in naira. Despite the low government debt stock, general government debt-servicing costs as a percent of revenues are high and have increased in recent years from below 10 per cent in 2014 to our projection of 18 per cent on average in 2017-2020. The central government alone has debt-servicing costs of close to 40 per cent of revenues, which in our opinion reduces fiscal flexibility. The steep increases in the ratio are due to a combination of the decline in oil revenues since 2014 and higher borrowing costs in the domestic market. The government's efforts to improve non-oil revenues through broadening the tax base and improving tax administration should improve its debt-servicing costs, which we expect to marginally improve over our forecast horizon through 2020.

“Nigeria's state-owned oil company, the Nigerian National Petroleum Corp. (NNPC), has agreed with international oil companies (IOCs) to clear close to $5 billion in arrears with joint venture partners. The financing strategy involves the IOC arm in the joint venture with NNPC being able to recover amounts owed by NNPC through revenues from incremental oil production (above agreed production levels). In the future, the federal government will no longer have to meet cash call obligations as part of costs of production in joint venture agreements, but will receive only the net revenues at the end, after all income and expenditures have been netted out (previously they were not netted out and required a transfer to the IOC at a later date). The new framework should therefore avoid a buildup of arrears in the future.

“The fall in oil prices over the last two years resulted in substantially lower export revenues. However, foreign currency shortages to financial and industry sectors in turn compressed imports of goods and services, resulting in a smaller trade deficit. We therefore estimate the overall current account deficit at below two per cent of GDP in 2016 compared with our previous forecast of 3.4 per cent in September 2016. We expect improved crude production and prices to support current account receipts (CARs). However, this could also result in the central bank gradually easing availability of foreign currency and repaying foreign currency backlogs to banks. We therefore expect that imports could rise higher than 2016 levels. Thus, the narrowing of the current account deficit may be limited by increasing import demand. Consequently, we expect an average annual current account deficit of around two per cent of GDP in 2017-2020 while gross external financing needs will average close to 140 per cent of CARs plus usable reserves over the same period. Gross external financing needs and funding risks have increased due to rising short-term external debt in the banking sector, which we estimate at 90 per cent of CARs. We expect the government's external financing need to be covered by a combination of credit lines from the World Bank and the African Development Bank, and from the international capital markets. On a stock basis, narrow net external debt (external debt minus liquid external assets) will average 52 per cent of CARs in 2017-2020, in our base-case scenario.

“The Central Bank of Nigeria liberalized the interbank exchange rate in June 2016, where most foreign currency trading activity takes place. However, we still observe excess demand for foreign exchange by financial and industry sectors through foreign exchange backlogs to banks and compressed imports by industry sectors. Because of an inadequate supply of foreign currency, the naira trades in the parallel market at lower levels than the interbank market rates. The interbank rate has traded between NGN300 and NGN320 since June 2016. At the same time, Nigeria still maintains foreign exchange controls on both current and capital transactions, including import restrictions on 41 categories of goods.

“Banks continue to face a shortage of U.S. dollars, which has caused them to shrink the volume of letters of credit they could extend to their customers and for some of them to restructure or pay back their facilities as correspondent banks tested their ability to pay. The central bank has recently started to provide additional U.S. dollars to the banks, and to private individuals at a rate up to 20 per cent higher than the official rate. However, in the event of devaluation, banks' asset quality and capitalization would be further constrained. We believe at least three banks are within 150 basis points of their minimum capital adequacy ratio owing to the 2016 devaluation of the naira and weak earnings. Further losses or devaluation could trigger an element of regulatory forbearance within the sector. It is therefore likely that a few banks will either actively shrink their balance sheets or seek capital injections in 2017, which could prove difficult in the current market and economic environment. We forecast that the Nigerian banks will suffer increased credit losses of 3.5 to four per cent in 2017 in aggregate, after an anticipated three per cent in 2016. Asset quality problems are expected to be most pronounced from domestic oil companies, power companies, manufacturing, and real estate. We also see particular risk from borrowers of foreign currency without foreign currency receivables.

“Inflation has risen over the last two years. In December 2016, annual consumer price inflation accelerated to close to 16 per cent compared with nine per cent in December 2015 or eight per cent in December 2014. The rising trend is attributed to the June 2016 devaluation and structural factors increases in costs for food prices, electricity, transport, and inputs, as well as low industrial activity. The central bank raised policy rates once in July 2016 and has since kept them constant. Recent trends show that the increases in the month-on-month inflation rate in November and December have started to decline (compared with the June-September period) suggesting inflation may be subsiding as non-oil output recovers and the naira exchange rate stabilizes.

“In our view, future government policy responses may be difficult to predict, due to the highly centralized political environment. In 2017, the government is working on improving the policy framework and has announced a new economic plan, Economic Recovery and Growth Plan 2020, focused on growing the oil and non-oil economic sectors. President Buhari's administration has also focused on reducing security risks in the Northeast, tackling corruption, and increasing the efficiency of institutions. We believe these anti-corruption and efficiency measures could bear fruit in the next several years. The security risks have abated, thanks to intensified military efforts in conjunction with Chad, Niger, and Cameroon to defeat Boko Haram, an insurgency group. Mr. Buhari, who was on sick leave in London for several weeks, has returned to Nigeria and has resumed his role as president from the vice president, who had been acting in his absence. This has reduced potential political and economic tensions that could have arisen if Mr. Buhari had remained on sick leave.

“The stable outlook signals our assessment that the oil sector improvements will be supportive of higher economic growth in Nigeria, although external financing pressures remain.

“We may lower the ratings if we observe further deterioration of Nigeria's fiscal or external accounts, or greater stress in the financial sector than we currently expect.

“We could raise our ratings on Nigeria if we see significantly higher economic growth prospects than our base case, marked improvements in external accounts, and an easing of foreign exchange controls on current and capital account transactions that enhances monetary flexibility.”

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