Leading provider of credit ratings, research, and risk analysis, Moody’s Investors Service has today downgraded the Government of Nigeria’s long-term issuer and senior unsecured debt rating to B2 from B1 and the senior unsecured MTN program rating and the provisional senior unsecured debt rating to (P)B2 from (P)B1. The rating outlook remains stable.
According to Moody’s, the downgrade was due to the inability of the government to address the key structural weakness exposed by the oil price shock, despite widely spoken about effort to broaden the non-oil revenue base.
“As a consequence, while debt levels remain contained and notwithstanding recent cyclical improvements, the government’s balance sheet remains structurally exposed to further economic or financial shocks, with interest payments very high relative to revenues and deficits elevated despite cuts in capital spending,” a statement by the ratings agency said.
However, the likelihood of a shock occurring that would further impair Nigeria’s economic and fiscal strength remains low, with external vulnerabilities having receded supported by the rebound in oil production, the current account projected to remain in surplus, and reserves boosted through external borrowings and increased foreign capital inflows. This has ensured a stable outlook. “Medium-term growth prospects are also credit supportive,” Moody’s also said.
Moody’s has also lowered the long-term foreign-currency bond ceiling to B1 from Ba3 and the long-term foreign currency deposit ceiling to B3 from B2. The long-term local-currency bond and deposit ceilings remain unchanged at Ba1.
THE AUTHORITIES’ EFFORTS TO INCREASE NON-OIL REVENUE HAVE SO FAR PROVEN LARGELY UNSUCCESSFUL, WITH KEY STRUCTURAL WEAKNESSES PERSISTING
The first driver of the rating action is Nigeria’s slower than anticipated progress in addressing its key structural weakness, which is its significant reliance on a single sector to drive government revenues as well as growth and exports. The oil shock severely weakened Nigeria’s public finances, with general government revenues suffering a 50% decline between 2014 and 2016 (from 10.5% of GDP to 5.3% respectively). The damage wrought by the oil price shock has not yet been undone, and the downgrade reflects Moody’s view that this weakness in Nigeria’s public finances will remain for some years to come; Moody’s forecasts general government revenue to average only 6.4% of GDP over 2017-2019, the lowest level of any sovereign rated by Moody’s.
The results of the authorities’ efforts to increase non-oil revenue since late 2015, which have focused on improving compliance and broadening the tax base, have been limited and negatively impacted by a contractionary environment in 2016. The Federal Revenue Inland Service (FRIS) has been able to increase non-oil revenue by 15% in nominal terms as of September 2017 compared to 2016, but this is at a pace that is below nominal GDP growth. Meanwhile, the independent re-appropriation of revenues from the ministries, departments and agencies (MDAs) has yielded less than projected results for two consecutive years, highlighting the considerable execution risks inherent in the transition to a less oil-dependent budget. Hence, while the rebound in the oil price and in oil production has led to oil revenues out performing the 2017 budget target, non-oil tax revenues are still below target with a 30% shortfall for the federal government at the end of September compared to budget and likely a similar situation for states and municipalities.
The challenges on the revenue side will negatively impact potential growth. Since 2014, the authorities have offset revenue shortfalls with large cuts in much needed capital expenditure, a trend that Moody’s expects to continue. In 2017 the government is likely to only match 2016 capital spending that reached NGN1.2 trillion (or 1.2% of GDP), given the 2017 budget is expected to run on a six-month cycle (for capital expenditures only) as the 2018 budget is likely to be passed in January. This is less than 50% of the 2017 budget for capital spending and still an insufficient level to have a meaningful impact on the large infrastructure gap that significantly constrains the country’s potential growth.
WHILE DEBT LEVELS REMAIN CONTAINED, THE GOVERNMENT’S BALANCE SHEET REMAINS EXPOSED TO FURTHER SHOCKS.
As a consequence of the inability to expand the non-oil revenue base, the government’s balance sheet will remain exposed to further shocks. Deficits will remain elevated and debt affordability will remain challenged, despite debt levels remaining contained. That exposure will persist notwithstanding the recent improvements in the economy, which are primarily cyclical and related to the strengthening in the oil sector.
Moody’s projects a general government budget deficit of 3.6% of GDP in 2017, down from 4.7% in 2016. In 2018, the deficit will decline only slightly to 3.2% of GDP, comprised of a 2% of GDP federal government budget deficit and around 1% of GDP deficit at the state and municipality levels plus some arrears that are likely to be split between the three levels of government. This is nearly double the general government deficits of 1.9% of GDP averaged between 2010 and 2015. While Nigeria’s general government deficit compares favourably to the 5.5% and 4.6% of GDP median budget deficit for B1- and B2-rated sovereigns, the challenges it poses are magnified by the country’s underdeveloped revenue base: Nigeria’s budget deficit is equivalent to roughly half of total general government revenue—a ratio much weaker than the median of B-rated sovereigns.
Relatedly, debt service is consuming an ever larger share of government revenue. At the federal level, debt service accounted for 38.2% of total revenues by the end of June, up from 29% in 2014 and 23% in 2013. At the broader general government level, the ratio of interest payments to general government revenues peaked at just under 30% in 2016, 10 percentage points above what the rating agency anticipated in December 2016 when it affirmed the previous rating of B1 and over four times higher than the B2 median of 6.6% in 2017. Moody’s expects the ratio of interest payments to general government revenues to only slowly decline to 28.4% in 2017.
While debt levels remain low, outstanding general government indebtedness has increased by around 50 per cent in recent years. Moreover, around a quarter of the NGN15 trillion of domestic debt outstanding at the end of June 2017 is comprised of T-bills, increasing refinancing risk and interest rate exposure. With inflation likely remaining elevated over the next two years, interest rates are likely to decline only slowly: Moody’s expects inflation to decline gradually from its 2016 peak of 18.6% to around 14% at the end of 2017 and 12% at the end of 2018. The government is seeking to shift the balance of issuance away from costly short-term domestic debt towards longer-term external borrowing in the Eurobond markets or from multilateral institutions including the African Development Bank (AfDB) and World Bank (The). However, the impact of this strategy will be slow to materialise: Moody’s estimates that external debt will represent 25% of general government debt by end-2017, versus 20% a year before.
Nigeria’s existing financial buffers are too small to provide any meaningful cushion against protracted oil price volatility or other shocks. As at the end of October, the excess crude account (ECA) stood at $2.4 billion and the National Sovereign Investment Authority (NSIA) at $2 billion, equivalent to merely 0.6% and 0.5% of GDP respectively.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects Moody’s view that the risk of a shock occurring that would further impair Nigeria’s economic and fiscal strength remains low, in part because of the recent improvement in the growth outlook and the measures taken to address foreign exchange shortages.
Nigeria’s economic growth and US dollar earnings are likely to continue to improve over the coming two years, albeit driven primarily by a recovery in oil production and revenues and relatedly in the availability of foreign exchange, rather than by a deepening of the non-oil economy.
In 2017, oil production has been steadily growing to currently reach 2.2 mbpd (including condensates). The government has tripled the amnesty programme payment to militants over the next two years to reduce the likelihood of production disruptions. The absence of further arrears on cash calls in Joint Ventures (JVs) this year has led some oil majors to consider further large investments in JVs from 2018. Moody’s baseline scenario assumes a slow but steady increase in oil production, averaging 2.3 mbpd between 2018 and 2020. Moody’s expects real GDP growth to reach 3.3% in 2018, compared to 1.7% in 2017 following the -1.5% contraction in 2016.
External vulnerabilities have receded. Foreign exchange reserves are expected to reach $38 billion at the end of 2017, albeit partly as a consequence of increased external indebtedness. Since the creation of the export-import window by the Central Bank in April 2016, net capital inflows have reached $5 billion and dollar liquidity — one of the main reasons for the economic contraction of 1.5% in 2016 — has improved. Nigeria’s current account has moved back further into surplus, supported by the pickup in both oil production and oil prices, and will likely average 1.5% in of GDP during 2018 and 2019. The overall balance of payments will benefit from government external borrowings and improved foreign capital inflows. At 24% in 2018, Moody’s expects that Nigeria’s External Vulnerability Indicator (the ratio of near-term economy-wide external outflows to foreign exchange reserves) will remain well below the B2 median of around 64%.
WHAT COULD CHANGE THE RATING UP
Positive pressure on Nigeria’s issuer rating could be exerted by: (1) the successful implementation of structural reforms, particularly with respect to public resource management and the broadening of the revenue base; (2) material improvement in institutional strength with respect to corruption, government effectiveness, and the rule of law; (3) the rebuilding of large financial buffers sufficient to shelter the economy against a prolonged period of oil price and production volatility.
WHAT COULD CHANGE THE RATING DOWN
Nigeria’s B2 issuer rating could be downgraded if Moody’s concluded that the sovereign’s exposure to a financing shock had materially increased, perhaps because of (1) continued erosion of debt affordability or a material deterioration in the government’s balance sheet in some other respect; or (2) materially weaker medium-term growth, for example as a result of delays in implementing key structural reforms, especially in the oil sector, or continued militancy in the Niger Delta, which undermine the level of oil production over the medium-term.
GDP per capita (PPP basis, US$): 5,936 (2016 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 1.7 % (2017 Estimate) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 14.4 % (2017 Estimate)
Gen. Gov. Financial Balance/GDP: -3.6 % (2017 Estimate) (also known as Fiscal Balance)
Current Account Balance/GDP: 1.8 % (2017 Estimate) (also known as External Balance)
External debt/GDP: 7.7 % (2016 Actual)
Level of economic development: Low level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 02 November 2017, a rating committee was called to discuss the rating of the Government of Nigeria. The main points raised during the discussion were: 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 fiscal or financial strength, including its debt profile, has materially decreased
The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
The Local Market analyst for these ratings is Aurelien Mali, +971 (423) 795-37.
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