Moody’s affirms Nigeria’s B2 ratings, maintains negative outlook

LAGOS (Capital Markets in Africa) — Moody’s Investors Service (“Moody’s”) has today affirmed Nigeria’s B2 long-term issuer ratings and senior unsecured rating and its (P)B2 senior unsecured MTN programme rating and maintained the negative outlook.

The negative outlook continues to reflect the material downside risks to Nigeria’s creditworthiness identified when the outlook on the sovereign’s rating was changed to negative in December 2019. However, those risks have increased since then, exacerbated by the oil price shock and the financial and economic implications of the coronavirus outbreak. The rapid and widening spread of the outbreak and related price shocks are creating an unprecedented credit shock across a wide range of regions and markets. For Nigeria, these shocks amplify existing credit vulnerabilities both over the immediate and longer-term. In the near term, the significant drop in oil revenues will reduce an already extremely low tax base, undermining fiscal strength. Combined with possible capital outflows, pressure on the fragile balance of payments may intensify, threatening external stability. In the longer term, the impact of the coronavirus on growth, particularly in the large informal sector, may weaken economic strength. The sovereign’s very low institutions and governance strength is likely to constrain the effectiveness of government measures to buffer the impact of the economic and financial shock.

The risk of such stresses materializing is rising, and while the negative outlook also encompasses longer-term challenges, downward pressure may materialize relatively early on in the outlook horizon. While not Moody’s current expectation, indications that the government was contemplating participation in broader debt relief initiatives with negative consequences for private sector creditors would be negative for the rating.

Set against these rising pressures, Moody’s affirmation of Nigeria’s B2 ratings also takes into account the government’s relatively low debt burden in relation to GDP and commensurately low annual borrowing requirements, its low external debt service needs over the next few years and the capacity of the large banking sector to absorb more government debt. These credit features lower the probability of imminent and severe liquidity or balance of payments stresses relative to some ‘B’-rated peers.

Nigeria’s country risk ceilings remain unchanged at their current levels: the foreign-currency bond ceiling at B1, the foreign-currency deposit ceiling at B3, and the local-currency bond and deposit ceilings at Ba1.

The rationale for Maintaining the negative outlook
As a result of the oil price fall in the face of depressed oil demand and a slow supply response, Moody’s now assumes that oil prices will average US$40-45 per barrel in 2020, and US$50-55 by 2021, around $20 and $10 below previous expectations in each year. Risks to that forecast are firmly to the downside. Beyond 2021, Moody’s currently assumes that oil prices will return in a medium-term range of $50-70 per barrel, as demand recovers and supply adjusts further.

As a large oil exporter, Nigeria heavily relies on the oil sector which accounts for around 50% of government revenues and more than 80% of merchandise exports proceeds. Lower oil prices in the next two years will weaken Nigeria’s credit profile by negatively affecting the government’s public finances and the country’s external position, exacerbating the near- and longer-term downside risks to the B2 rating already identified when the outlook on the sovereign’s rating was changed to negative in December 2019.

While the fiscal and external implications of the coronavirus outbreak manifest immediately, in the current environment the downside risks to Nigeria’s rating also relate to the longer-term implications for the sovereign’s economic strength, should the economy not recover fully once the epidemic subsides.

Fiscal and external weakness exacerbated by Coronavirus-related oil price and financing shock
Nigeria’s public finances are increasingly fragile. Given the already extremely low government revenue base (at around 8% of GDP pre-shock), the significant loss of oil-related fiscal revenue will exacerbate the persistent fiscal deficits and raise the debt burden.

At unchanged oil production levels (between 2.0 and 2.2 million barrels per day including condensates), Moody’s estimates that a $10/barrel decrease in oil price leads to a $3-$3.5 billion loss in government revenue (around 0.7% of 2019 GDP or close to 10% of general government revenues). Additionally, coronavirus-related spending to prevent its spread throughout the country is expected to further widen the fiscal deficit.

While in relation to GDP, Nigeria’s fiscal and liquidity metrics are not weaker than seen for other B2-rated sovereigns, very low revenue magnifies the impact of the oil proceeds shortfall on Nigeria’s challenges to finance essential expenditure and service its debt. Moody’s expects the deficit and government’s borrowing requirements to widen by around 1% of GDP this year compared to its pre-shock projections, to around 5% and 8.5% respectively. Meanwhile, as a ratio to revenue, the general government’s debt burden will rise by around 120 percentage points to about 430%, with interest payments absorbing more than 30% of revenue compared with around 20% previously expected.

On the external side, vulnerability relates to the expected widening in the current account deficit and to possible capital outflows in light of Nigeria’s significant reliance on foreign investors to fund the country’s foreign exchange reserves.

The current account, which turned into a substantial deficit estimated at 3.6% of GDP or $17 billion in 2019, will deteriorate further adding pressure on declining foreign exchange reserves. Taking into account a probable slowdown in imports as GDP growth falls, Moody’s estimates that the current account balance will move to a deficit of more than 5% of GDP this year. Although Nigeria’s foreign exchange reserves are currently adequate to cover imports and external debt payments, they are vulnerable to a deterioration in investor sentiment. Indeed, foreign portfolio investors’ holdings of central bank certificates are significant, amounting to an estimated $12.5-15 billion at the end of 2019. With the widening current account deficit, a further decline in reserves (from $35 billion at the end of March 2020 and $38.6 billion at the end of last year) could exacerbate foreign capital outflows, which in turn would accelerate the decline in reserves.

Longer-term downside risks to economic strength
Over the longer term, the fiscal and external vulnerability risks mentioned above combine with the risk that a largely informal economy is more deeply and negatively affected by the coronavirus outbreak than Moody’s currently assumes. This could undermine the economic strength provided by a large and diversified economy supported by vast oil and gas endowments.

Consistent with Moody’s global assumptions, the rating agency projects Nigeria’s GDP growth to start rising again next year, from a contraction in 2020, as global economic activity resumes more normally, oil prices rise and domestic containment measures are lifted. However, there is a risk that Nigeria’s majority of very low-income households face a longer-lasting negative shock if the informal sources of revenue that they rely on do not recover. Rising dollar scarcity in the economy may also constrain real GDP growth to a greater and longer extent than Moody’s currently assumes.

The rationale for affirming Nigeria’s B2 ratings
Moody’s decision to affirm the rating at B2 balances features which exacerbate these increasingly acute financing and growth pressures, and others which mitigate them.

On the negative side, the B2 rating reflects the significant credit constraints arising from Nigeria’s weak institutions and governance, that are likely to impede an effective response by the government to the economic and financial shock.

Set against that are credit features which lower the probability of imminent and severe liquidity or balance of payments stresses relative to regional and rating peers facing similar pressures from the spread of the coronavirus and the oil price shock. In particular, Nigeria benefits from a relatively low public debt stock as a share of GDP, commensurately low annual borrowing requirements and long external debt maturities that lower external debt service needs over the next few years. It also possesses a deep domestic capital market and a large banking sector with capacity to absorb more government debt.

Despite rapid debt accumulation since 2015, to an estimated NGN34.2 trillion (23.5% of GDP) in 2019 from NGN12.6 trillion (or 13.2%) in 2015, the government’s debt burden measured in relation to the whole economy’s sources of revenue (GDP) remains relatively moderate compared to peers. The government’s annual financing needs are similarly moderate at around 8% of GDP — though its weak ability to raise revenue magnifies the challenge posed by any refinancing needs somewhat.

The domestic capital market is likely to be able to absorb higher borrowing needs by the government at moderate costs given the current relatively low exposure of the banking system to government securities (estimated at 12% of banking assets at the end of 2018). Moreover, as has been the case in the last three years, the government is likely to continue to rely on central bank financing under an existing overdraft facility.

The government’s external debt amounts to only 6% of GDP with an average maturity exceeding 14 years, and the depth of its domestic capital market has allowed the government to also issue domestic debt at relatively long maturities (more than 7 years on average), which lowers its financing needs. Moreover, slightly more than half of government external debt is on concessional terms, with almost half owed to multilateral development banks. Overall, Nigeria’s external debt service (principal and interest) is small, around $2-2.5 billion (0.5% of GDP) per year in the next five years. Looking across the broader economy, the country’s External Vulnerability Indicator is well below 100% and is expected to remain so, indicating adequate coverage by reserves of near-term economy-wide maturities.

Together, these features provide some assurance that Nigeria has the finances and the access to supportive funding needed to weather the current storm and support the B2 rating.

Moreover, while the government’s capacity to mitigate the shock will be severely tested, the authorities have taken some measures that will limit the more immediate risks. They have started to adjust the official exchange rate and the import-export window, announced a supplementary budget law based on a $30 dollar per barrel oil price (instead of the current $57), phased out oil subsidies and called for $7.2 billion in financial support from international financial institutions including the World Bank, the IMF and the African Development Bank (Aaa stable).

Environmental, social and governance considerations
Environmental considerations are not material for Nigeria’s rating. As an oil producer and exporter, Nigeria’s environmental risks derive from carbon transition. Nigeria’s credit profile would face downward pressure in a scenario of rapid global transition to lower reliance on hydrocarbons that would depress global hydrocarbon demand and prices. However, in light of the measures against climate change taken so far, this is not Moody’s baseline.

Social considerations are material for Nigeria’s credit profile given the country’s very low average income levels and high levels of poverty. 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 measures of inequality in income, education and health. Despite vast natural resources wealth, more than half the population lives on less than PPP$1.9 a day. Prolonged and intense social unrest in protest against living conditions could have a marked negative impact on growth, government finances and foreign investors’ willingness to purchase Nigerian assets, threatening the country’s external position. More immediately, Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. As explained above, the direct and indirect credit implications of the health shock are material for Nigeria.

Governance considerations are material to Nigeria’s credit profile and are a driver of this action. Moody’s assessment of Nigeria’s institutions and governance strength is very weak at “caa3”. Institutional capacities remain limited and the management of public resources remains opaque and lacking in effectiveness.

Factors that could lead to an upgrade or downgrade of the ratings
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 the implementation of a credible fiscal and economic policy response from the government that mitigated the immediate fiscal and external vulnerability risks, and limited the long-term negative economic and social implications of the coronavirus outbreak.

Moody’s would downgrade the rating if it were to conclude that Nigeria’s government was unlikely to be able to alleviate the damage to its revenues and its balance sheet and the subsequent rise in liquidity and external risk. Downside risks could escalate rapidly in the event of further downward pressure on oil prices that deepened and lengthened the revenue shock for the government and/or an intensification of capital outflows that jeopardized macroeconomic stability. While not Moody’s current expectation, indications that the government was contemplating participation in broader debt relief initiatives with negative consequences for private sector creditors would be negative for the rating.