Nigeria | Moody’s downgrades Nigeria’s sovereign issuer rating with a stable outlook

LAGOS, Nigeria, Capital Markets in Africa — Moody’s Investors Service has today downgraded Nigeria’s long-term issuer ratings to B1 from Ba3 and has assigned a stable outlook, concluding the review for downgrade initiated on March 4th 2016.

The key drivers of today’s rating action are as follows:

1) Increased external vulnerability brought about by the prospect of lower-for-longer oil prices;

2) Execution risk in the transition to a less oil-dependent federal budget, and the implications for the government’s balance sheet should it not achieve its aims;

3) An elevated interest burden over the next two years while the government grows its non-oil tax receipts.

The stable outlook reflects the fact that Nigeria’s credit fundamentals will continue to compare favorably with peers at the B1 level, despite the likely further deterioration in the country’s credit metrics due to the oil price shock.

Concurrently, Moody’s has lowered Nigeria’s long-term foreign-currency bond ceiling to Ba3 from Ba2, the long-term foreign-currency deposit ceiling to B2 from B1, and the long-term local-currency bond and deposit ceilings to Ba1 from Baa3.

RATINGS RATIONALE

INCREASED EXTERNAL VULNERABILITY RESULTING FROM THE PROSPECT OF LOWER-FOR-LONGER OIL PRICES

The first driver of the rating action is Nigeria’s increased external vulnerability. Assessed against Moody’s scenario of lower-for-longer oil prices, Nigeria’s external accounts have come under more pressure than expected since our rating affirmation in December 2015. The country registered a balance of payments deficit of 1.4% of GDP at end-2015, owing largely to its first current account deficit (3% of GDP) in over a decade. As a result, foreign currency reserves dropped by $6 billion to $28.4 billion last December and as of April 4, FX reserves were lower still at $27.7 billion.

Moody’s notes that the government’s policy response alleviated some of the external pressures: the Ministry of Finance adjusted the budget further, while the central bank devalued the currency to NGN197:USD and imposed foreign currency restrictions and soft capital controls. However, the central bank’s measures have also hampered economic activity as a number of sectors rely on access to foreign exchange for their ongoing operations. Should oil prices remain low, pressure on the exchange rate is likely to continue, evidenced by the persistence of a parallel market for dollars. Although the government says that the soft capital controls are temporary, they have nonetheless deterred foreign investment — foreign direct investment (FDI) inflows halved from 2014-15 while portfolio net investments have fallen by a multiple of 5 since 2013, from $13.6 billion to $2.5 billion in 2015. We still forecast a moderate current account deficit in 2016 of 2.3% of GDP and a likely further decrease in FX reserves to $25 billion.

Moody’s says that reserves could be supported by government external concessional borrowing in excess of $4.5 billion in 2016, which would imply that reserves would provide 4 to 5 months of import cover. Pressure on the exchange rate is likely to continue until the mismatch between the supply of and demand for dollars is resolved, either through a devaluation or a strengthening of FX reserves or through an accumulation of fiscal surpluses. When finalized, the currency swap currently discussed with China will provide yuan liquidity and alleviate some of the pressure, with China being the source for one third of Nigeria’s non-oil merchandise imports in 2015.

EXECUTION RISKS IN THE TRANSITION TO A LESS OIL-DEPENDENT FEDERAL BUDGET AND THE IMPLICATIONS FOR THE GOVERNMENT’S BALANCE SHEET SHOULD IT NOT ACHIEVE ITS OBJECTIVES

Moody’s says that the second driver of the downgrade to B1 is the execution risk in the transition to a less oil-dependent federal budget. The 2016 budget, developed by the Buhari administration which is expected to be signed imminently, is expansionary. By seeking to enhance growth and broaden the sources of revenue available to the government, it aims to reduce the share of revenue coming from oil to 19.5%, compared with 47.6% in the 2015 budget and above 60% in prior years. Correspondingly, it projects a very large increase in non-oil revenue of 70%. Should these efforts succeed, they will strengthen Nigeria’s credit profile and offer a route back to a higher rating level. However, the government’s objectives are extremely ambitious: since 2012, non-oil tax revenue has gradually grown but at a much lower pace, and the limitations on the government’s ability to generate revenue is reflected in a revenue to GDP ratio of below 7%. Should the government not achieve its objectives, real growth in 2016 is likely to remain subdued, and the government’s balance sheet could deteriorate further.

The finance ministry expects one major new source of non-oil revenue into the federal government budget to come from its re-appropriation of the surpluses of Ministries, Departments, and Agencies (MDAs). Following the launch of the Treasury Single Account (TSA) in late 2015, the federal government expects NGN1.5 trillion in recurring revenues each year from the MDAs (a tripling compared with previous years) through setting performance targets and requiring revenue in excess of approved expenditure to be returned to the federal government. The government also expects to generate NGN350 billion by recovering stolen funds, and it aims to reduce current expenditure by increasing coverage of the payroll system and eliminating ghost workers as well as improving overall efficiency.

Most of the extra resources derived from these efforts will be allocated to capital spending, which is budgeted to more than double to represent 28.9% of budget spending in 2016, up from 13.4% in 2015. If successful, the government’s plans should enhance the growth potential of Nigeria’s economy. However, such a fundamental shift in the structure of the budget carries substantial execution risks and will, at least in the short term, reduce the strength of the government’s balance sheet. Overall, Moody’s expects a general government deficit of around 3.7% in 2016.

AN ELEVATED INTEREST BURDEN OVER THE NEXT TWO YEARS AS THE GOVERNMENT GROWS ITS NON-OIL TAX RECEIPTS

Moody’s says the third driver of the rating action is the expected increase in the government’s interest burden over the next two years. While the increase in government liquidity risk is still manageable given available foreign-currency resources, revenues at all levels of government have fallen significantly along with the collapse in oil prices during the past two years. General government revenue decreased from 10.5% of GDP in 2014 to an expected 6.7% in 2016, representing a drop of 36%, which increased the interest payments-to-revenue ratio. General government interest payments are expected to peak at 21% of revenue this year (31% for the federal government). We expect this ratio to decline to 16% by 2019 (below 25% for the federal government).

Moody’s notes the authorities plan to borrow around the same amount on the domestic capital market as they did last year and finance half of the deficit this year externally on concessional terms. An increasingly deep domestic capital market (mainly derived from accumulated pension funds and local banks’ liquidity) should still be able to accommodate the borrowing requirements of the government. The cost of domestic borrowing will remain elevated, however, with government short-term paper currently carrying interest rates of 8%-10%.

RATIONALE FOR CHANGING THE OUTLOOK TO STABLE

The stable outlook is driven by Moody’s view that the downside risks posed by the weakening of the country’s fiscal strength, and the external and economic pressures anticipated this year and next, are balanced by Nigeria’s strengths, which exceed those of sovereigns rated below B1. In 2016, Nigeria’s external vulnerability indicator of 31% will remain far below the expected B1 median of 57%, while its debt-to-GDP of 16% will remain far below the expected B1 median of 53%. Conversely, its expected debt servicing burden in terms of interest payments to revenue of 21% is more than double the B1 median of 9%. To a large extent, Moody’s believes that this reflects Nigeria’s underdeveloped public sector revenue base, a credit weakness that the new administration is attempting to address.

WHAT COULD MOVE THE RATING UP

Positive pressure on Nigeria’s issuer rating will be exerted upon: 1) successful implementation of structural reforms by the Buhari administration, in particular with respect to public resource management and the broadening of the revenue base; 2) strong 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 MOVE THE RATING DOWN

Nigeria’s B1 issuer rating could be downgraded in case of failure to implement the independent revenue reform that might lead to a further accumulation of debt; 2) greater-than-anticipated deterioration in the government’s balance sheet; 3) material delay in implementing key structural reforms, especially in the oil sector, to maintain the level of oil production over the medium-term.