Fitch Affirms Lagos State at ‘B-‘ with Outlook Positive
Fitch Ratings has affirmed Lagos State’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B-‘ with positive outlook.
The global ratings agency said the affirmation reflects the unchanged sovereign cap, Lagos’s vulnerable risk profile by international standards and Fitch’s expectations of rising but sustainable adjusted debt.
The Internally generated revenue (IGR) underpins Lagos’s capacity to service its financial obligations, as evidenced by its standalone credit profile (SCP) of ‘b+’.
The positive outlooks mirrors that on the sovereign, according to Fitch Ratings.
The rating note explained that Lagos benefits from a broad tax base and a diversified economy that contribute to a stable revenue structure led by IGR.
The state IGR represented over 70% of Lagos’s N1,199 billion operating revenue in 2023 and is driven by moderately cyclical taxes such as personal income tax (PAYE).
The stability of tax revenue is counterbalanced by some volatility in other operating revenue sources such as transfers from central government, sales proceeds, rents, fees and fines.
Fitch does not view Lagos as reliant on government transfers from the Federal Account Allocation Committee (FAAC), as statutory allocations, excluding VAT, represent less than 10% of Lagos’s operating revenue.
These transfers show high volatility due to the variation of oil prices and FX rates. Fitch believes that Lagos’s fiscal flexibility relies on the wide but not fully exploited tax base of PAYE – which corresponds to about 45% of operating revenue- for which it has no tax-setting power.
Rigid revenue sources collectively represent more than 85% of Lagos’s revenue, driving the ‘Weaker’ assessment of revenue adjustability, together with the low affordability of additional taxation.
Analysts estimate that this would cover less than 50% of reasonably expected decline of revenue. Fitch believes that Lagos will more likely absorb possible revenue shocks by reducing its operating margin towards 35%-40% from the average 47% over the past five years.
Lagos is exposed to a deteriorating operating environment, which weakens the state’s control over total expenditure growth, influenced by high inflation, rising commodity prices, and supply
The state is noted to have a wide set of responsibilities and high need for capex to maintain its attractiveness as Nigeria’s main economic hub, with demographic pressures to provide more infrastructure, health and education services, limiting the scope for cutbacks.
“We expect Nigeria’s double-digit inflation to lead to a 13% opex CAGR, a faster pace than operating revenue growth”.
The central government does not have mandatory balanced-budget rules defined for Nigerian states, which are required to maintain their deficits at 3% of national GDP.
Capex made up 46% of Lagos’s expenditure before debt service in 2023, keeping the share of inflexible costs well below 90%.
Lagos’s expenditure cuts are moderately affordable, due to better infrastructure and existing services compared with national peers.
However, Fitch expects Lagos will continue to maintain a high level of capex to maintain its attractiveness for companies and residents.
Nigeria’s framework for local and regional government debt is evolving so borrowing limits are quite wide. Nigerian states have no restrictions on debt maturities, interest rates or currency exposure.
Lagos prudently keeps debt service at no more than 30% of operating revenue. To ensure timely debt service, its internal debt is assisted by a state-level irrevocable standing payment order while external debt is serviced by deductions from FAAC.
Lagos has material exposure to FX risk, Fitch stated.
The note explained that the State external debt with development lenders raised to 54% of Lagos’s direct debt in 2023, up by 43% from 2022, due to the fast naira depreciation since June 2023.
“We expect Lagos’s debt stock to keep increasing, driven by an expected over 1000 NGN/USD exchange rate over our scenarios from 900 NGN/USD at the end of 2023. Our scenarios consider that Lagos could hit NGN3 trillion of debt stock by 2026”.
The ratings agency stated that Lagos has good access to local financial markets with repeat bond issuance, which represented 19% of its N2.1 trillion debt at the end of 2023.
The state can also access liquidity lines and short-term credit from domestic banks, which drives ‘weaker’ assessment of this factor.
Fitch noted that Lagos holds cash in a sinking fund to support its debt service on bonds and Fitch deems year-end cash as partly earmarked to offset payables.
The global ratings agency considers Lagos a type B local and regional government under its criteria.
According to Fitch, the state benefits from resilient fiscal performance with a sound operating margin at 53% in 2023, supported by the dynamism of IGR , up by +34% in 2023, driven by inflation and economic growth.
“Our rating case envisages a progressive reduction of the operating margin towards 40%, incorporating decreasing transfers from central government and inflation-driven opex”, Fitch said.
The ratings agency expect Lagos’s net adjusted debt to reach N3.6 trillion in 2028 from N2.0 trillion in 2023, under a scenario in which the NGN/USD exchange rate remains above 100.
Fitch estimates N3.5 trillion capex in the medium term, largely funded by the state’s own resources and new borrowing.
Lagos’s ambitious capex plan aims to accelerate the completion of several infrastructure projects – mostly schools and transport and health facilities- and to boost the state’s technology capacity and food security. #Fitch Affirms Lagos State at ‘B-‘ with Outlook Positive
