Fitch Revises Nigeria’s Outlook to Stable, Affirms at ‘B’
Fitch Ratings has revised Nigeria’s outlook to stable, said the revision of the Outlook reflects a decrease in the level of uncertainty surrounding the impact of the global pandemic shock on the Nigerian economy.
The rating firm anchored the stable outlook on the fact that Oil prices have stabilised, while it noted that global funding conditions have also eased and domestic restrictions on movement have started to be relaxed.
It said Nigeria has navigated external liquidity pressures from the shock through partial exchange rate adjustment combined with de facto capital flow management measures and foreign-currency (FC) restrictions.
In addition, Fitch noted that the disbursement of external official loans has supported the level of international reserves.
“While external vulnerability persists from currency overvaluation and a possibly large FC demand backlog, this is adequately captured by the ‘B’ rating, in our view“, the rating firm stated.
In its view, Fitch noted that the Central Bank of Nigeria (CBN) continues to prioritise exchange rate stability over other policy goals.
It explained that a 6% depreciation in March of the Investor and Exporter (I&E) exchange rate at which most foreign currency (FC) transactions are carried out fell short of fully correcting the naira’s appreciation by about 35% in real terms between mid-2016 and February 2020.
Steep real appreciation has been driven by persistent double-digit inflation, which has offset gains from the devaluations in 2016 and 2017.
Meanwhile, Fitch detailed that the CBN has achieved progress towards its stated goal of unifying the exchange rate, following a cumulative 19% two-step devaluation of the ‘official’ exchange rate, which is mostly used for the government’s and the oil sector’s FC transactions.
The firm added that the broad stability of the I&E rate since end-March has been mostly achieved through a severe contraction in FC supply.
This was illustrated by a drop in the average value of daily transactions on the I&E window by 87% in April-August relative to the first quarter 2020 average.
“Tightening FC supply for trade and financial transactions could harm growth and exacerbate inflationary pressures, driving further misalignment of the naira’s real exchange rate“, Fitch said.
The rating firm said, “Inflation accelerated to a 29-month high of 13.22% in August and we expect it to average 13% over the full year, well above the forecast ‘B’ median of 5%“.
It also added that unfulfilled FC demand could constitute a drain on reserves once supply is relaxed.
“The CBN has started to increase FC provision in September through a combination of spot and forward sales but the magnitude of actual FC outflows in case of full supply normalisation is unknown.
“We understand that the stock of outstanding non-resident holdings of CBN open-market operation (OMO) bills was around USD10 billion in August“, Fitch noted.
The firm holds that non-resident investments in short-term money market instruments amounted to USD27.7 billion at end-2019, equivalent to 72% of international reserves at the time, more than half of which were in OMO bills.
It stated that de facto FC restrictions could also damage investor confidence and possibly lead to Nigeria’s exclusion from benchmark equity indices, durably impeding a return of foreign inflows.
“This would place the onus of rebuilding reserves on sovereign external borrowing amid continued current account (CA) deficits“, Fitch stated.
Fitch report noted that the government has secured multilateral loans of USD4 billion in 2020, of which USD3.4 billion is from the IMF, helping a recovery in international reserves from a 30-month low of USD 33.4 billion in April to USD35.8 billion on 24 September.
“We understand that around 15% of international reserves are pledged in swaps“, Fitch Rating said.
Explaining further, the rating firm said international reserves will remain under pressure from current accounts (CA) deficits in 2020 and 2021, marking an interruption to a long streak of external surpluses.
“We project Nigeria to record a CA deficit of 3% of GDP in 2020 (forecast ‘B’ median: 5%), versus a 4.2% deficit in 2019, as the contraction in imports and lower outflows of investment income offset a decline in both hydrocarbon exports and remittances (6.5% of GDP in 2017-2019).
“The CA will revert back to balance in 2022 under our baseline driven by import compression from weak domestic demand and tighter FC restrictions on a wide range of imports“, Fitch explained.
The firm said hydrocarbon exports will also be lifted by the gradual recovery in prices and a rise in oil extraction volume as production caps under the ongoing OPEC+ agreement expire.
It explained that the ‘B’ rating also reflects weak fiscal revenues, comparatively low governance and development indicators, high dependence on hydrocarbons and a track record of subdued growth and high inflation.
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These rating weaknesses are balanced against the large size of Nigeria’s economy, low general government (GG) debt relative to GDP, small FC indebtedness of the sovereign and a comparatively developed financial system with a deep domestic debt market. Fitch noted.
The rating firm however said low fiscal revenues are a major credit weakness.
The firm’s data dictates that general government receipts averaged 6.8% of GDP in 2015-2019, well below the current ‘B’ median of 22%.
Fitch said revenues will benefit from the removal of the fuel subsidy, which has cumulatively cost the budget around 7% of 2019 GDP in 2016-2019.
It noted that the government has affirmed its firm commitment to this reform as well as its intention to continue phasing out costly electricity subsidies.
However, the energy price reform faces strong opposition from labour unions and the authorities have reinstated subsidies in the past in response to social protests.
“We do not expect any further progress on fiscal revenue-enhancing reforms over the forecast horizon“, Fitch said.
With broadly stable budget receipts, general government debt will rise to 450% of fiscal revenues in 2022 (federal government, FGN: 1162%), far above the forecast ‘B’ median of 321% and up from 343% in 2019 (FGN: 898%).
However, Fitch said ggeneral government debt is low relative to GDP, at 26.7% in 2019 (FGN:22%), rising towards 31% in 2022 (FGN: 27%), less than half the forecast ‘B’ median of 69% of GDP.
Exchange rate risks to the debt trajectory are low given a small share of FC debt at 26% of total GG debt at end-2019, compared to a ‘B’ median of 63% in the same year, the firm explained.
Given the lack of fiscal space, the budget response to the pandemic shock has been muted relative to comparable emerging countries.
It said general government spending will only increase by 0.5% of GDP in 2020 under our forecasts as the bulk of the pandemic-related expenditures will be offset by cuts to capital and other current outlays.
“We project the hit to revenues from the pandemic shock to prompt a deterioration in the GG balance from 3.6% of GDP in 2019 to 5.4% in 2020, a still much smaller deficit than the forecast ‘B’ median of 7.3% of GDP“, Fitch said.
It recognised that spending restraint and economic recovery will drive a modest narrowing in the general government deficit to 4.5% of GDP in 2022 (forecast ‘B’ median: 4.8%).
Public finances are vulnerable to fluctuations in oil prices and Nigeria’s fiscal breakeven oil price is high, at USD134/barrel in 2020 under our estimates.
“We expect the government to cover most of its funding needs in 2020-2022 domestically, supported by ample liquidity in the non-banking financial system as highlighted by the negative real rates on local currency debt2, the firm positioned.
However, Fitch said the authorities are also likely to seek to increase the share of external borrowing, mostly on concessional terms, although slow progress on reforms might hinder further official creditor support, in Fitch’s view.
The firm noted that withdrawals from the already thin fiscal buffers at the outset of the pandemic has left them merely depleted.
The government continues to resort to monetary financing since early 2019 with net CBN claims on the FGN soaring to 4% of GDP at end-2019, exceeding annual FGN revenues, from nearly 0% at end-2018.
The rating agency however said transparency on contingent liabilities is low.
The firm remarked that the collapse in oil prices will pressure already overstretched state and local governments’ resources, possibly requiring financial assistance from the FGN.
It noted that recurrent delays to electricity tariff hikes towards cost-recovery levels will raise needs for further support to the ailing electricity sector.
In addition, Fitch stated that the exposure of banks to the oil sector is sizeable and the likely deterioration in asset quality following the oil price crash could increase the need for government support to the sector.
It said contingent liabilities for the sovereign stem from the debt of the Asset Management Corporation of Nigeria of 3.3% of GDP at end-2018.
The Nigerian economy will contract by 3% in 2020 (forecast ‘B’ median: -2.6%), its sharpest decline in 37 years.
Fitch expects Oil-GDP will be affected by productions cuts under the OPEC+ agreement despite some slippages in earlier months while non-oil activity will be weighed down by spillovers from the hydrocarbon sector, restrictions aiming to halt the spread of the pandemic and FC scarcity.
“We project GDP to grow by 1.3% in 2021 and 3% in 2022 (forecast ‘B’ median: 4% and 4.6% respectively), assuming an easing of disruptions from the health crisis, a slow recovery in oil prices and adherence to OPEC+ production caps.
“The medium-term growth outlook is subdued but progress on the elaboration of the long-stalled Petroleum Governance Bill could lead to revival in investment in the hydrocarbon sector“, Fitch noted.
