Moody’s, a global ratings agency has downgraded Nigeria’s local currency and foreign currency long-term issuer ratings as well as its foreign currency senior unsecured debt ratings to B3 from B2 and placed them on review for downgrade.
Moody’s said the decision was driven by the significant deterioration in Nigeria’s government finances as well as its external position, exerting increasing pressure on the sovereign credit profile despite a strong increase in international crude oil prices in 2022. The ratings agency added that its assessment was that the developments are partly the result of weak governance and are likely to last.
It stated that the steep fall in oil production in 2022 and the extension of the expensive oil subsidy have almost entirely eroded the boost to government revenue and exports that would otherwise have been anticipated from higher oil prices. Added to that, Moody’s noted that policy levers available to manage weaker oil revenue and rising borrowing costs amid monetary tightening in Nigeria and globally were limited.
Similarly, on the external front, it stated that the capacity of the Central Bank of Nigeria (CBN) to protect foreign exchange reserves from external outflows has its limits. According to Moody’s, the initiation of the review for downgrade is prompted by the risk that the ongoing fiscal and external deterioration accelerates, weakening further the government’s capacity to service debt and thereby increasing further its risk of default.
The next review, it stated, would focus on understanding the Nigerian authorities’ strategy to address both domestic and external pressure and assessing the associated default risk for the government’s private creditors. Concurrently, Moody’s announced that it has lowered Nigeria’s local currency and foreign currency country ceilings to B1 and B3 respectively, from Ba3 and B2 respectively.
In justifying the new rating, Moody’s stated that Nigeria’s fiscal and external position hasn’t benefited from higher oil prices in 2022, which have been 42 per cent higher on average than in 2021. It explained that this was due to the 32 per cent drop in oil production since the beginning of the year and growing domestic consumption of petroleum products.
“The constraints on oil production increasingly appear structural, caused by repeated theft and lack of investment in infrastructure. While the oil sector is a relatively modest contributor to Gross Domestic Product (GDP), it is a primary source of revenue and foreign exchange generation,” it pointed out.
On the fiscal side, the agency said the scope for the government to deliver on fiscal consolidation was constrained, noting that it expects government debt affordability to weaken further in the years to come from already very weak levels.
“Ultimately, as the government dedicates a growing share of its revenue to paying interest, the policy dilemma between servicing creditors and meeting the population’s demand for social and economic development will intensify. In particular, the cost of oil subsidy will soon absorb the whole revenue flow from the sector unless the subsidy mechanism is wound-down—a task that has been delayed multiple times despite the country’s intensifying credit pressures,” Moody’s said.
It explained that Nigeria’s Ministry of Finance has recognised the pressing need to remove the oil subsidy, but its removal from mid-2023 onwards would likely prove difficult politically and to implement in practice. While the generation of non-oil revenue has gradually progressed broadly in line with budget targets, Moody’s said it remains far from compensating for the lower oil revenue net of subsidy and higher interest payments.
“Therefore, Nigeria’s share of revenue consumed by interest payments, which is already exceptionally high in 2022 at 65 per cent at the federal government level and 35 per cent at the general government level, is set to rise further. Externally, financial and capital outflows from Nigeria are exceeding the current account surplus, eroding foreign exchange reserves. CBN’s foreign exchange reserves declined by $3 billion since the beginning of the year, reaching $37 billion as of September 2022.
“To limit the fall in reserves, the CBN’s main policy response has been to ration foreign exchange liquidity, scaling down the size of its interventions in foreign exchange markets and accumulating a backlog of foreign exchange demand. Meanwhile, depreciation pressure on the currency has intensified, with the gap between the official and parallel market exchange rates widening. The limited foreign exchange liquidity has also affected banks and companies operating in Nigeria with need of cross-border transactions,” it added.
It noted that the review for downgrade reflects the risk that external and fiscal pressure further intensifies and constrains the government’s access to funding. Government external debt payments, it stated, remain contained over the coming years – and mostly due to the official sector – but sizeable enough to add to the external pressure absent external funding.
The coming review, it said, would focus on the authorities’ policy response to alleviate external and fiscal pressure, including their strategy to manage debt service obligations and foreign exchange reserves, and their capacity to raise significantly government revenue.
“In that regard, the government has already announced that it is exploring options to lengthen the maturity of its debts, which may help limit the size of future funding requirements but could constitute a distressed exchange under Moody’s definition depending on the terms and the debts affected.
“The review will also assess the likelihood of a devaluation of the currency, which the country resorted to in 2016 and which would increase the government’s debt burden, weaken its affordability since 30 per cent of the debt is denominated in foreign currency and raise social risks by fuelling inflationary pressures. If sizeable, a devaluation of the naira would also exert downward pressure on the rating,” Moody’s said.
It further pointed out that Nigeria’s Environmental, Social, Governance (ESG) considerations remain very highly negative, reflecting very high exposure to environmental risk and social risk and very weak governance. In addition, it said Nigeria has a very highly negative governance profile score , reflecting weak control of corruption and rule of law as well as very weak fiscal and monetary policy effectiveness and opaque management of public resource.
“Management of oil revenue is particularly weak; absent fiscal stabilisers, the government runs pro-cyclical policy or worse fails to take advantage of high international oil prices. In 2021, the country’s hydrocarbon exports amounted to $41 billion, the general government received only $5 billion in net oil revenue or 1 per cent of GDP,” it stressed.
Moody’s said it would likely downgrade Nigeria’s rating further if it concluded that fiscal and external pressure is likely to continue to intensify, with the government’s funding options narrowing further.
“Should Moody’s assess that the likelihood of default, including through a distressed exchange, has increased, the rating may be downgraded by multiple notches,” the ratings agency said.