Nigeria

Nigeria’s Sovereign Rating at Risk of Further Downgrade

Charles Malize

Nigeria has been able to amass a substantial amount of revenue in its excess crude account. This follows last years surge in oil prices and the successful 2003 reforms the International Monetary Fund (IMF) put in place, shielding it against volatility on the global energy market. Nigeria saves any oil revenue above a predetermined price into an excess crude account.

The unwavering political environment together with increased oil revenue earnings and the 2005 consolidation of its banking sector has lent support to the country in maintaining its “BB” sovereign rating.

This rating is at risk of a sobering downgrade as the unrelenting global economic crisis and the recent correction in the overall energy prices take its toll on revenue threatening economic growth prospects. (Approximately 85 percent of the nation’s foreign reserve is earned from the oil and gas sector).

The financial sector, which has been the pillar of the country’s capital market, is also looking vulnerable. Some of the financial institutions balance sheets lack transparency and financial losses prompted by the global economic crisis have their books much weaker than they were previously.

These developments are drawing the attention of rating agencies.

S&P recently downgraded Nigeria from “stable” to “negative.” The rating agency maintains that the decision to revise the outlook was based largely on the government’s inept response to the global economic downturn and the sharp fall in the price of oil.

There concern:

* President Umaru Yar’Adua’s current administration’s ambition of increasing spending by 17 percent based on the rise of oil production seems too optimistic.
Achieving a rise of oil production from current level may be difficult to attain given long standing constraints on output stemming from unrest in the Niger Delta.

* Nigeria’s central bank imposed notorious currency controls late last year in order to protect the country’s dwindling foreign exchange reserves. This is prone to hurt domestic banks access to cross border funding and may weaken investor’s confidence.

* The quality of the banks credit and security portfolios is expected to weaken given the turbulence in local capital markets and the sudden slowdown in economic growth. It has forecast bank lending growth to fall sharply to 6 percent in 2009, following an estimated average of more than 80 percent over the past two years, which S&P said, will in turn constrain overall Gross Domestic Production growth to 1.5 percent this year. The rating agency forecast a current account deficit of 7.2 percent of gross domestic product (GDP) in 2009.

* “The negative outlook reflects the increased risk that the institutional response to falling oil revenue will result in a continued worsening of the business environment and a deterioration of Nigeria’s balance sheet beyond our central assumptions,” the agency said. “The ratings are unlikely to be raised in the near term given Nigeria’s deteriorating terms of trade outlook and the opacity of public accounts.”

* “The revision of the outlook indicates that a downgrade of the main rating (BB) is possible and this decision reflects Nigeria’s over reliance on oil and the deteriorating economic outlook , the agency said in a statement.”

* They claim that if the Nigerian government makes progress towards pacifying the Niger Delta and if it improves both the non oil business environment and its own record of governance, S&P ratings could stabilize at current level.

I have included at the bottom of this newsletter an article that I published on my blog: 02/18/09 Nigeria: avoiding a downgrade from rating agencies.

Nigeria: avoiding a downgrade from rating agencies

02/18/09

Charles Malize

Nigeria, in attempt to drive its economy, should promote spending in its manufacturing sector and protect its dwindling currency. While its capital market has been declining following the recent global financial crisis, it should avoid its current sovereign credit status (BB minus) from being downgraded by rating agencies. (i.e. Fitch and Standard & Poor).

Nigeria’s weakening balance sheet due to capital outflows, heightened strains in the banking sector and increased political uncertainty could augment downward pressure on its sovereign ratings. This is prone to put more pressure on its local currency and its industrial production, which is already shrinking rapidly. This sector, having had some minimal growth recently, could experience layoffs of thousands of workers, raising the risk of social unrest.

This would be enough to trigger Nigeria to be on their watch list. With this uncertainty, attracting foreign investment would be challenging.

The unveiling of a series of measures by the government to contain the widespread global economic crisis is a positive step for Nigeria’s economy.

They made a strategic move to offer guarantees of N70 billion ($500 million) in the troubled manufacturing/ textile industry, thus helping to recapitalize the industry. This means the government is not required to dip into its foreign reserves for support. The government needs these reserves to maintain broader economic stability. This is an industry that employs over six hundred thousand people at a time and a continuous deterioration could prove catastrophic for the ailing economy.

The Naira has weakened some 30 percent versus the dollar in the past six months due to capital outflows and low oil prices. My opinion is that, as oil continues to dwindle around the $35 mark, the Naira could lose between 15 to 20 percent of its value in 2009. In other words, as oil prices continue to decline, this commodity which accounts for 90 percent of the nations export earnings would also decrease. This would add more strain on the local currency as well as depleting foreign reserves.

As of late the Central Bank of Nigeria (CBN) has been limiting the sales of dollars to commercial banks in order to protect its diminishing reserves as oil revenue shrinks and foreign investors liquidate their assets. This is a country that is relatively poor compared to other African countries and cannot justify using its reserves to defend its currency.

Nigeria should continue the path of assisting its manufacturing sector while conserving resources to stabilize its situation while spurring growth. These are difficult challenges the economy is facing with economic forecast looking extremely bleak.

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