Belated Fitch Downgrade: A No-Confidence Vote but ‘Sweet Spot’ Ahead

Barely a week since the marked shift in FX policy from a fixed regime to a market driven two-way quote interbank system, one of the three major Global Ratings Agency – Fitch Ratings ( the Agency) – downgraded Nigeria to ‘B+’ (highly speculative non-investment grade) with a Stable outlook from ‘BB-‘ (speculative investment grade) with Negative outlook. This downgrade by Fitch brings its sovereign rating for Nigeria into alignment with peers - S&P (‘B+’) and Moody’s (‘B1’).  The country’s Long-term foreign currency Issuer Default Rating (IDR) was downgraded to 'B+' from 'BB-' and Long-term local currency IDR to 'BB-' from 'BB'.

In justifying the reasons for the downgrade, the Agency highlighted some underlying fiscal strengths of the economy – mainly the low level of government debt to GDP (Fitch forecast of 14.0% in 2016) below ‘B’ rated countries median of 53% - and also acknowledged positives from the Government’s fiscal adjustment strategies to curtail recurrent expenditure growth and raise non-oil revenue; notably 1) reforms in the NNPC and petrol subsidy removal, 2) implementation of the Treasury Single Account (TSA), and 3) implementation of Information systems to remove “ghost workers” from public payroll.

Yet, the Agency deemed the pace, scope and scale of policy responses to the external shocks arising from oil price crash inadequate to sufficiently rebalance the economy. The key areas of vulnerabilities the Agency identified include 1) the renewed agitation in the Niger Delta region which has pared oil production with impact on trade balance and foreign exchange earnings, 2) deteriorating debt ratios as Fitch has forecasted government debt to revenue ratio to increase 259% in 2016 from 181% in 2015, higher than 223% median for rated peers, 3) Shortage of foreign currency liquidity due to erstwhile pegged exchange rate regime and 4) political and security risk emanating from insurgencies in the North and Niger Delta regions as well as sectarian tensions. These have had negative feedbacks on domestic economic growth, fiscal revenue, inflation rate, and external sector balances. Fitch is forecasting another economic contraction in Q2:2016 and also estimated current account deficit to widen to 3.3% of GDP in 2016 from 2.6% in 2015.

Whilst we share Fitch’s view that the economy will contract in Q2:2016 and current account deficit would widen, we are more bullish on government revenue - due to recent foreign exchange rate  movement and renewed drive to boost non-oil revenue - though still expected to be below 5-year trend. Also, fresh revelation by Reuters indicated that Nigeria’s oil exports have been more resilient than what news of militants’ attacks on production facilities suggest. As against media claims of 1.37mbpd production in May, oil exports declined slightly by 62,000bpd to 1.89mbpd in May according to Windward - a global maritime data and analytics company - and by 100,000bpd to 1.77mpbd according to Reuters.

We believe the recent Fitch Ratings’ downgrade is belated and lags actual movement in economic cycle which, by consensus (including Fitch) could improve in the medium to long term due to policy realignment in the FX market, fiscal reforms to wean the economy off oil-price dependency and ongoing restructuring of the NNPC.

Nigeria’s Sovereign Eurobonds which rallied last week on the FX policy news retraced steps today in reaction to the rating downgrade and partly due to the global selloff on assets due to the BREXIT referendum result. We however do not expect this to be sustained as other rating agencies had already taken same rating action earlier, hence already factored into market valuation. Besides, Nigeria may be in for a “sweet spot” with investors if FX reforms become fully functional.