After downgrading Nigeria’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B’ from ‘B+’ with a negative outlook in April 2020 due to COVID-19 pressures, Fitch Ratings has revised its outlook to stable following reduced uncertainties, stable oil prices and the reopening of the economy. The rating action was also largely influenced by CBN’s management of external liquidity pressures through partial exchange rate adjustment, capital controls, FX restrictions and the rise in external reserves following the disbursement of IMF’s $3.4bn Rapid Financing Instrument (RFI). However, the rating agency cited the persistence of external vulnerabilities due to an overvaluation of the naira and a large FX demand backlog.
The revision to the rating is surprising given that severe external and fiscal financing pressures persist. While Fitch alluded to stable oil prices, the potential threat to oil demand from the second wave of the pandemic is putting downward pressure on prices. The slow and uneven recovery in global oil demand is also expected to linger till the end of 2021, implying that oil prices would remain below 2018 levels while uncertainties still abound in the oil market due to global geo-political tensions.
Beyond oil & gas exports which only accounts for 35.8% of current account receipts, inflows from foreign investment and remittances are expected to sharply reduce. External reserve at $36.2bn, despite inflows from IMF, is still down 15.5% YTD. Meanwhile the adjustments to the official exchange rate from ₦307.0$1.0 to ₦380.0/$1.0 in August and the slight weakness in the NAFEX to ₦380.0/$1.0 from ₦360.0/$1.0 are too weak to correct the shock from weak oil prices, falling remittances and reduced capital flows.
The restrictions on FX demand and the existing FX demand backlog have brought about a significant premium of around ₦79.0 in the parallel market, which we now consider to be a more market-reflective segment. The implication of the measures CBN has adopted appear to be understated by Fitch, despite citing the impacts in the form of poor investor confidence, slow growth recovery and trade weakness. With foreign investors still holding around $10.0bn of OMO bills as at August 2020 according to Fitch, we believe there remains severe risks to the external reserves and the currency, especially given weak prospects for the recovery of oil and non-oil sources of FX supply.
With debt service to revenue at 72.2% between January and May 2020, the FG’s fiscal position is under pressure. This is a more prominent debt sustainability risk than Nigeria’s low debt to GDP ratio of around 20.4%, since revenue collection has been underwhelming and below peers at less than 10.0% of GDP. While we believe the subsequent adjustment to the official exchange rate to ₦380.0/$1.0 in August, removal of energy subsidies and the recovery in oil prices since Q2:2020 would have supported revenues in Q3:2020, we suspect that this would not be enough to significantly close the fiscal funding gap. Accordingly, we are a little less optimistic than Fitch that recent developments have lowered Nigeria’s external and fiscal risks.