Nigeria Sovereign Debt Rating: A "Junk Status" Could Prove Devastating For the Economy

Nigeria Sovereign Debt Rating: A "Junk Status" Could Prove Devastating For the Economy

Charles Malize

Nigeria's economy seems to give the impression of a nation that lacks direction and is swimming in circles. Nigeria's rating with the London based credit rating agency Fitch stands at BB- (or three notches into "junk"). Fitch recently revised the country's outlook from stable to negative that could translate to - below investment grade status Junk. This action by Fitch should not be a surprise as a deteriorating economic condition becomes a foremost concern. There is growing anxiety about the country's tactless withdrawal of funds from its crude-oil account supposedly to help finance government operations. In addition there's the continuous fall of foreign reserves at a time of high oil prices and record oil production.

The Excess Crude Account (ECA), which stood at over $20 billion in 2007, is now at $500 million and depleting. In a recent report by CBN, Nigeria's foreign reserves dropped to $33.91 billion, its lowest level in several years. This reflects a decline of $1.682 billion from previous month. The fall in reserves is being fuelled by dollar sales at the bi-weekly foreign exchange auction conducted by the Apex Bank.

As light as this downgrade may seem, one should not discount a situation of future relegations from the agency. Another international rating agency; Standard & Poor, a few days ago gave the country a B+/B' rating pass mark with a stable outlook amid weak fiscal performance and high political risk. The report added that political risk in Nigeria may be aggravated by the forthcoming presidential elections expected in spring 2011. Also the supervision and management of ECA remains a concern.

According to Mr. Esters at Standard & Poor (S&P); "We also expect that tensions surrounding the forthcoming April 2011 presidential elections could increase political uncertainty and destabilize the country for some time after the elections." In the same report: "we consider political institutions to be weak, and governance to be poor. This is demonstrated, for instance, by what we consider poor management of the Excess Crude Account, whichcontrary to the intention of providing cushion absorbing oil-related fiscal revenue volatilityhas not been effectively ring-fenced from access by state governments".

S&P last year lowered Nigeria's ratings outlook to "negative" from "stable", due to falling oil revenues that impaired public finances. It warned that it was watching Nigeria's rating "very closely", and was nervous over falling reserves and "unorthodox policy measures" that risked undermining foreign investors' confidence.

Equally, Fitch, having assessed the political, economic, and budgetary challenges that the Nigerian government faces, envisage a situation where borrowing spirals out of control. They see the burden of public debt soaring, making it challenging for the government to implement its fiscal and structural reform programs. The economy appears weak in their view. Government policy options seem tapering by the day as weakening economic growth prospects persist.

Fitch director Veronica Kalema said that while there were plans to remedy the situation through the establishment of a sovereign wealth fund and removal of the fuel subsidy currently taken out of the country's excess crude account, implementing those actions "will be challenging before elections expected in April next year." The poll has increased short-term political uncertainty.

Razia Khan, Regional Head of Research, Africa, Standard Chartered Bank, in her reaction to both ratings said, "The first thing that should be noted is that Nigeria is rated differently by S&P and Fitch. S&P downgraded Nigeria's rating last year to only B+. It is rated higher by Fitch, at BB-, despite the change to the ratings outlook from stable to negative. So it really does not matter much if S&P assign a stable outlook to the rating. This just means they are not about to upgrade Nigeria any time soon. The Fitch rating of BB- with a negative outlook is actually more favorable".

The Domino Affect

Political ambiguity and augmentation of government debt puts pressure on the nations sovereign's creditworthiness. In the case of Nigeria, this could render its investment status unsuited with an investment-grade rating, thus, making it exigent for the country to raise funds in the international markets. Commercial borrowing cost could rise, and those that will lend are likely to charge excessive interest rates for their exposure. The nation's capital market could disintegrate as a result of the elevated risk. Banks will be at risk from the country's weakening credit quality.

As asset value and profitability come under pressure an imminent outcome is a "junk status" for these banks due to their exposure to Nigerian bonds. The significance of this status is the domino affect on the performance of their shares that could send bank stocks crashing. The value of their debt collapses in the secondary market. The decline in collateral could perhaps prompt demands for additional collateral with creditors. These banks will be at risk of eventually running out of extra collateral passable to their creditors and pilot a run on the banks from depositors in the process.

On the national level, there was a spiral effect on Fitch ratings within the country. The ratings agency adjusted Lagos State's long-term foreign currency rating outlook to negative from stable, while still affirming the actual rating (BB-). The State is currently in the debt market to raise $2 Billion for developmental purposes.

Paying Its Way Out Of Crisis

Assuming Nigeria finds itself in a debt crisis, official lender support would be highly conditional and revocable. This could prove a nuisance for an economy that is developing. Structural Adjustment Program (SAP) is a familiar territory and a path the country will not wish on itself while other frontier /emerging markets are fast developing. Nigeria with the excessive rise on its national and domestic debt could find itself "hat in hand" seeking emergency aid from international donors including the International Monetary Fund (IMF). Any support would be accompanied with stern measures. Under any austerity measure expect the tightening of its consolidation program that could further depress Nigeria's medium-term economic growth prospects. Also there are no assurances the country would qualify for a rescue package from donors.

As the country plans a $500million 10-year Eurobond debut inthe international marketbefore the end of the year,the World Bank has aired its concern that government must tread cautiously so as not to burden the nation with another debt. The obvious is that increased government spending, falling foreign exchange reserves and political uncertainties ahead of the 2011 elections are creating anxiety amongst potential investors. Avoiding this uncertainty will depend on Nigeria's ability to contain the rate of its foreign debt exposure and turn the situation around.

The World Bank is warning the government to ensure that the planned borrowing is within the nation's debt strategy and, in particular, that proceeds from the bond issue are used for the outlined purposes and not diverted to unproductive ventures.

Contact:info@cmcapitalmarketresearch.com

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