Overview

• Low (albeit recently rising) crude oil production, large refined-petroleum subsidy costs, high debt service expenditure, and associated sizable fiscal deficits are exacerbating Nigeria's fiscal and external imbalances.
• In addition, limited and expensive access to international capital markets, and a consequent increasing reliance on significant domestic funding at relatively high interest rates, is further weighing on net interest costs and the government's fiscal position.
• Nigeria will hold general elections on Feb. 25, and a close three-way presidential race is being fought. All three leading presidential candidates have pledged significant reforms, but they will inherit a deteriorating fiscal story.
• We therefore revised our outlook to negative from stable and affirmed our 'B-/B' sovereign credit ratings on Nigeria.

Rating Action

On Feb. 3, 2023, S&P Global Ratings revised its outlook on Nigeria to negative from stable. At the same time, we affirmed our 'B-/B' long- and short-term foreign and local currency sovereign credit ratings on the country.

We also lowered our long - and short-term Nigeria national scale ratings to 'ngBBB-/ngA-3' from 'ngBBB/ngA-2'.

The transfer and convertibility assessment remains 'B-'.

Outlook

The negative outlook reflects increasing risks to Nigeria's debt servicing capacity over the next one-to-two years due to intensifying fiscal and external pressures.

Downside scenario

We could lower the ratings if risks to Nigeria's capacity to repay commercial obligations continue to worsen, either because of declining external liquidity or a reduction in fiscal flexibility. This could occur, for instance, if we see higher fiscal expenditure, higher debt servicing costs, or significantly reduced liquid foreign exchange reserve levels.

Upside scenario

We could revise the outlook to stable if Nigeria experiences significantly stronger economic performance than we expect, and external and domestic financing pressures prove to be contained, while fiscal deficits decrease faster than we project.

Rationale

The outlook revision reflects our view that Nigeria's debt servicing capacity has weakened due to high fiscal deficits and increased external pressures. These stresses stem from low (albeit recently rising) oil production volumes, large refined-petroleum subsidy costs, high debt service expenditure, and a relatively large planned fiscal deficit in the 2023 budget.

The economy is estimated to have expanded by about 2.8% in 2022 and we forecast real GDP to average 3.1% in 2023-2026. Below-capacity oil production will likely continue to affect export growth, while inflationary pressure, fiscal constraints, and sluggish investment will weigh on consumption and investment growth. However, these factors are likely to be partially counterbalanced by a new, potentially more business-friendly administration after the elections.

Oil production (including condensates) averaged about 1.37 million barrels per day (mbpd) in 2022, below the budgeted 1.60 mbpd, and below Nigeria's OPEC production quota of 1.8 mbpd. Low volumes more than offset relatively high average oil prices (at $98, compared with a budgeted $73) in 2022, keeping the general government fiscal deficit at 6.2% of GDP. Significant underperformance of oil revenue in 2022 and higher debt service expenditure support our view that the government's financial commitments appear strained unless there is credible fiscal consolidation after the elections.

External buffers are also under pressure. Rising prices of imported goods, payments to clear foreign exchange (FX) backlogs, the Central Bank of Nigeria's (CBN's) intervention in the FX market to stabilize the naira (NGN), and low oil volume exports reduced gross foreign exchange reserves by about $3 billion in 2022, reaching $38 billion by year-end. We also lowered our estimate of usable reserves to $28 billion for 2023 to account for what S&P Global Ratings estimates to be encumbered reserves of about $10 billion.

The 2023 federal budget (excluding that of the states) estimates a fiscal deficit of NGN11.34 trillion, 5% of GDP for this year. Debt service expenditure is budgeted at NGN6.3 trillion, 57% of federal revenue of an estimated NGN11.9 trillion. The budget is based on the assumption that petrol subsidies will be removed by mid-2023. At the general government level (federal budget plus states), we forecast a fiscal deficit of 5.9% of GDP in 2023 before averaging about 5.4% over 2024-2026, on the assumption a new government will pursue a degree of fiscal consolidation.

Alongside fiscal and external imbalances, expensive access to external capital markets (due to currently high global interest rates demanded from emerging market issuers) and an increasing reliance on significant domestic funding at higher interest rates will weigh on ratios, with average annual interest as a share of general government revenue rising to a high average of 31% in 2023-2026, while the federal tax take--general government revenue as a percentage of GDP--will average only 10%, significantly lower than among peers. The government will largely rely on domestic borrowings to finance its deficit in 2023, with limited planned external issuance.

Despite increasing external and fiscal pressures, we think the government has sufficient debt-servicing capacity to pay the Eurobond maturity of $500 million due in July 2023. Parliamentary debates on a draft bill aiming at restructuring debt accumulated under the CBN's Ways and Means facility (an overdraft facility provided to the ministry of finance) are underway in the National Assembly. If implemented, it will not constitute a default as per S&P Global Ratings' criteria because we do not classify central bank financing as a commercial debt obligation, and will deliver significant interest-cost savings. We already include the Ways and Means facility in our debt stock calculations.

There may be some sporadic violence in the run-up to and during the presidential elections in February, but we expect a broadly smooth democratic transition between the governments as President Muhammadu Buhari will complete his second term in May and stand down. We expect the new government to undertake structural reforms, but these will likely take time.

Institutional and economic profile: Lively elections will deliver a new president, and we expect the new government to launch structural reforms

• After elections in February, we expect a transition of power in May, followed by some positive reform momentum and a potentially more business-friendly president.
• We forecast that the Nigerian economy will grow 3.3% in 2023, supported by non-oil growth, followed by average 3% annual growth over 2024-2026.
• We expect the oil sector's prospects to improve over 2023-2026 as crude oil production levels increase, while significant refining capacity (classified as non-oil) is launched.

Presidential elections will take place on Feb. 25, and despite some likely sporadic violence during the election process, we expect a democratic transition to a new president. Incumbent president Muhammadu Buhari is completing his second term and, as per the constitutional two-term limit, will have to stand down. Bola Tinubu, the national leader of President Buhari's ruling All Progressives Congress party and former governor of Lagos state, has been selected as the party's presidential candidate. He will face Atiku Abubakar of the opposition Peoples Democratic Party, while the Labor party's Peter Obi has emerged as a strong third contender, especially among younger voters, who are shunning the traditional two parties. All three candidates are viewed as fairly business-friendly and have cited stimulating GDP growth, exchange rate liberalization, fiscal consolidation, revenue mobilization, and the removal of oil subsidies as top priorities.

In the past decade, notwithstanding sporadic violence, Nigeria, has achieved reasonably peaceful transfers of power via elections despite its large size, ethnic and religious diversity, and complex federal structure. However, relatively weak checks and balances, strained public finances (including frequent use of CBN funds to finance fiscal deficits), and a myriad of security issues underscore significant institutional and economic weaknesses.

Nigeria is a sizable producer and exporter of hydrocarbons, ranking among the world's top 15 exporters. However, oil production (including condensates) in 2022 averaged about 1.37 mbpd due to technical and security issues. Militancy in the Niger Delta (which some commentators view as tied to largess ahead of the elections) and incidents of vandalism caused oil production to fall in 2002, although the situation has improved in the past few months. In addition, technical and regulatory issues and divestments by big international companies are holding back oil production levels and investments. Long-stalled liquefied natural gas (LNG) projects like Brass and Olakola are also delaying planned expansions of LNG production.

Crude oil production levels improved in late 2022 and early 2023, partly due to improved security surveillance tied to the establishment of a new security task force and security command and control center, while repairs at the Forcados terminal added to production. Via the task force, oil producers have enhanced collaboration with government and defense forces to improve the security situation. Moreover, oil producers are beginning to work on alternative evacuation methods and shutdown optimization to reduce the loss of oil and shutdowns via thefts and vandalism. Following these efforts, we expect oil production to slowly recover. However, production levels will still be below Nigeria's current OPEC quota of 1.79 mbpd. An overhaul of the governance structure and fiscal terms in the oil sector under the Petroleum Investment Act (PIA) should unlock further investment in the hydrocarbon sector. We assume Brent oil prices will average $90 per barrel (/bbl) in 2023 followed by $80 in 2024 (higher than the $85/bbl in 2023, $55/bbl in 2024 that we had at our most recent review), before falling in 2025-2026.

We anticipate a substantial increase in refining capacity: a large refinery, owned by the Dangote group, is to start large-scale production by March 2023. It has capacity of 650,000 barrels per day. In addition, several refineries such as those at Port Harcourt, Warri, and Kaduna are being rehabilitated, which will materially contribute to the country's refining capacity in the next couple of years. This new refining capacity should make it easier for any new president to cut refined-petroleum subsidies, currently budgeted to end in mid-2023.

We expect the Nigerian economy to maintain annual growth of about 3.1% over 2023-2026. Although we expect the economy to recover and exceed its pre-pandemic size in 2023, growth in GDP per capita terms will remain low, partly reflecting the country's high population growth. Increasing digitization tied to the pandemic has worked well for growth in sectors like insurance, finance, and information and communication. However, severe floods in large parts of the country constrained agricultural growth in the second- and third-quarters of 2022. Agriculture contributes about 20% of nominal GDP. Due to the sharp fall in oil production, the oil sector is estimated to have declined almost 15%.

Nigeria's internal security deteriorated over the past several years with violence, kidnappings, and general instability having increased. Police and military forces tend to be overstretched and are forced to deal with a multitude of security crises. The militant groups Boko Haram and Islamic State West Africa Province are active in the northern regions. In the Middle Belt, tensions between farmers and herdsmen have increased, notably over scarce land and water resources, and this is affecting food supplies. In the southern oil-producing states, Niger Delta militants have historically disrupted oil production when conditions have not worked in their favor, but since late 2022 volumes have risen slightly. We expect the Election Commission, supported by the security services, to manage a broadly democratic transition via the election. This will be the first election in Nigeria's history that will use electronic voting machines and will require voter IDs, the rollout of which has faced delays and could cause issues if a significant section of voters do not receive voter IDs before election day. We do not expect an immediate improvement to the security situation after the election because high unemployment, high inflation, and rising poverty levels have stagnated social development.

A recent exercise by the Central Bank of Nigeria (CBN) calling for the withdrawal of high value Naira notes (NGN 200, 500 and 1,000 notes) has led to significant issues and bottlenecks owing to a shortage of new notes across the country. The note withdrawal deadline was extended to Feb. 10 from Jan. 31 (with a likely seven day grace period to Feb. 17) to give the public more time to exchange old notes, which will not be valid or exchangeable after the Feb. 10 deadline. A number of state governors have called on the administration and CBN to extend the deadline further.

Flexibility and performance profile: Fiscal and external metrics have deteriorated, necessitating credible fiscal consolidation efforts post-election

• We expect interest payments to consume more than a quarter of general government revenue over 2023-2026, indicating a strained debt trajectory.
• Despite higher oil prices and improved collection of non-oil revenue, we estimate the consolidated fiscal deficit (federal and state) at a relatively high 6.2% of GDP in 2022, but post-election, fiscal consolidation efforts will see it average 5.5% a year in 2023-2026.
• We expect usable foreign currency reserves will remain near $29 billion over 2023-2026, covering over three months of current account payments and sufficient to cover planned upcoming external debt repayment needs.

Despite higher oil prices and better non-oil revenue collection, we estimate that the general government fiscal deficit increased to 6.2% of GDP in 2022 from 6.1% in 2021. This reflected low oil production volume and a supplementary budget approved in December 2022 to accommodate additional expenditure to repair flood-related damage and interest payments of about NGN1.5 trillion on Ways and Means funding, which was not included in the initial 2022 budget. Furthermore, oil revenue underperformed by about 60% of budget due to a fall in oil production volumes.

The 2023 federal budget (central government; excluding state budgets) envisages a fiscal deficit of NGN11.34 trillion, or 5% of GDP. The budget is based on a reasonable oil price estimate of $75/bbl (S&P Global Ratings estimates Brent at $90/bbl for 2023) but an ambitious oil production volume target of 1.69 mbpd. We project the general government deficit, which includes that of the federal government, states, and local governments, will stand at 5.9% of GDP in 2023 and average 5.4% in 2024-2026. The 2023 budget assumes removal of refined petroleum subsidies by mid-2023, which cost about NGN4 trillion (2% of GDP) in 2022. Subsidy removal might be done in a phased manner to avoid inflationary pressures. We account for modest fiscal slippage in 2023 at the state and central government levels during the election cycle.

For 2024-2026, we expect modest fiscal consolidation through the elimination of the petroleum subsidies and an increase in collection of non-oil taxes and other revenue owing to ongoing digitization and improved compliance, as well as the restructuring of the CBN's Ways and Means advances, which will reduce interest expenditure.

The government has been attempting to reform the Fiscal Responsibility Act 2007 and is reforming the Federal Inland Revenue Service (FIRS) to improve transparency and increase the tax take. General government revenue averaged only about 8% of GDP--very low even by African and frontier market standards. This highlights the limited tax-generation capacity, partly explained by the high level of informality in the economy and the two-tiered federal and state tax system. The states are particularly poor at garnering taxes. Nevertheless, authorities have recently made efforts to increase revenue streams, especially non-oil revenue. The Finance Bill 2022 includes increases in the Tertiary Education Tax, a new corporate tax rate of 50% on companies engaged in gas flaring, a new import levy for goods imported from outside Africa, and an increase in scope of services liable for excise duty. We forecast fiscal revenue to GDP to increase to 10% by 2024 due to efforts and continued strong collection of value-added and corporate income tax. Nevertheless, high debt servicing costs and security-related spending will continue to weigh on fiscal dynamics, leaving less flexibility in allocating funds for capital investment, infrastructure development, or social safety nets.

In 2023, the Debt Management Office plans to finance the bulk of the budget via domestic issuances; of the NGN10.6 trillion due to be raised, NGN7.0 trillion is planned to be raised domestically, with only NGN3.5 trillion borrowed externally. External borrowing will constitute NGN1.8 trillion in multilateral borrowing (largely already granted), and NGN1.76 trillion ($4.1 billion) in commercial external borrowing--either Eurobonds or syndicated loans--down from NGN2.6 billion in the 2022 budget. The government will likely only issue Eurobonds if market conditions improve, due to high yields in the international markets, and could resort to syndicated loans in lieu. Nigeria last issued Eurobonds in March 2022. While issuance conditions for emerging and frontier markets have deteriorated since then, they recently improved somewhat. On the domestic market interest rates have also gone up sharply, partly due to a 600 basis point (bp) hike of the monetary policy rate (MPR) rate by the CBN. So far, the market remains liquid, with recent auctions significantly oversubscribed (473% oversubscribed at the most recent auction on Jan. 25), partially due to the growing level of deposits and funds under management in the domestic pension and banking sector.

We forecast Nigeria's net general government debt stock (consolidating debt at the federal, state, and local government levels, and net of liquid assets) will continue rising and average about 45% of GDP for 2023-2026. We include debt issued by the Asset Management Corp. of Nigeria (created to resolve Nigerian banks' nonperforming loans) in our calculation of gross and net debt. We also include CBN open-market-operation (OMO) bill issuance and central bank lending to the federal government (via the Ways and Means advances) in our debt stock calculations. From 2020 onward, the CBN sharply reduced rolling over its OMO bills, but this was partly counterbalanced by the increase in the Ways and Means advances. Naira depreciation has continued to inflate foreign currency debt, which makes up approximately 40% of total debt. However, the majority of external debt is concessional in nature, at very low interest rates.

Overall, government debt servicing costs as a percentage of revenue are high. We include interest payments on CBN bills and Ways and Means in our calculation of total interest costs. The government is looking to restructure debt amassed under Ways and Means amounting to about NGN23 trillion (12% of GDP). The ministry of finance and CBN have proposed the securitization of this debt for 40 years, with a moratorium on principal repayment for three years and a 9% interest rate. The president recently submitted this proposal to the National Assembly for ratification. The government currently pays interest rate of almost 20.5% on this debt (MPR plus 3%).

Despite being a sizable hydrocarbon exporter (close to 90% of exports receipts are from crude oil and gas exports), we project only small current account surpluses of 0.2% of GDP for 2023-2024. Relatively high oil prices, and robust remittances will strengthen current account receipts (CARs) in 2023 and 2024 while the increase in the country's refining capacity owing to the new Dangote refinery will help reduce the import bill beyond 2023, in our view.

Despite the continued increase in CARs, costlier imports and clearance of FX arrears, CBN intervention in the Investors and Exporters window will limit the proportionate increase in FX reserves. We also deduct $10 billion from gross FX reserves to account for what we estimate as encumbered reserves, which could make them unavailable for meeting external financing needs. We project usable reserves (gross reserves minus encumbered reserves) to average about $28 billion over 2023-2026. Relatively high imports and reduced level of usable reserves will keep our estimate of gross external financing needs (all payments to nonresidents) averaging 110% of CARs plus usable reserves for 2023-2026. Nevertheless, currently, external liquidity remains sufficient for upcoming external redemptions, including the Eurobond maturity of $500 million due in July 2023. Over the past several years, Eurobond interest and redemptions have been paid on time and in full.

After running a very tightly managed exchange-rate regime, in May 2021, the CBN devalued the currency (by only 7.6%) and ostensibly abandoned its official exchange rate, adopting the Nigerian Autonomous Foreign Exchange Fixing Mechanism rate, which currently stands at NGN460 against the U.S. dollar. However, the naira continues to trade at a significant discount in the parallel market, where it stands at NGN750 per dollar.

Inflation hit 18.8% year on year in 2022--versus the CBN's 6%-9% target--on surging fuel, utility, and food prices. Due to the spike in consumer price index inflation, the CBN raised its benchmark rate by a cumulative 500 bps in 2022 to 16.5%, followed by another 100 bps rise in January 2023. We project 17% headline inflation will persist in 2023 but will gradually decline to 12% by 2026 owing to monetary tightening and improvement in supply of refined crude products in line with increasing refining capacity. The government plans to remove petroleum subsidies by mid-2023, which will weigh on inflation for 2023. We understand that World Bank financing will partially fund social spending intended to offset the impact of subsidy elimination on the population.

The banking sector's earnings resilience to economic downturns has improved over the past few years, supported by efforts to expand digital channels and noninterest income. The system's dollarization has moderated as banks continue to de-risk their credit portfolios in a tight FX market. Still, credit risks stemming from sensitivity to currency depreciation, concentration, and energy transition risks persist because lending to the hydrocarbon sector still forms a sizable share of banks' lending (30% of total loans). This leaves banks vulnerable to asset price shocks, resulting in asset quality problems. The nonperforming loan ratio fell to 5% in 2021 and breached the 5% regulatory limit in 2022, when it fell to 4.2%. Nevertheless, we think pressure on asset quality metrics could re-emerge amid high inflation and interest rates. Similarly, we expect credit losses will increase in line with that trend to a moderate 1.2% of total loans. Moreover, the CBN's naira and U.S dollar liquidity management creates some distortions in the banking sector, which in turn have negative implications for banks' cost of funding and risk-adjusted returns. Overall, we expect the sector will remain profitable. Banks' earnings will come under pressure in 2023 because of higher cost of funds amid elevated cash reserve requirements. Banking sector assets stand at about 35% of GDP, while the sector's exposure to government (and the CBN) constitute a relatively high share of of banks' total exposure (approximately 40%).

Key Statistics

Table 1

Nigeria--Selected Indicators