The effect of the recent downgrade of Nigerian Sovereign debt rating by Moody’s from B- to Caa1 (stable outlook) was almost muted as far as the markets are concerned with about 2pct sell-off on the sovereign curve and 1.2pct for the FIS. This may suggest that the markets may have proactively priced this into Nigerian risk and that expected similar rating downgrades by Fitch and S & P might not result in a price rout.
Nonetheless, this tamed market response would not mean that the more fundamental implications of such an outcome would not kick in. Apart from obvious pressures on liquidity and transaction costs, the widening credit spread would exert more strain on an already weakened debt service capacity in-country. Ironically, it is this same pressured debt capacity that the ratings cite as a key driver, pointing to the expanding fiscal deficit and the constrained capacity to respond to economic shocks, so a self-reinforcing equation is in play here. For the Nigerian banks and by extension import dependent customers, access to trade lines with foreign banks would come at a higher premium especially given the persisting in-country foreign exchange pressure. For size, a 100bps increase in funding cost on an annual import bill of $50bn would result in an additional cost of $500million (this not including other noninterest costs) thereby fueling imported inflation into the local economy.
To be clear, such downgrades have been making the rounds across the emerging markets (EM), so this is nothing that is Nigeria-specific. For example, by October 2022, Fitch has made 21 EM ratings downgrades across 11 different countries, representing the worst year on record apart from 2020. This is also hardly surprising given that the past 3 years have seen intervening factors which best mirror a perfect storm. The advent of covid 19 pandemic invited aggressive responses, mostly in the form of quantitative easing and increased public spending from policymakers to stave off economic stagnation. While this was arguably the right response, the resultant high levels of inflation and widening fiscal deficit have significantly weakened the economic position of many a sovereign. Then came the Russian-Ukraine war a year ago, further disrupting global supply chains and unleashing a fresh wave of price shocks in the oil and food markets. Additionally, the strength of the US dollar in recent times has contributed in no small measure to the foreign currency crises in most (import-dependent) emerging markets with our experience in Nigeria as a good reference point. In effect, while the barrage of economic pressures we have witnessed in recent times can be unnerving, it is important to take things in the broader context of global macroeconomic and geopolitical developments.
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At its current rating, Nigeria shares company with countries like Tunisia, Ethiopia, Argentina, Pakistan, the Democratic Republic of Congo, El Salvador, and Burkina Faso etc. Some would argue that Nigeria should be in better company given the size and capacity of its economy, but this would elicit the question: why should that be the case? Our ongoing efforts to diversify the economy away from oil and sustain a local manufacturing environment that would drive a more manageable balance of payments have not been as successful as anticipated despite notable improvements in some areas, while the foreign exchange shortages that we experienced with every oil price cycle appear to have now become structural. It may well be that the recent downgrade is reflective of these realities.
Nonetheless, given the primacy of strong access to the international capital markets for an emerging economy like ours, the need to have all hands on deck to achieve a rating upgrade (upgrades) within the shortest possible time cannot be overemphasized. That Nigeria has a sizeable economy with strong capacity is fact and not conjecture. However, this is not the whole story as far as sovereign ratings go. The recent Moody’s downgrade commentary pointed to 4 overarching factors that drove the rating outcome.
(1) Economic Strength: this expects diversification of government revenues away from the oil sector and returns to more robust GDP growth rates thereby moderating government debt and strengthening foreign reserves
(2) Institutions and Governance Strength: expects improved enforcement environment and institutional stability in the medium to long term.
(3) Fiscal Strength: expects removal of oil subsidy in 2023 and a smaller fiscal deficit thereafter as oil industry reforms take effect. Interest rates are expected to moderate in the medium term.
(4) Susceptibility to Event Risk: expects the current limitations on outgoing foreign currency transactions to ease as our reliance on oil revenues reduces. Improved security nationwide, easier access to financing and lower risk profile for Nigerian banks.
These expectations are not new, nor would the recent downgrade have come as a surprise (at least in theory). But it presents a fresh opportunity to engage robustly at high levels within the rating agencies to clarify that the contemplated policy responses would be enough to move the needle positively within a reasonable time frame. This is typically a detailed process that would require to be “overmanaged” just to make sure the needed levels of communication and engagement are achieved.
Delivery timelines around policy responses can vary widely depending on the issue in question. For example, the removal of oil subsidy, whilst a difficult decision to embark on given its complicated position in our society, is a more definite deliverable and can be assigned a short-term timeline once the decision is taken. So is the issue around foreign exchange management which must not be taken lightly given that the exchange rate remains a key driver of most aspects of our national economy. However, once a decision is taken on a more predictable (preferably inflation-linked) exchange rate management policy, a short-term deliverable timeline can be assigned. The case is different for expectations around institutional stability and governance strength (including ESG) as these are more structural factors that would typically require long-term systemic improvements in key public institutions.
Experience in the process suggests that a definite resolution of issues is not necessarily a condition precedent for improvements in rating outcomes. After all, some of these issues existed in some form or another in the past when the country was rated better. Rather, a well-articulated and operational remedial strategy with realistic and achievable timelines plus a demonstration of the existence of a positive direction of travel towards this objective would oftentimes be strong enough to positively impact rating outcomes.
To conclude, although the recent Nigerian sovereign downgrade is an event that we don’t need, especially at this time given many more-present issues facing us, it provides a fresh opportunity to re-engage on the thorny issues that have plagued Nigeria’s creditworthiness over time. There is good reason to be positive about achieving the desired outcome in this process, especially when the upcoming elections are concluded in a peaceful, free, and fair manner.
Our ongoing efforts to diversify the economy away from oil and sustain a local manufacturing environment that would drive a more manageable balance of payments have not been as successful as anticipated
Okonkwo is the immediate past managing director of Union Bank of Nigeria Plc where he served for about 9 years on the board.
