Risk drivers and outlook

Africa’s largest economy is going through a rough patch. Nigeria’s economy has been hard hit by the dramatic fall in international oil prices while parts of the country are torn by violence and war. External surpluses are eroding, foreign exchange reserves have plunged and the local currency has had to be devaluated twice over the past few months. Nigeria’s commercial risk is classified at the highest risk level (C) because of its detrimental corruption track record, institutional weaknesses and exchange rate, which is under pressure. As a consequence of decreasing liquidity and scattered insecurity, the short-term economic position is categorised in a restrained political risk rating (4/7). On top of these economic strains, the country recently experienced a fierce election campaign that uncovered regional and communal polarisation, raising fears of possible poll disputes and an outbreak of political violence in the continent’s most populated country. Instead, the elections were peaceful and brought overwhelming relief, making them an example for democracy in Africa. What’s more, pulling off credible elections in such difficult circumstances might even revamp Nigeria’s impaired domestic and international reputation.

The new government will be confronted with many challenges, given the high expectations at a time when government coffers are dwindling. Unpopular austerity measures will have to be taken sooner or later to make up for the blatant loss in oil revenues, and an increase in external debt liabilities will also be inevitable. Even though Nigeria has a low risk of debt distress, projected tightening of external financing conditions would raise its exchange rate and roll-over risks. Moreover, it remains to be seen whether the new government can erase underlying obstacles by implementing ambitious structural reforms in order to attract investments and unleash the broader economic potential. Nonetheless, security concerns – like an escalation of violence in the Niger Delta or sustained failure to stabilise the north – continue to weigh on the country’s outlook. All this justifies Nigeria’s more stringent long-term political risk category rating (5/7).

Facts & figures

Pros

  • Abundance of natural resources
  • Africa’s largest market
  • Low debt ratios
  • Net external creditor

Cons

  • Deeply rooted corruption
  • Insecurity in north and Niger Delta
  • Regulatory uncertainty
  • Vulnerable to external shocks

Main export products

  • Oil and gas (75.3% of current account revenues), private transfers (17.8%)

Income group

  • Lower middle income country

Per capita income

  • USD 2,760

Population

  • 173.6M

Description of electoral system

  • Presidential: every 4 years, most recent in March 2015
  • Legislative: every 4 years, most recent in March 2015

Head of State and of government

  • President Muhammadu Buhari

Country risk assessment

Foundations of Africa’s largest economy

One in five Africans is Nigerian since the country’s population reached a staggering 174 million. Nigeria is not only Africa’s largest market, but with oil production at around 2 million barrels a day, it is also Africa’s leading oil exporter. And to top it off, the April 2014 ‘rebasing’ of GDP by the National Bureau of Statistics has transformed Nigeria into Africa’s largest economy before South Africa. Nevertheless, GDP per capita remains more than twice as low as that of its South African peer.
Indeed, poverty is widespread and even growing, ranking Nigeria 152nd out of 187 countries on the UN Human Development Index, while youth unemployment has jumped to over 50%. Underdevelopment and inequality are important loopholes that have been feeding conflict and instability in this large country.

GrapheEN1NigeriaMay2015

Nigeria’s domestic economic activities are relatively well diversified. Driven by domestic consumption and non-oil sectors like textiles, telecommunications, real estate and agriculture, average economic growth has reached 6.7% over the past decade. The government budget and trade balance, on the other hand, are excessively dependent on oil sector revenues, constituting a major vulnerability. About 60% of fiscal revenues are oil-related and oil exports account for 75% of total export receipts, leaving Nigeria exposed to commodity shocks like the 50% decline in international oil prices witnessed since the second half of 2014 (see below).

On a global level, Nigeria holds the 10th largest proved reserves of crude oil (see graph above). Experts claim production could double if it wasn’t for corruption and insecurity keeping hydrocarbon activity below its potential. During the years of military rule before 1999, unbridled corruption became deeply rooted, particularly in the oil sector. The legal framework to reform the oil sector – the Petroleum Industry Bill (PIB) – has been delayed in parliament for the last six years, as certain high officials benefit greatly from the opaque malfunctioning of the business. The PIB should restructure the Nigerian National Petroleum Corporation (NNPC), boost transparency and increase tax revenues, while addressing the shaky infrastructure and eliminating irregularities surrounding fuel subsidies that incite oil theft (‘bunkering’) and corruption. Illegal trade in stolen oil fuels violence while oil spills seriously pollute the region. Absence of such important reforms has been dampening the appetite for investment in the country’s potential for years now. As a consequence, 2014 foreign direct investment inflows actually dropped fourfold compared to 2011 (see graph below).

GrapheEN2NigeriaMay2015

Enduring a painful fight against Boko Haram

Over the last 12 years, an insurgency in northern Nigeria embodied by the Islamist Boko Haram group has killed thousands and is affecting the livelihoods of millions of people. Between 2002 and 2009, the group’s principal goal was the creation of a strict Islamist state in northern Nigeria, yet through a non-violent strategy. At the time, Boko Haram denounced corruption and bad governance and appealed to the local Muslim population by providing services the state did not deliver (employment, education). In 2009 the government intensified its military strategy and Boko Haram’s leader, Mohammed Yusuf, was killed in an extra-judicial execution together with 800 Boko Haram followers. Subsequently, Abubakar Shekau took over and Boko Haram entered a new phase in which the organisation became further radicalised and went underground. The condemnation of economic marginalisation and poverty (with GDP per capita in the north being half of that in the south) is utilised as a mobilisation instrument, appealing to young people in particular. On the other hand, religion is exploited to justify its purposes and demonise the opponent. Under Shekau’s leadership, the group’s tactics have shifted to a more indiscriminate and excessive use of violence, targeting not only Christian, commercial and government or security aims, but also critical Muslim clerics, traditional leaders and civilians through punitive attacks and the destruction of villages.

Boko Haram’s wide geographical expansion underscores the army’s complete incapacity to counter the insurgency. The long and bitter war has damaged the morale and prestige of the army, marked by equipment shortages and growing division among military ranks. Violence has accelerated over the past few months, spilling across borders and prompting international outrage. Subsequently, an international joint task force with neighbouring countries Chad, Cameroon and Niger has been installed. This new offensive helped secure some victories against Boko Haram during the election campaign, although it further eroded Nigeria’s claim of being the regional military powerbroker. Despite the fact that Boko Haram has suffered important casualties since the joint offensive, its target ability remains intact for now, particularly in border areas. Under the newly elected president, the insurgency is likely to get more attention, increasing hopes for an improved security situation, depending first and foremost on a credible military reorganisation.

Historic elections with a fearful campaign

On 28 March 2015 the opposition won a multi-party election for the first time in Nigeria’s history. The ruling People’s Democratic Party (PDP) did not gain from the traditional incumbency advantages, frequently used to rig elections in the past. The PDP came to power in 1999 after decades of military rule and coups when democratically elected President Obasanjo was sworn in. Fellow party member Goodluck Jonathan took over in 2010, after President Umaru Musa Yar’Adua died in office, and was re-elected for his first full term in 2011. During this year’s election, the PDP was challenged by the All Progressive Congress (APC), a new merger of all main opposition parties complemented by powerful PDP members who defected out of dissatisfaction with Jonathan’s presidency. The APC’s presidential candidate, former General Muhammadu Buhari, seized power in a military coup three decades ago and failed to win at the ballot box in subsequent attempts since democratisation.

With incumbent Goodluck Jonathan being a southern Christian and Buhari a northern Muslim, polarisation was amplified. During the campaign, regional division and communal religious distrust fast-tracked and raised anxiety over electoral violence. Furthermore, Buhari’s air of soberness and anti-corruption severity frightened the ruling elite with their ‘lavish’ lifestyles. In early February the government postponed the elections for six weeks on account of security concerns, though it looked like a desperate attempt by the PDP and its military rank to avoid losing the vote and their associated privileges, not least protection from corruption persecution. Consequently, observers feared that a PDP loss would not go down well. Surprisingly, the electoral process proved fairly peaceful and transparent in spite of the anticipated violence and destabilisation. Buhari eventually managed to win a clear margin (54.5%) and rendered a legitimate mandate across the country. Jonathan’s willingness to cordially concede his loss and encourage his supporters to accept the outcome directly reduced the threat of turmoil and helped stabilise the country after a precarious election period.

A vote for change, but challenges remain significant

Nigerians voted for change beyond religious or regional rifts, disillusioned by the flood of corruption scandals, flagrant nepotism and harsh socioeconomic conditions during Jonathan’s presidency. Moreover, the way the ruling elite downplayed the northern Boko Haram conflict for years damaged Jonathan’s reputation even more. It is hoped that Buhari’s new technocratic government will deliver better results and restore confidence in Nigerian governance. The primary focus is likely to be on anti-corruption initiatives and reorganisation of the military. This should help rebuild the country’s reputation for attracting higher levels of investors and promote re-engagement of donors and trade partners. Moreover, campaign promises on greater devolution of power will lead to more control over policy priorities by state governments instead of merely centralised planning.

Nevertheless, challenges will abound given the high expectations at a time when government coffers are meagre due to an expensive election campaign and a global oil price crash. Henceforth, harsh and unpopular decisions will have to be made sooner or later, making an anti-government backlash likely, which might find its hotspot in the pro-PDP Niger Delta. Already, sporadic attacks by Delta militia targeting oil/gas pipelines and foreign or local workers have re-intensified. Buhari should be aware that southern Niger Delta militias could become just as dangerous for stability should they be neglected in favour of an excessive focus on Boko Haram.

The gloomy impact of an oil price crunch…

Since the shale gas boom in its most important oil purchaser, the United States, Nigeria has started shifting its focus towards its Asian customer base. Nonetheless, the sharp fall in international oil prices as of June 2014 together with below-target oil production has exposed Nigeria’s weak spot of oil reliance. Economic growth is expected to drop to 4.8% in 2015 – the lowest level in more than a decade – following export contraction, lower public investment and falling domestic consumption. Looking to the future, oil prices are not expected to completely recover to the levels of previous years. Henceforth, the importance of economic diversification away from crude oil is suddenly very acute.

GrapheEN3NigeriaMay2015

Unfortunately, Nigeria is one of those countries that squandered their oil-money savings during the glory days and are confronted with insufficient buffers now that times are rough. The oil savings fund, Excess Crude Account, reached only USD 2 billion in 2014 compared with USD 10 billion in 2012, which is largely insufficient to cover the shock to oil receipts. The government is therefore forced to make hard fiscal adjustments by squeezing spending and increasing non-oil sector taxes (though the large informal sector remains outside the reach of tax authorities). Hence, by means of austerity they will try to keep the budget deficit below 3% of GDP in 2015 with a budgeted benchmark oil price revised from USD 77/barrel to USD 52/barrel.

Plunging export proceeds have been eroding Nigeria’s current account surplus, expected to balance around equilibrium for the coming years. In terms of capital flows, the oil price crunch together with election-related uncertainty and investors’ reversing risk appetite triggered large capital outflows in 2014 and early 2015. This prompted a sharp decline in international reserves (see graph below) and put great pressure on the local currency (naira). Falling dollar inflows made it difficult to keep defending the value of the naira in the fixed exchange rate regime through selling these shrinking foreign exchange reserves. This incited the Central Bank of Nigeria (CBN) to officially devaluate its currency for the first time in November 2014 with 8% against the US dollar (exchange rate adjusted from NGN 155 per USD to NGN 168). At the same time, monetary policy was tightened by raising its benchmark interest rate for the first time in three years to a record 13% (up from 12%) so as to tackle rising inflation, which is expected to average around 11.5% in 2015. However, pressure continued, so in late February the CBN implemented further exchange regulations and introduced a de facto second devaluation by temporarily abandoning its auction system. As a result the exchange rate was virtually made more flexible and the naira lost 20% of its value. Ever since the peaceful elections, market uncertainty and speculation have eased somewhat, helping the naira to stabilise at about 200 per US dollar, which is likely to become the new fixed rate for the time being. Despite the erosion of foreign exchange reserves, they continue to represent adequate liquidity levels with an import cover of four months, though nominally they have dropped below USD 3 billion.

GrapheEN4NigeriaMay2015

This year, fiscal austerity, together with a continued tight monetary policy, will be required to mitigate the blatant impact of falling oil returns. The new government will have to address infrastructure bottlenecks (power and transportation) and structural regulatory reforms, such as the delayed PIB, to reignite foreign investments and improve growth prospects. Accordingly, the economy is likely to show some resilience and – ceteris paribus – reach an average growth of 5.4% over the coming four years.

...yet long-run fundamentals seem matched up against revenue drop

Owing to a limited public debt stock, Nigeria’s public finances are considered solid and sustainable over the medium to long term. Government debt as a percentage of GDP stood at 10.5% in 2014. With merely 2% of GDP being owed externally (largely at concessional terms), Nigeria is a strong international net creditor. In terms of total external debt stock, about half is privately held. The drop in debt stock ratios (see graphs below) is clarified by the 2005 Paris Club agreement, in which Nigeria paid back USD 12 billion to its creditors and had USD 20 billion of arrears cancelled. Ever since, gross external debt ratios have remained far below critical thresholds, even though nominally they have more than tripled over the past eight years.

It is therefore fair to say that for now, the risk of debt distress remains minor notwithstanding low oil prices pressurising Nigeria’s liquidity. There is more than sufficient space to incur new debt liabilities in order to cover the loss in oil revenues. Nevertheless, external financing costs are likely to increase due to the expected tightening of the US monetary policy, toning down global liquidity. With Nigeria’s relatively open capital account, both the government and private sector have a high exposure to volatility on the international financial market. Less favourable external borrowing terms and higher domestic interest rates will accelerate the increase in debt levels and worsen the debt servicing burden. Moreover, a continued appreciation of the dollar would also add to debt servicing costs of dollar-denominated liabilities. Consequently, regardless of sustainable debt stocks, the exchange rate risk and roll-over risks are likely to increase in the short term.
GrapheEN5NigeriaMay2015

Analyst: Louise Van Cauwenbergh, l.vancauwenbergh@credendogroup.com