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In this interview, Jide Akintunde, Managing Editor, Financial Nigeria, and Director, Nigeria Development and Finance Forum, spoke with Aurélien Mali, Moody's Senior Analytical Advisor – Africa Sovereign Risk Group, on the fiscal adjustments that are ongoing in Nigeria and Moody’s forward-looking “stable” rating for the country.

Q: Moody’s has maintained a ‘Stable’ outlook for Nigeria over the economic and political cycles. What informed this rating decision?

A: Yes, it is true that Moody’s maintained its Ba3 rating on Nigeria during this period of the drop in oil prices, lower government receipts and throughout the political electoral cycle. These issues were a source of uncertainty among many investors in the first half of this year. We were aware of the negative impacts on the economy of the drop in oil prices, but our rating is based in part on our assessment of the balance sheet of the federal government and the cost of the drop in oil prices to government revenue.

Overall, the metrics compare favourably with Nigeria’s peers in its rating category, even though we detailed the likely accumulation of arrears at the state and local government levels, as well as the lower revenues, and the adjustments of the budget which will mean lower economic growth as the government retrenches. Yet, even these will not significantly change the debt metrics.

The point is that when there is a shock, we look out for the response of the government to know if its response can mitigate the shock over the cycle and the deterioration of its credit fundamentals. We think that during this adjustment phase, where much of the adjustment is supported by the real economy, the balance sheet of the federal government will still compare favourably to its peers. In other terms, because of the lack of fiscal savings, most of the adjustment will come from the real economy while federal government revenues are not really dependent on the real economy. It’s mostly the oil sector, which is still producing 2.1million barrels per day, and taxes paid by large multinationals in the country.

The negative impacts will be felt more by the state and local governments, not on the federal government, which still has a strong balance sheet.

The electoral cycle was not difficult to pass compared to what many observers were predicting. The fact that Nigeria had successfully conducted elections with alternance of power for more than a decade at state and local government levels with sometimes very large number of inhabitants was an illustration that democratic foundations were stronger than anticipated. We communicated that we were not too worried that the elections would be organized smoothly. We try to rate through any cycle.

We have a forward-looking view because our ratings speak to bondholders that will buy government bonds and hold it to maturity. What is the risk of a default by the federal government despite all the shocks? The stock of debt of the federal government is small. The government’s external debt is few percentage points of GDP; mostly bilateral and multilateral. Half of the debt is from World Bank, a quarter is from China and rest the Eurobond. So there’s not much risk on external payment by the federal government.

Now on the domestic side, Nigeria has large domestic capital markets made up of banks and non-banking institutions that have been strong and able to buy at least all the issuances of the government over the last few years. In addition, the Nigerian capital market is growing quickly. This means that government has a captive domestic market eager to buy government bonds. So in terms of funding, the fact that the economy has been deteriorating and adjusting to the shock of the oil prices, has not drastically reduce the ability of the government to finance domestically its deficits.

Q: I observed in your presentation that the metric that measures “institutional strength” was the weakest of the four factors you use. Could you shed some light on the make up of that factor? What does it measure and what would be the policy response?

A: At Moody’s, our methodologies to rate a sovereign issuer uses a factor approach. We try to assess several factors, including the strength of the institutions. We do this because historically a country sometimes defaults due to the inability to implement the necessary policies to cope with shocks. But we know institutions are important, especially institutions that deal with the rule of law and respect of contracts, whether government effectiveness is high enough to implement the changes that promote growth. We also look at the capacity of the economy to absorb shocks.

This is why we try to assess the strength of the institutions; in other words transparency, accountability and so forth. In Nigeria, many of these metrics in terms of governance, rule of law, corruption, transparency are relatively weak. In our ratings universe, we use all these metrics. Nigeria is ranked very low in these international listings by various reports like World Bank’s Doing Business, Transparency International’s Corruption Perception Index, and others. This doesn’t mean we don’t follow all the progress that has been made such as the payroll system, and the Treasury Single Account. These are key reforms to prevent corruption, increase transparency, and better manage public resources. The size of the reforms needed to increase the relative ranking of Nigeria is still large. It is a long-term constraint on the rating as the sovereign rating is penalized by these factors.

Also, in the recent elections, we noted that one of the agenda of the new president was fighting corruption and improving transparency and the rule of law. We see this as positive for the country overtime, which will be conducive for investment in the economy although it is too early to say if everything will be implemented and successful. But it seems as if there is sort of structural change happening in the country.

Q: You have repeatedly talked about the adjustments that Nigeria is going through. Tell us if you foresee a social backlash in these adjustments. I also observe that you didn’t mention the possibility of withdrawal of petroleum subsidy. Is that an attempt to side step potential social risks to these adjustments and do you foresee a safe landing for Nigeria and the government?

A: We rank this kind of risk within our political risk assessment which is still moderate for Nigeria.  However, the inability to promote a real growth that is more inclusive, that creates jobs is one of the risks going forward. This is because of youth unemployment and rising inequality, in particular between the north and the south, especially the northeast that was impacted by Boko Haram insurgency.

Over the long term, if inequality is not reduced, it could create instability. So we are fully aware of this and it’s fully factored in. Overall, we think that today, political risk has been reduced in spite of the fact that Nigeria is in a period where the economy is not growing as fast as before. There’re people losing jobs and companies closing down, but Nigerians now know that they can oust their leaders through the polls by casting their votes. So it means that they can signal their discontent with government policies and they may have the chance to do so at the next elections.

Another point is that even in the Jonathan government, with much higher oil price, the economy had some difficulties. So this new government will be given time before judgment, especially while the current situation of the economy is normalizing. Concerning oil subsidies, there are no more large amounts concerning oil subsidies because of the reduction in oil prices. The real cost of the subsidies is much lower than in the past. There will be a residual subsidy which may exist on some petroleum products used by the poor for example. However, it is small compared to before when subsidies were several billion dollars in opportunity cost for the country. As oil prices are not forecasted to rise quickly, the government will have time to remove and/or re-adjust subsidies going forward without much impact on its balance sheet. So it’s an opportunity for the government to transform the expenditure side of the government going forward.

Q: This leads to another topic that is already trending, which is the huge jump in the anticipated 2016 budget. We have heard it from the vice president, who said the budget will move from N4.4 trillion this year to up to N8 trillion next year – about 90 percent increase. The immediate question is how do we fund the difference? Where is the money going to come from?

A: Let me first say that the budget has not been released. These are just indications. When a budget is voted, there is also the funding side that is discussed with the participation of the DMO (Debt Management Office) and the ability of the FIRS (Federal Inland Revenue Service) and other entities to explain their contributions to the budget. All those have not been done yet. So, talking about N8 trillion budget would be pure speculation from me. That being said, it is possible that with the economy slowing down, there may be a view from the authorities that it’s time to stimulate the economy to compensate from the contracting revenue and its impact at local and state government levels. So the government may spend a bit more.

But there’s no silver bullet.

If there’s a large spending next year, it has to be matched with more resources on the budget side. There may be a large push to raise non-oil sources of revenue from the government into the budget. And also other reforms are likely to be implemented such as improving management of these resources, broadening the fiscal base and increasing taxes. If the budget is passed and the administration is not able to raise enough budget revenue to match most of the budgeted spending, it would mean larger deficits to finance. But you have to take into account that the Fiscal Responsibility Act limits the federal deficit at 3 percent of GDP – so they can’t go further than that. The only other possibility in that case – if there is more fiscal slippages while there is still a lack of savings in the economy – is to get more naira per dollar, with further depreciation of the naira to have more flexibility to finance the budget.

So there may be increase in oil production or decrease in exchange rate. But for the moment, all these are just speculations because we can only know what the budget is when it has been approved by all the relevant authorities.

Q: My next question is on the financial sector. How are the banks going to behave going forward? Are we going to see more lending to the private sector or more investment into government bonds?

A: There has been several changes since the election of the new president. E.g. the banks had to transfer the deposits of the MDAs into the Treasury Single Account, meaning that before, there was a free lunch for the banking sector because they were using these government deposits to invest in government bonds at a yield that was above the remuneration of the deposits. But all this is gone because of the TSA.

Banks will have to realign their strategies so that they continue to be profitable. They may still buy government bonds, but they will also have to find within the economy opportunities like financing some SMEs and infrastructure to use their liquidity, because they have a lot of liquidity. It is also important to understand that the banking system is still growing its penetration of the domestic market as more Nigerians join the banking system – giving more resources to the banks. So the search for instruments and where to invest this liquidity will be key. Banks will do banking differently from now on because there are not anymore large deposits from the government and the environment makes it difficult to find good investments as the economy is slowing down.

Q: What are your closing remarks?

A: What is important to stress is that in the cycle, the deterioration of the credit fundamentals of Nigeria is still not large enough to justify a negative outlook or pressuring the current rating. Nigeria is a bit in a paradox. You have a situation where the real economy has to make more adjustments because of lack of fiscal savings to smooth the oil shock; an oil sector where funding solutions need to be found for Joint Ventures, and also an exacerbated drag on the economy as a result of fiscal retrenchment, especially at the state and local governments.

But at the same time, Nigeria is a country where the opportunities are extremely large, the market is very attractive for long term foreign investors and there is no need of much, to change current perceptions, like few successes so that a lot foreigners investors can come and invest in Nigeria. A new cabinet has been appointed and I think they will design a policy that is clear to everyone and there may be a period that could be very positive for the country especially if oil prices stabilize and rebound a bit.

Q: So you believe that if Nigeria make these adjustments FDI will flow in?

A: Let’s be clear; the potential of Nigeria is well identified in everything. Your economy is projected to be several trillion dollars by 2050 and the oil sector will be much larger in terms of oil production because of the size of the reserves, if the framework is conducive for investors and all the stakeholders. So the potential is large.

The rating speaks to the ability and willingness of the government to pay the debt it owes, so managing the public finances will also be key. Everything that could increase the sources of funds at the budget level of the federal government is positive for the rating e.g. an increase in non-oil sector taxes so that revenues are less reliant on the volatility of the oil sector. The reform agenda and institutional strength, and the progress on this side could exert pressure on the rating. At the same time, fiscal slippage that could damage the balance sheet of the government could also affect the rating.

A long period in stagnation of the oil sector and especially the inability to adopt a framework conducive of investment means that overtime, the oil production will start to decrease very quickly as well as fiscal revenues. This could also exert pressure on the rating. So, it’s a balancing act. At the moment, the rating is stable. It could go up, it could go down. Our baseline scenario is that, taking into account the current situation, it is still strong enough to justify a stable outlook despite the deterioration in fundamentals.