WHY FG IS JITTERY OVER FITCH DOWNGRADE OF CREDIT RATING

Oteh
The Finance Minister, Dr. Olusegun Aganga, was in pains the other day, trying to wish away the dire consequences of the recent downgrade of the nation's sovereign credit rating by Fitch, an international rating agency headquartered in New York, US.

According to him, the latest international rating, which adjusts the country's economic outlook downwards, was unduly punitive and unacceptable, given the positive features of the economy and the current administration's ongoing reforms.

Fitch, in the rating, had cited the following as the major reasons for the revision of the nation's outlook: the depletion of the Excess Crude Account (ECA); the decline in foreign exchange reserves; and their concern that the reform agenda of the current administration which they found to be very positive may not be implemented before the elections.

As a result of these, the rating agency then slammed BB-minus, three notches below investment grade, on Nigeria. It further assigned Nigeria's Long-term foreign currency Issuer Default (IDR) 'BB-', Long-term local currency IDR 'BB', short term foreign currency IDR 'B' and Country Ceiling 'BB-'.

Its sovereign ratings analyst,Veronica Kalema, gives much meat to the story: 'The outlook revision reflects the weakening of the institutional framework of fiscal management of oil revenue by continuing withdrawals from the Excess Crude Account (ECA).

There is no clear legal basis to determine how excess crude account funds should be shared among the federal, state and local governments and the savings have fallen to less than $500 million from $20 billion in 2007 amid political wranglings. ''The depletion of the ECA and continued gradual fall in international reserves at a time of high oil prices and record high oil production is a major concern. It also raises vulnerability to any renewed fall in oil prices and threatens macroeconomic stability'.

Reacting sharply, Aganga, who until his recent appointment was the managing director of Goldman Sachs, another international rating agency, said: ''we do consider the decision to adjust the outlook downwards unduly punitive and disagree with it given the numerous positive features of the country's economy and ongoing reforms cited by Fitch in its recent press release.''

He said that Fitch should have recognized the fact that there are many positive measures being taken by the present administration to address these concerns which he described as the 'renewed reform momentum in 2010.' These measures, according to Aganga , include 'the proposed establishment of a Nigerian Sovereign Wealth Fund(SWF) and urgent steps which are being taken to address the infrastructure deficit particularly in the power sector as outlined in the Power Roadmap that was unveiled by Mr. President in August.'?

The minister explained that the measures, which Fitch has identified as important for Nigeria's outlook to return to stable, are already being implemented, citing the passing of the Bill to establish the NSWF, which he said was very positive. According to him, the Bill is being drafted and gave assurance that it would receive a positive and speedy reception in the National Assembly as expectation is high that the Fund will be in place before the end of this administration.

The government's alibi on this issue notwithstanding, the big question is this: should a nation panic just because its credit rating has been adjusted downward? Does it portend a any danger to its economy? Should the government bend over backwards to satisfy the rating agencies in order to secure a pass mark?

Wikipedia, an online encyclopedia, defines a credit rating agency (CRA) as a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities ( bonds) that can be traded on a secondary market.

A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued.

The value of such ratings has been widely questioned after the 2007/2009 financial crisis. In 2003 the U.S. Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest.

Uses of ratings
Credit ratings are used by investors, issuers, investment banks, broker-dealers, and governments. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both borrowers and lenders.

Issuers rely on credit ratings as an independent verification of their own credit-worthiness and the resultant value of the instruments they issue. In most cases, a significant bond issuance must have at least one rating from a respected CRA for the issuance to be successful (without such a rating, the issuance may be undersubscribed or the price offered by investors too low for the issuer's purposes).

'Every country has something called a 'sovereign' rating, these ratings determine a country's ability to borrow money, and how much interest it needs to pay. The higher a country's credit rating, the better its interest rate will be. And countries with higher scores also have an easier time attracting investment capital.

Brazil's stock market surged to a record high in 2008 when the country's rating was upgraded to 'investment grade' by Standard & Poor's. But credit ratings don't always tell the whole story.

Some countries, like Japan, have excellent credit ratings, but have been lousy investments in recent years. And many emerging markets have delivered robust returns despite shaky credit histories. Sovereign credit ratings can be a great starting point when analyzing a country, but they're just one piece of the puzzle,' says About.com, an online journal.

From the foregoing, the panicky explanation offered by Aganga is understandable considering the fact that the Federal Government is planning to hit international capital market to raise $500 million through Eurobond sale. The proceeds from of the offer is expected to be used to develop roads, railways and housing and reduce dependence on oil exports, the source of more than 80 percent of government revenue.

Implications of the rating
Investors look out for countries with low risk factors: security risk, foreign exchange risk, default risk, country risk, environmental risk, political risk and more, which are key determinants of ratings. If these risks are high, means there is no security on investment. As investment climate becomes less competitive investors are inclined to hold back their money. These investment decisions are taken under the guidance of rating agencies who collect, collate available data on basic economic and governance indicators. They carry out analysis and projections into the future of companies and governments.

Mr Tajudeen Olayinka of Tajudeen A. Olayinka,Wyoming Capital & Partners Limited explains the implication of the rating on Nigeria.His words: ''The direct implication of the downgrade of the rating of the Nigerian economy by Fitch and Standard & Poor is that risk level associated with any long term investment in Nigeria is higher now than it was before the downgrade.

''It then follows that any investor, foreign or local, would assess the risk level in the economy in relation to possible returns, before staking their money in financial instruments issued by any Nigerian entity. The downgrade basically affects investments. In the more extreme position, the new grade may not be attractive to investors from some environment where BBB+ or BB+ is the minimum standard for any meaningful investment.

It may also lead to review of existing business relationship, whereby some investors in the category mentioned above could commence possible divestment if the downgrade persists for too long.''In a plain language, it is not a good development for the economy'' Olayinka stated.

He noted that the current rating would affect the pricing of the debut US$500 million sovereign bond being contemplated by the Federal Government. This is clearly the fallout of bad economic management and policy somersault inflicted on the nation by the administration of the late Yar'Adua. It remains the most tribalistic and worst administration in recent history.

This position was supported by Sterling Capital Market Ltd, in its latest report on the economy:

'We are of the view that the rating downgrade will impact negatively on the impending $500million FGN Eurobond offer. Being a mono-product economy, Nigeria remains susceptible to the vagaries of the international oil market. The botched importation of military grade ammunition, coming against the backdrop of the October 1 bomb blast, has also increased security concerns in the country, with unsavory implications for investment decisions.'

However, the Director General of the Debt Management Office(DMO), Dr Abraham Nwankwo, disagreed with this. According to him, there is no big deal about raising the amount as it is less than what DMO raises every month. His words: 'We will raise the $500 million comfortably. Individual investors are ready to take up $300 million out of the $500 million. It is less than what we raise every month. It is no big deal.'

Explaining why the Federal Government is forging ahead with the offer, he said: 'We want to establish Nigeria's presence in the international capital market for three main reasons: One, foreign investors have to be familiar with the fact that there is a country called Nigeria. We will be prominent in the international capital market. Two, to use it to establish a benchmark so that private sector will have it easier to access the international bond market to execute their various real sector projects geared towards employment generation and poverty reduction.

There are reasons to believe that that the bond will be a success, foreign investors have been begging to be part of the offer. So it will be well subscribed to.' Some analysts have also opined that the Fitch ratings downgrade of Nigeria fundamentally means that Foreign Direct Investment (FDI) into Nigeria which has declined to $6billion as against $20billion it attracted in 2008 will reduce further.

The Managing Director, Financial Derivatives Limited, Mr. Bismarck Rewane, said though the bond would be subscribed to, but the pricing would be affected. ''The bond will succeed, but it would have been subscribed to at a higher price, if the rating was not revised to negative. The success of the bond is a function of risk, which will definitely affect pricing'' Rewane said; noting that though he share sentiments of the minister in faulting the rating, the country should be thinking of how to change those factors that Fitch based its judgement on.

Regional Head of Research, Africa Global Research, Standard Chartered Bank, London, Razia Khan, said though the downgrade was not unexpected, there were clear guidance on what the country needed to do to retain the confidence of the international investing community.'Ahead of its maiden Eurobond, the market implications of the Fitch outlook revision are probably limited,' Ms. Khan said.

'However, there is considerable market expectation that any eventual external debt issuance by Nigeria is likely to trade tighter than similarly-rated peers,' she said in her quick view of Nigeria's latest sovereign rating.

Khan maintained there have been concerns about the way Nigeria spends her revenue, a fact reflected in the Fitch Ratings report. Ms. Khan said there was need for the institutionalisation of oil savings, fiscal improvements, including a removal of fuel subsidies, and greater transparency overall in order for Nigeria to enjoy the confidence of the international investing community.

This is coming after the former Vice President Atiku Abubakar called on the Federal Government to take drastic measures to check what he described as the deteriorating state of the economy. He made this call recently judging from Standard and Poor's (S and P), a credit rating agency's poor rating of Nigeria's economy in August.

''The latest Fitch's ratings, which lowered Nigeria's investment grade by three notches to BB minus should be a wakeup call to all those currently living in denial about the true health of the nation's economy. No serious government can afford to ignore these danger signals from international credit rating agencies as this would amount to non-challance,'' a statement by the Atiku Abubakar Campaign Organisation in Abuja quoted the presidential aspirant as saying.

What Fitch stands for
Fitch Ratings is a global rating agency committed to providing the world's credit markets with independent and prospective credit opinions, research, and data. With 50 offices worldwide, Fitch Ratings' global expertise, built on a foundation of local market experience, spans across capital markets in over 150 countries. Fitch Ratings is widely recognized by investors, issuers, and bankers for its credible, transparent, and timely coverage.

Fitch Ratings with headquarter in New York and London and is part of the Fitch Group. In addition to Fitch Ratings, the Fitch Group also includes Fitch Solutions, a distribution channel for Fitch Ratings products and a provider of data, analytics, and related services. The Fitch Group also includes Algorithmics, a world leading provider of enterprise risk management.

Fitch in rating entities believes that in addition to enhanced and sustained revenue, profitability and strong capital over an extended period of time, the company or government would need to demonstrate a material shift in risk profile and long-term stability characteristics. Rating rationale includes strong reserves by government agencies and strong capitalization for companies, high quality asset portfolio, diverse sources of revenue and well distributed earnings from its four main positive outlook. For instance ''AA'', ''A+'' reflects a company's solid statutory capitalization.

Any minus from either AA, BB,A+,B+, reflects a downgrade from former stable or positive position due to such factors as realized and unrealized investment losses from challenging economic environment and the view that such losses may not be manageable in the nearest future or escalate into credit crisis. Such risk position is usually considered too high compared to other governments or industry average in case of companies. Another negative rating factor is weakening budgetary performance, lack of accountability and weak governance culture.

Past ratings
In July 2009, Fitch Rating affirmed the Federal Republic of Nigeria's long-term foreign and local currency Issuer Default Ratings(IDR) at 'BB-' , 'BB', short-term foreign currency at 'B' and the country calling at 'BB' saying that the outlook was stable. The rating agency cited strong sovereign balance sheet (despite reduction in reserves by $44.8billion in May after its peak of $62.1 billion in September 2008), low government debt, strong overall and public net external creditor position, low foreign liabilities of both the public and private sectors which meant that the country's ''balance sheet remains robust and is still one of the strongest in the 'BB' category''. Fitch commended government economic foresight and swift move to base the 2009 budget on lower benchmark oil price of $45/barrel.

State of the economy
Despite the minister's defence of the country, Nigeria's economy continues to take a beating from all fronts as indications emerged recently that her foreign reserves dipped further by another 7.6 per cent in just one month. Available information from the Central Bank of Nigeria (CBN) website shows that the latest development has reduced the nation's foreign-exchange reserves to $33.9 billion between September end and Oct. 21, as the apex bank sold dollars to prop up the value of the naira.

Reacting to the development, an economist Dr Ayo Teriba, observed that 'The foreign reserve was partially depleted because government struggled to meet huge foreign-exchange demands at its twice-weekly foreign-exchange market in September,' Teriba, Chief Executive Officer of Lagos-based Economics Associates, told Daily Sun.

Also, 'The outlook is very bleak if you continue to deplete your foreign reserves at this rate; there will come a time when you will have nothing left to cover your imports,' said Babatunde Obaniyi, an analyst at Lagos-based Afrinvest West Africa Ltd. Only last weekend, Aganga while speaking at the 51st edition of the Nigerian Economic Society (NES) in Abuja, put Nigeria's infrastructure deficit at $100 billion, at the same time imploring the private sector to join forces with government to provide the infrastructure needs of the country.

There is need for the FG to compare the state of the economy when past ratings were received with pride and now that the rating is being rejected. In addition, elections in the first half of next year have increased short-term political uncertainty. Political risk had been heightened by the end of the zoning agreement within the ruling Peoples Democratic Party (PDP) under which power rotates from the South to the North every two terms. This could give rise to instability in the Niger Delta or in the northern states, depending on who the PDP chooses as its candidate. A flare-up in the region would be the worst outcome for the economy as a whole as it would likely bring a renewed decline in oil output, budget revenues and international reserves.

Issues
Following Nigeria's unimpressive position in the recently released Global Competitiveness Index (GCI) rankings for 2010-2011 by the World Economic Forum, the Federal Government invited the authors of the survey in a bid to improve the country's ranking. The global competitiveness survey had ranked Nigeria as 127 out of 133 countries, citing among other things lack of reliable electricity supply and existing infrastructure deficit as reasons for the poor performance?

Besides, it ranked Nigeria 25th out of the 35 nations covered in the African continent, coming behind smaller and very poor countries such as Ethiopia, Rwanda, The Gambia, Benin, Botswana, Cameroon, Tanzania, and Swaziland.

The minister is apparently running from pillar to post because like he noted, the administration's actions are aimed at increasing the attractiveness of the investment climate through the adoption of liberal and market-oriented economic policies. But it has long been established that the problem with the country is not paucity of good policies but its implementation.