Tank up before you go

The government faces wide-ranging fiscal pressures, while the capacity to respond remains constrained by Nigeria's long-standing institutional weakness and social challenges. The risk that a negative feedback loop sets in over the next couple of years due to a combination of higher government borrowing needs and rising interest rates has intensified. In addition, the government’s limited access to external funding sources will add to the pressure from depressed oil production and capital outflows, thereby eroding Nigeria's external profile further over time. At this stage, however, immediate default risk is low, assuming no sudden, unexpected events such as another shock or shift in policy direction.

Rising prices of imported goods, payments to clear foreign exchange backlogs, interventions by the central bank to stabilize the naira (NGN), and low oil exports reduced the gross FX reserves by about USD3bn in 2022 to USD38bn at year-end. Usable reserves are estimated at USD28bn in 2023, equivalent to only 3.6 months of current account payments (down from 5.4 months in 2022).

Production in the key oil sector remains weak. Despite being the 12th world producer of oil (1st in Africa), Nigeria did not benefit from the favorable oil and gas prices in 2022, unlike many other producers. Oil production fell by -32% in Q1-Q3 2022 due to persistent extraction constraints. Despite a pick-up in production in November to 1.16mn barrels per day (bpd), with officials attributing the increase to the security services making headways against oil theft, output was still well below the country’s OPEC+ quota of 1.74mn bpd. More recently, security issues forced operators to suspend some LNG exports. To add to this, between September and October 2022, the heaviest floods in a decade hit 34 out of the 36 states in the country and weighed on the agricultural output, which historically contributes to one quarter of Nigeria’s GDP.

Inflation hovered at 21.3% y/y in December after reaching a peak of 21.5% in November. With the country largely dependent on imported refined petroleum products, elevated prices may continue to push up the fuel import bill and impact the local currency. The naira has depreciated by 11% against the USD since the outbreak of war in Ukraine, while oil producers have generally benefited from advantageous terms of trade. Despite criticism from the IMF, the World Bank and many investors, the central bank (CBN) has opted to maintain the controversial system of multiple FX rates that hampers economic recovery. In early January, the CBN sold hard currency to importers at a record-low NGN500 per USD1 (the official exchange rate at the time was NGN450) as the country struggled with FX shortages and rising demand fueled by pre-election spending.

While the CBN has allowed the naira to weaken across all FX segments, it is believed the naira is still much stronger than its market-clearing rate, as evidenced by the huge gap between the official FX rate and the black FX market rate. The naira traded at NGN750 per USD1 on the parallel FX market at the beginning of June, indicating a 62% gap with the official rate – up from 36% in early February 2022.