As an oil exporter, Nigeria (B2 stable) is set to benefit from higher oil prices this year.
However, its economic and financial performance have gradually deteriorated since the
beginning of the year, as illustrated by subdued growth (+3.5% year-on-year over the first half of 2022), eroding foreign exchange reserves and downward pressure on the currency. In this report, we answer frequently asked questions about these developments.
» Are higher oil prices exerting positive or negative pressure on the government’s
finances? So far, higher oil prices remain positive for Nigeria’s fiscal accounts because
revenue derived from oil production (2% of GDP in 2021) still outweighs the growing cost of the country's oil subsidy program (1% of GDP in 2021). However, constraints on oil production on the one hand and faster-growing oil consumption – incentivized by the oil subsidy and inherent to the country’s economic development – on the other, have meant that the positive impact of higher oil prices on government finances has diminished and may reverse in the future, exerting negative pressures instead.
» How sustainable is government debt? Nigeria's general government (all tiers of
government) debt is small at 32% of GDP at year-end 2021. However, the share of
revenue dedicated to servicing that debt is exceptionally high at 70% at the federal
government level and at 33% at the general government level. This weak debt
affordability constrains the scope of public policy, intensifying the trade-off between
servicing debt and delivering services to the Nigerian population. Absent structural
reforms that increase government revenue going forward, debt affordability would
weaken further, raising debt sustainability risks.
» Have higher oil prices improved foreign exchange liquidity? No. While higher oil
prices have increased net oil exports in the first quarter of 2022, and thereby Nigeria’s
current account surplus, capital outflows have been stronger. Foreign exchange reserves
dropped by $1 billion since the beginning of the year, to $39 billion as of end of August
2022, which still provide strong imports coverage. The central bank, which is the main
provider of foreign exchange in the country, has scaled down the size of its interventions.
Meanwhile, depreciation pressure on the currency has developed, with the gap between
the official and parallel market foreign exchange rates widening.

Are higher oil prices exerting positive or negative pressures on the government’s finances?
So far, higher oil prices remain positive for Nigeria’s fiscal accounts because revenue derived from oil production (2% of GDP in 2021) still outweighs the cost of the country's oil subsidy program (1% of GDP in 2021). However the margin between the two is rapidly diminishing because of declining oil production levels and growing oil consumption, a concern recognized by the Nigerian Ministry of Finance’s pre-budget statement1 released in August.
The government’s petroleum exports via the state-owned oil company, Nigerian National Petroleum Corporation (NNPC), yielded
about 2% of GDP in revenue in 2021, which was split between the federal government and sub-national tiers of government. While this appears small, it still represents a significant source of revenue (a third of general government revenue). As such, when oil prices rise, government revenues increase, all else equal.
Government spending is also sensitive to oil prices through the premium motor spirit subsidy, which is unconditionally available to all. It cost the government 1% of GDP in 2021 and could cost 2% of GDP in 2022 according to the government's latest pre-budget
statement. It is unclear how long the mechanism will remain in place – there have been plans to remove it before. But if prolonged, the oil subsidy could start to outweigh oil revenue in the near future, in which case the relationship between
oil prices and government finances would reverse, meaning higher oil prices would have net negative implications for government finances. In its pre-budget statement, the government presented a scenario where the oil subsidy would last throughout 2023, costing up to 3% of GDP, which could well exceed oil revenue at that point.

How sustainable is government debt?
At 32% of GDP in 2021, Nigeria's general government debt – which includes all levels of government, as well as advances from the central bank, excluding guarantees – is small relative to the country's large output level ($440 billion). Adding the varying guarantees
provided by the government as well as the debt of AMCON (a public company that manages bad assets) pushes the public debt ratio to 36% of GDP at year-end 2021, according to IMF estimates. This is still small compared to peers (median for B2-rated sovereigns is 68%, even when considering the current upward trend

However, interest payments to creditors consume an exceptionally high share of revenue compared with rating peers, which is primarily a result of the government's low revenue intake (7% of GDP in 2021 at the general government level), while the average interest rate on debt is relatively low. At the general government level, 33% of revenue is dedicated to interest payments. If we add interest payments (3% of GDP) and oil subsidies (1%), these two spending items consume about half of total gross revenue
according to our estimates. Debt affordability at the federal government level is even worse, at 70% of total revenue. This is because the federal government holds the largest share of the debt burden, while revenues are split among all levels of government.

Nigeria’s weak debt affordability limits the scope of public policy, intensifying the trade-off between servicing debt and delivering services to the Nigerian population. This is accentuated by the small financial size of the general government, which means that when creditors are paid, the remaining revenue to finance policies is small as a percentage of GDP. Meanwhile, very low social development
outcomes in health, education, financial and physical security, which underscore Nigeria's very highly negative social risks (S-5 issuerprofile score), mean that the demand for public goods and services is strong. Because governments have limited control over interest payments, at least in the near to medium term, the Nigerian government’s
strategy has logically relied on growing its revenue base, especially the non-oil segment. So far, the government’s track record has been limited and admittedly shaken by the pandemic, which led to a drop in revenue in 2020. Going forward, the government's capacity to expand its revenue base will be a key driver of the sustainability of its debt.
Have higher oil prices improved foreign exchange liquidity?
While higher oil prices have boosted Nigeria’s current account surplus in first quarter of 2022, financial outflows amid flight to quality,
high inflation, domestic oil production constraints and security concerns weigh on the availability of foreign exchange liquidity. The
central bank’s provision of foreign exchange has diminished, while depreciation pressures on the currency have emerged.
Higher international crude oil prices have improved Nigeria’s current account balance, albeit not as much as it could have in the
absence of oil production constraints. Nigeria’s crude oil production averaged 1.3 mbpd in the first quarter of 2022, 20% lower than
the average production of 1.62 mbpd in the first quarter of 2021. The current account surplus rose to $2.6 billion in the first quarter
of 2022 from an average of $935 million in the previous three quarters, thanks to higher crude oil exports, up 35% compared to the
average of the previous three quarters to $13.5 billion. Because Nigeria imports refined oil, which is then sold domestically at a much
lower price, oil imports have also risen, but at a slower pace than oil exports, growing 20% in first quarter of this year compared to the
average of the previous three quarters. Consequently, net oil and gas exports rose to $11.1 billion in first quarter of 2022 (10% of Q1
2022 GDP) from an average of $7.9 billion over the previous three quarters.
Dangote refinery will improve Nigeria's current account modestly when fully operational. Substituting imported refined petroleum by
domestic products will save current transport cost and other related costs on an import bill that reached $14 billion in 2021. Indeed, while Nigeria would no longer need to import refined petroleum, it would also lower the country's export of crude oil since a part of the production would be used domestically.
Net financial outflows in the first quarter of 2022 exceeded Nigeria’s current account surplus, driving foreign exchange reserves down by $884 million. We estimate outflows amounted to $3.5 billion, and consisted of i) net purchases by Nigerian residents of external financial assets ($4.2 billion), which was only partially offset by higher net liabilities ($3.3 billion), resulting in net financial outflows
of $1.7 billion and, ii) errors and omissions amounting to $1.8 billion of outflows, which we assume relate to financial transactions.
Nigeria’s errors and omissions of the balance of payments (BoP) tend to be negative, having averaged $1.1 billion on a quarterly basis since the start of 2017, meaning that outflows are underreported if we do not take errors and omissions into account. While small relative to the size of the economy, they are large relative to the other items of the BoP

At the Nigerian Autonomous Foreign Exchange Rate Fixing (NAFEX), the naira depreciated to 427 Naira/USD at the end of July from 416 Naira/USD in January. However, in the parallel market, which represents about 5% of the total foreign exchange market according to data from the central bank, the depreciation has been much sharper, with the Naira depreciating to more than 700 Naira/USD.
The controlled deprecation of the currency (see Exhibit 5) and widening gap between official and parallel market rates is largely a reflection of dollar rationing by the central bank. The Central Bank of Nigeria sold $4.86 billion at various windows of foreign exchange in the first quarter of 2022, according to the Economic Report for Q1 2022. This is 5.8% lower than in the previous quarter. The average size of transactions at the Investors and Exporters’ (I&E) window was 36% lower than the previous, suggesting lower liquidity
at the window