How reliable is Nigeria’s debt-to-GDP ratio?

In my article titled “of unpaid salaries and our public finance”, I did mention there are obvious flaws in the use of public debt-to-GDP ratio as a prudential limit indicator for public sector debt. I said that in passing with a view to attempt, at a later date, a broader analysis of the discourse essentially to highlight why less emphasis should be placed on the ratio as an indicator of the country’s capacity to meet debt obligations when due. Coincidentally, a few weeks after the article, the same view was rightly echoed by the immediate past Governor of the Central Bank of Nigeria (CBN) and now Emir of Kano, Mallam Sanusi Lamido Sanusi at a seminar organized by the Institute of Chartered Accountants of Nigeria (ICAN) at the MUSON centre, Lagos on the 2015 Federal Government budget. But there are those who are completely sold on the impregnability of this ratio, if my conversation with a few acquaintances is anything to go by.

True, debt sustainability must be quantified, one way or the other, and the use of debt-to-GDP ratio as an indicative threshold is fairly common but it is foolhardy to slavishly embrace and hype a particular indicator whose universal applicability is questionable, just because other countries have adopted it. This reminds me of an adage in my language which says that it amounts to an exercise in self-deception and in fact dangerous for a snail to willfully or ignorantly compare its stalked eyes with the horn of a cow lest it begins to indulge in self destructive adventures. This is precisely what we do as a nation when we compare Nigeria’s seemingly low public debt-to-GDP ratio with other countries as a justification for accumulation of unsustainable debt stock. The pertinent questions we need to ask are; is this ratio an absolute reflection of prudential debt capacity, should we even rely on the indicator in the first instance, is it in alignment with our economic realities and are there “home-made” ratio(s) which is/are internally consistent with our earnings profile that should be given equal, or even greater prominence as Debt-to-GDP ratio?

In all fairness, the Debt Management Office (DMO) adopts various parameters and scenarios to gauge Nigeria’s debt sustainability in line with the joint World Bank/IMF Debt Sustainability Framework for Low Income Countries (DSF-LIC). The problem, however, is that only one of the indicators is often hyped, usually for self-serving reasons mostly by government officials. The methodology adopted by DMO is pretty clear, it separates our national debt into fiscal (total public debt) and external debt blocks and applies GDP, revenue and export as denominators. What is however less clear is the rationale behind the use of GDP as the sole denominator for the fiscal block? The implication of this practice is that where domestic debt constitutes a larger or significant proportion of the total debt as is the case with Nigeria, the fiscal block indicator of debt sustainability (which is a more generally referenced quotient) may be grossly masked by the inadequacies of GDP.

Evidently, the main sources of public debt repayment in Nigeria are cash earnings from oil, taxes and investment. Of course, other debt repayment option include debt monetization. The source of debt repayment has never been GDP and never will. GDP, a monetary measurement of a country’s overall economic activity, does not equate cash and is not a reflection of government’s potential earnings capacity in the context of our structurally weak economy – Nigeria is essentially a “hydrocarbon economy” that is highly susceptible to volatility in commodity price, dominated largely by the informal sector and characterized by weak tax compliance and enforcement. Therefore, our debt repayment capacity is largely dependent on the benevolence of the global oil market. Equating Nigeria’s low Debt-to-GDP ratio with sustainable debt capacity is akin to a corporate entity that is supremely confident of its ability to meet debt repayment obligations solely on the strength of year on year profitability meanwhile its net cashflows from operating and investing activities are almost always negative- no investment to show for the negative cashflow from investing activities, remember.

Nigeria’s main source of earnings is oil revenue which accounted for 77% of government revenue between 2005-2014. Unfortunately, earnings from oil has dipped in five out of the last ten years, the worst being 51% drop in 2009 and has remained permanently within the negative corridor since 2012 thus underlying the vulnerability of the economy and debt repayment capacity to oil price.  Though, there is an upward movement in non-oil earning from 2007-2014, the growth rate has remained nearly flat and grossly inadequate to cover the cyclical shortfall from oil earnings in absolute terms. Conversely, Nigeria’s debt profile has experienced accelerated growth during the past ten years and the relationship between public debt stock and revenue in the last four years has been consistently negative and uni-directional – total debt stock is on a free ride up north whereas revenue is on a downward trend.

Therefore, the use of GDP as the basis for assessment of debt sustainability could be misleading especially where the size of an economy is rebased without any corresponding positive impact on government earnings. Consequently, exceeding the debt to GDP  benchmark is by no means a fool proof indication of threatened fiscal sustainability neither does a comparably lower ratio necessarily suggest fiscal prudence. Debt is a potential force for economic good but excessive debt constrains financial flexibility, limits government’s policy options, undermines price stability, has the capacity to slow growth, disrupts investors’ confidence and generally harmful to an economy. As a result, an oil-dependent public sector like ours requires prudent fiscal policy anchored on counter-cyclical spending to effectively manage the shocks embedded in the boom and bust of oil revenue.

In conclusion, beyond the wholesale adoption of the World Bank/IMF Debt Sustainability Framework for Low Income Countries (DSF-LIC), what the DMO could do is to constitute a technical study group with the aim of expanding the scope of debt sustainability assessment by using the same denominators employed in the analysis of external debt component for the fiscal block component as follows; Present Value (PV) of Total Public Debt to Revenue, PV of total Public Debt to Export, Nominal Total Public Debt Service to Revenue and Nominal Total Public Debt Service to Export, all under the three scenarios of baseline, pessimistic and optimistic. By implication, as part of the outcomes of the technical study, appropriate prudential limits would then have to be established for Nigeria’s peer group. In addition, because ours is principally an oil economy, it may not be out of place to compare Nigeria’s debt sustainability data with other major oil and gas exporting countries.

Ubohmhe G. Olowojaiye