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How long can Bond Vigilantes go quiet amid Nigeria’s spiralling debt pile?

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Data from the 2019 budget estimates shows that the Federal Government (FG) plans to spend N2.1 trillion to pay interest on the outstanding debt alone, equivalent to 24 percent of total spending and 5 percent higher than in 2018.

The overall 2019 budget deficit is estimated at N1.859 trillion which would be financed to the tune of N1.649 trillion by domestic and foreign borrowing.

For 2018 the FG budgeted to spend N2.01 trillion for debt servicing, while the budget also had an embedded N2.01 trillion deficit largely to be financed by domestic and foreign borrowings.

Nigeria’s debt service costs have skyrocketed over time, as total debt outstanding ballooned.

The Federal Government’s domestic and external debt is up about 73 percent to N18.9 trillion as at September 2018 from N10.9 trillion in 2015, according to the Debt Management Office (DMO) data.

The foreign borrowings grew spectacularly by 40 percent in the 1-year period between September 2017 and September 2018 to $21.59 billion from $15.35 billion, recent data from the budget office show.

While the Government often touts a comfortable debt to GDP level of around 18 per cent , government revenues were a paltry 6 per cent of GDP, as of September 2018.

Meanwhile there is no hint from the markets (yet) that Nigeria is nearing a debt dynamic that’s unsustainable.

Bond traders aren’t sending Treasury bills and bond yields through the roof to compensate for higher issuance of Government paper.

The theory goes back to the notion of “bond vigilantes,” a term coined in the 1980s to describe how debt markets could punish governments for economically irresponsible policies.

Benchmark naira and dollar denominated bond yields have actually fallen since January.

Following the February 26 announcement of a second term for President Muhammadu Buhari in the 2019 general elections, dollar denominated government bonds rose to the highest in 5- 7 months.

Average yields on benchmark 5, 10 and 20 year sovereign domestic bonds have declined since the beginning of the year by some 113 basis points from 15.4 percent to 14.26 percent.

Yields on the more widely traded and liquid Treasury Bills sold by the Central Bank of Nigeria (CBN) have also fallen. Last week the CBN auctioned 91, 182 and 364 day paper at yields between 10.75 percent and 12.84 percent, as against 11.9 percent and 15 percent in February.

The CBN eventually allotted a total of N89.5 billion which was significantly oversubscribed by investors to the tune of N200.17 billion, indicating a bid to cover ratio of about 2.2.

At its last monthly bond auction held in February, the debt management office (DMO), offered  three instruments of 5, 7 and 10-year tenors, with a total value of N150 billion, but received bids from investors in excess of N234 billion.

Clearly portfolio investors are bidding bonds and treasury bills to take advantage of high yields.

For offshore fund managers the appeal lies in the high real rate of returns or ‘carry’ they earn, even as they bet that the dollar/naira exchange rate will not see a major move in the next six months at least.

So should the Government and investors be so sanguine about the worsening fiscal situation in Nigeria and have bond vigilantes lost their power to discipline non-fiscally responsible states?

Not quite.

For one the failure of investors to force a shift in Nigeria’s government fiscal habits may be due to the out-sized real yields they can earn at a time when U.S and developed market interest rates are still at record lows.

The extra yield investors get to hold a 10 year Nigerian sovereign bond over similar tenor U.S Treasuries is close to 11.5 percent. Those are juicy real returns which some offshore investors will not mind risking some exposure to.

For domestic large and institutional investors such as Banks, Pension Funds, Money Managers and Insurance Companies, the dismal performance of the stock market over the past 4 years is an incentive to buy bonds, even if real returns are close to zero and have been negative in the recent past, with inflation still elevated at 11.3 percent for February.

However the Nigerian Government cannot keep running trillion naira deficits annually, financed by borrowing without hitting a brick wall soon.

The FGs total retained revenue as at September 2018, came in at N2.57 trillion, 52 percent lower than the N5.37 trillion, it expected to earn as at Q3, according to the latest budget implementation report from the Ministry of Budget and planning.

Total actual inflows, which include other financing sources, FX differentials and revenue from special accounts was N2.814 trillion for the 3 quarters, 47.6 percent less than was budgeted.

This compares to total debt service expenditure (domestic and foreign) for the period of N1.769 trillion, equivalent to 62 percent of revenues.

Total actual expenditure was at N5.329 trillion (as at Q3, 2018), leaving a fiscal deficit of N2.51 trillion, which was financed to the tune of N908 billion by domestic (N608 billion) and foreign (N303.58 billion) borrowing.

There is a N1.6 trillion expenditure line or deficit spending (as at Q3, 2018) for which the financing was not made clear in the budget implementation report.

We suspect some form of monetary financing of the fiscal deficit which would be a continuation of the CBN’s actions of recent past.

The idea that government debt can be financed by the Central Bank increasingly referred to as modern monetary theory (MMT) has been dismissed by most serious economists, and called a ‘dangerous proposition’ by the European Central Bank (ECB).

Nigeria’s low oil production per capita means the country cannot delay reforms any longer while it hopes for a rebound in oil prices.

Amid the surge in borrowing, the economy has barely budged as GDP growth declined from 2.5 percent in 2015 to 1.9 percent in 2018.

That should signal some warning bells.

It is pertinent to note when investors finally begin to fret over the possibility of hyperinflation and economic turmoil in Nigeria, due to excessive deficits, borrowings and monetisation of the debt, the currency (naira) would be the first casualty as they unwind positions.

In that sense as bond vigilantes currently look the other way they might just be buying us some precious time to get our fiscal house in order.

 

 

PATRICK ATUANYA

 

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