The money is on the table, take it!

The 2020 budget projects new external borrowing of N850 billion, and the objective is to raise the funds from concessionary sources for the lower interest rates and longer tenors. Any shortfall, the Debt Management Office (DMO) noted, can be raised from the market.  Warnings about the FGN’s total indebtedness can be heard in many quarters. In our view it should not hesitate to borrow from concessionary and market sources if it wants to transform the economy into a production-based model.

In 2016 the FGN had a similar strategy, only its multilateral partners were reluctant to lend to Nigeria. The World Bank would not disburse anything, and the African Development Bank released just $600 million of the $1 billion requested. This arose because the FGN requested budget support and therefore had to pass unspecified conditionality tests. It reportedly failed its exams because of objections to the CBN’s circular of June 2015 which listed 41 import items that would no longer have access to fx (other than through the parallel market). Now it is looking for external financing for projects, which, we understand, is not subject to the same tests.

It may be that the federal finance ministry will access project loans to cover the entire N850 billion. Timing is generally an issue however. The paperwork to secure such loans can consume much more time than, for example, the rapid process of tapping the Eurobond market. Additionally, we note that the FGN had an external borrowing target (also of N850 billion) in the 2019 budget but pushed it back into the current year because of the successful harmonization of calendar and budget years.

The argument for caution is based upon an analysis of the indicators and upon the FGN’s track record for deploying loan proceeds over many years. The debt stock ratio, even when we adopt a loose definition of public debt, is exemplary. It currently stands at less than 30 percent of GDP on a worst-case scenario that assumes, for example, that AMCON makes no more recoveries. Kenya’s latest comparable figure is 67 percent.

We should also address the issue of FX risk. As at end-September, the total public debt of the FGN and states combined was 31 percent external and 69 percent domestic. The external component was 41 percent commercial and 59 percent bilateral/multilateral on concessionary terms. Put differently, the FGN has $11.2 billion in commercial borrowings for a $350 billion economy (at the NAFEX exchange rate). This is modest FX risk by any criteria.

The weakest link in the credit story is, of course, the debt service ratio. Total debt service consumed 68.6 percent of the FGN’s total inflows in 2017, and 55.9 percent in 2018 according to the implementation reports of the Budget Office of the Federation. Purists may object to the measure of total inflows, which consist of retained revenue plus assorted extras and one-offs such as transfers from special accounts and exchange-rate adjustments.

Nigeria is moving in the right direction, albeit far too slowly. The increase in the standard rate of VAT takes effect from next month, and the National Assembly has passed legislation that will boost the tax take from the oil industry

The ratio is alarming, and reflects the dire history of tax collection in Nigeria. Gross federally collected revenue (i.e. for distribution to the three tiers) reached N7.1 trillion in 2017, equivalent to 6.2 percent of GDP. In 2018 it picked up to N9.6 trillion (7.5 percent). A frontier/emerging market should be generating more than 15 percent, and more than 20 percent if, like Nigeria, it produces commodities for export on a large scale that it can tax.

Nigeria is moving in the right direction, albeit far too slowly. The increase in the standard rate of VAT takes effect from next month, and the National Assembly has passed legislation that will boost the tax take from the oil industry. The mining of data for sharing between government departments and public agencies has started to pay off. More generally, coverage of the population will grow as financial inclusion rises. The ratio will also look better now that the borrowing rates on both FGN bonds and NTBs have fallen considerably in the last three months.

The wish list for improvement remains long, including: the removal of most tax exemptions; the strengthening of the judiciary to pursue tax defaulters and recover assets marked for confiscation; an increase in the remuneration of officials in the tax collection agencies: and education campaigns to encourage the payment of tax.

As for the second argument for caution in new borrowing, the record for productive use of loan proceeds is poor. The proceeds are often lost in funding recurrent spending. This, however, is not a reason not to borrow. Estimates of the infrastructure deficit vary: we have seen figures of $100 billion or more, or $10 billion or more per year.

The FGN’s capital spending amounted to about $5 billion equivalent in 2018. When we add contributions from the donor community, dedicated infrastructure funds and private equity, we are still well short of the annual requirement. The FGN therefore needs to borrow to cover the deficit: if it does not, it cannot transform the non-oil economy. Nigeria will remain a rent-seeking economy without the transformation.

If it chose, the FGN could tap the Eurobond market quickly and offer a decent case to investors, based upon its external balance sheet. This would fund overdue capital spending and put a better gloss on official reserves (as defined by the CBN). Investors have shown a little fatigue with issuers which have tapped the market regularly such as Kenya. Nigeria has not issued since November 2018, and there seems little doubt that an issue would be well received on competitive terms.

 

Gregory Kronsten