Infrastructural development is a major source of capital formation for growth sustainability. However, when there are domestic resources constraints to support required infrastructural development, borrowing and debt accumulation become inevitable. But countries are guided by debt sustainability framework as continuous borrowing and debt accumulation can be detrimental.
For instance, Nigeria’s debt is currently N46 trillion and with the CBN ways and means to the FG, it is approximately N70 trillion. This is amidst the rising government spending that is mostly procyclical than countercyclical when global monetary policy is contractionary to combat inflation.
This becomes more worrisome with the global concern for funding squeezes arising from increasing global interest rate that makes cost of external borrowing unbearable. In this article, I present a critical diagnosis of the current debt sustainability concern for the new government to avoid the previous governments’ mistakes.
Let me put my discussion in perspective by providing conceptual clarification to Debt sustainability. In debt sustainability analysis, there are two important areas: solvency and liquidity. Debt stock ratios relative to repayment capacity are indicators of solvency while debt service ratios are indicators of liquidity.
The new government may need to set up economic intelligent unit to give room for proper policy scenario analysis and rule on the platform of meritocracy and honesty to reposition Nigeria
Thus, government debt is sustainable if the present value of its current and future primary expenditures is less than the present value of its current and future stream of income. This indicates that projected debt ratios are either stable or declining overtime. Simply put, debt cannot grow faster than income and capacity to repay (revenue).
In 1999, Nigeria’s debt service-revenue and debt-GDP ratios were just 5.0% and 61.0% respective but at the end of President Obasanjo’s regime in 2006, these ratios stood at 14.0% and 7.3% respectively. The pattern of these trends in this regime is connected with the debt forgiveness secured. At the end of President Yar’Adua’s regime in 2010, these ratios stood at approximately 14.0%and 8.0% respectively.
But in 2015 when President Jonathan’s regime ended, these ratios had reached 39.0%and 14.1% respectively and at the end of President Buhari’s regime in 2023, the ratios peaked at 91.0% and 24.0% respectively. The Buhari’s regime however experienced two recessions occasioned by external shocks and thus in controlling for business cycle, the ratios are moderate though they will still be rising considering current spending pattern and cost of governance.
These rising trends in these ratios are at variance with the debt sustainability concept, which expects the ratios to be stable or declining overtime, else it is an indication that the country’s debt is growing faster than income and capacity to repay.
With a lag effect, borrowing is expected to spur economic activities overtime and by implication results in increased output and revenue generation since revenue is a percentage of output. Thus, the ratios are expected to be constant or declining.
Furthermore, Nigeria’s debt was approximately N3.4 trillion in 1999 but at the end of President Obasanjo’s government, it declined by 34.0% to N2.2 trillion mostly due to the debt forgiveness secured and this was a plus to the government. However, at the end of President Yar’Adua tenure, the country’s debt had increased by 138.0% to N5.24 trillion with an annual average borrowing of N1.01 trillion.
At the end of President Jonathan’s tenure, the debt increased by 157.0% to N13.45 trillion with an annual borrowing of N1.37 trillion. While the debt increased significantly in President Jonathan’s regime compared to President Yar’Adua, this is attributed to the 6 years as against 2 years of the previous regime.
However, it is still clear that on average annually President Jonathan added more to the debt with a difference of N0.36 trillion as there was no serious external shocks during the period. President Buhari’s government moved the country’s debt to N46.25 trillion with a 244.0% increase and an annual borrowing of N4.1 trillion. However, this government experienced two recessions from external shocks.
If we control for business cycle due to the two recessions and place the regime on the same external conditions like the previous government, President Buhari would have added approximately N16 trillion instead of N32.8 trillion to the debt profile amounting to an annual borrowing of N2 trillion instead of N4.1 trillion. Thus, the total debt would have been N29.1 trillion at the end of his regime.
This implies that resolving the two recessions cost us roughly N17.2 trillion all things being equal. Expectedly, these previous 48 regimes borrowings should help to improve the economic conditions thus spurring private sector-led growth and significant revenue generation if they were productive spending that were countercyclical instead of procyclical due to uncontrolled cost of governance over the years. Else, the debt ratios would have been declining or stable overtime.
In 2005/2006 Nigeria’s external debt was roughly US$30 billion and President Obasanjo government secured a debt relief to the tune of US$18 billion. Unfortunately, at the end of 2022, our external debt peaked to US$41 billion thus surpassing the pre-debt relief values with over US$10 billion. In public debt discussion, there has been this common statement, “Nigeria has no debt problem but revenue challenge”.
This statement is incorrect from the debt sustainability conceptualisation above. When you have revenue challenge but your spending pattern is procyclical and not prudent enough then it is a recipe for unsustainable debt as present value of current debt and future expenditures will outweigh present value of future streams of income.
For instance, in 2015 federal government budget was roughly N5 trillion with a deficit of N1.5 trillion and by 2023, the deficit peaked to more than N10 trillion which is twice the 2015 budget when we claimed to have only revenue challenge. With this pattern of spending amidst revenue challenge which must be avoided by the new government, an analysis of the pattern will show unsustainable debt.
On May 29, 2023 President Tinubu took the bold step to remove the PMS subsidy which the previous governments struggled with. This is to free up resources for infrastructural development and reduce the big funding squeeze, as noted in a recent report by the IMF. I am in full support of the policy though this article is not to analyse the policy. However, one of the proposed palliatives, which is a US$800m World Bank loan for conditional cash transfer to the extreme poor is an example of procyclical spending.
This loan will add to the existing stock of external debt of US$41 billion that has US$10 billion above the pre-debt relief values irrespective of the fact that it is a concessional loan. The plan is to transfer N5000 monthly for the next 6 months to roughly 10 million households out of 133 million extreme poor. This is just 7.5% of the extreme poor population.
This will be an unproductive spending and mistake without proper scenario analysis to consider efficiency. For example, N5000 divided by 30 days is N166 per day which is far below the extreme poverty line of US$2.15 (approximately N1000). Unfortunately, the idea is to cushion the effect and spur aggregate demand for increased output. This will add to our existing stock of debt without spurring revenue generation to service the debt.
In debt dynamic analysis, there are six drivers to consider-real interest rate, real GDP growth, exchange rate depreciation, the previous debt stock and the primary balance. The primary balance is the deciding factor among them as it has the power to alter the direction of the remaining drivers.
Thus, the new government must take this seriously in policy decisions. Nigeria’s primary balance has always been in deficit over the years even in periods of stable and high oil prices. Unfortunately, this expansionary path, as against the contractionary monetary stance, has not yielded in improved economic conditions and stable business environment.
The current trend of primary balance (rising deficit financing in Nigeria) affects BOP position through income and interest rate channels and in most cases deplete our foreign reserves in Nigeria as the negative income effect outweighs the positive interest rate effect. Thus, this puts pressure on the exchange rate with a possible imported inflation from terms of trade shock and the net effect will be debt stock accretion. This shows fiscal policy procyclicality in Nigeria.
Despite this rising spending trend, Nigeria’s revenue-GDP ratio remained low amidst rising debt-GDP ratio. By implications, this is indicative of the followings:
· Rising cost of governance, perhaps spending on non-critical growth enhancing projects that should be avoided by the present regime because expansionary fiscal policy is expected to spur economic activities and invariably lead to revenue generation. This has not been the case.
· Leakages in both spending and revenue collection as evidence of a rent seeking system.
The economic cost of large deficits and rising debt-GDP ratios include: economic uncertainty and high inflation, intergenerational equity, crowding-out of private investment, repayment or refinancing risk, current account deficit, foreign reserves depletion and exchange rate risk.
With the rising funding squeezes and debt due to increased cost of external borrowing, innovative approach is urgently required to build domestic buffers in Nigeria through domestic resources mobilisation and a bold step to cut down the current cost of governance.
It is also importance to eliminate short-run binding constraints to real growth through a proper diagnosis of the mistakes of the previous 4 regimes to avoid toeing the same path. This demands efficiency of government spending to reverse the trend of current debt ratios.
The new government may need to set up economic intelligent unit to give room for proper policy scenario analysis and rule on the platform of meritocracy and honesty to reposition Nigeria on the path of sustainable growth and development.
I hope and believe that, with the bold strategy to removing the age long subsidies on refined PMS, curbing non-productive debt accumulations for a sustainable non-declining consumption and welfare that meets both intra- and inter- generational equity in terms of what good looks like in the short, medium and long term, Nigeria would be on the path to economic transformation.
Prof Eregha writes from the Pan-Atlantic University, Lekki-Lagos. +2348052350021, [email protected]