Debt overhang looms in Nigeria
In a recent paper by Brookings on the danger of accumulation of debt by African countries, he expressed concerns for African countries racking up debts. Sadly, Nigeria came to mind. While putting finishing touches to this article this morning, the news broke that the Nigerian debt has risen by N2.66trillion in one year! This translates to about $8.7.
It is a common prayer in Nigeria that ‘may we not leave debt for our children’. You will gauge from the chorus ‘Amen’ that that is seen as an important prayer. But is debt bequest a bad thing? Can we avoid it? If not, what sort of debt and how much of it can be left for the children? Finally, is Nigeria moving towards a debt overhang? Answering all these questions leads us to starting from understanding the concept of debt overhang.
Debt overhang, a phenomenon that applies to individuals, households, business entities and government alike, refers to a situation whereby even though new debt will improve the profile of an entity, it is unable to access it because the present level of debt is such that the benefits of additional debt is deemed to be subject to partial appropriation by the existing debt holders. A structural macroeconomic debt overhang is a condition where additional credit creation measures are engaged in to address an underemployment or output gap, the build-up of which leads to a debt overhang. It so happens that in most scenarios, the debt overhang is preserved by substituting one form of public debt for another and it keeps growing.
Debt overhang has various negative consequences. In the literature, its major consequence of serving as a disincentive for investment attracts my attention as a perspective. The importance of investment as a factor of economic growth is emphasized by the employment channel. Through the employment channel, investment enhances, not only productivity, but also the general welfare of the citizenry, thereby leading to economic development. But debt overhang hinders investments. For instance, an economic entity is forced to pass up investments that yield positive net present value (NPV). A positive NPV is a selection criterion for some projects and when profit-oriented entities have to pass up investment alternatives just because it does not have additional capacity to take up debts to execute such alternatives, opportunities to add value is lost. For a nation, this ultimately leads to a GDP growth that is less than its potential. The concern in this instance is Nigeria.
Not only is Nigeria the most populous black nation in the world, but also one of the world’s fastest growing countries in terms of population. Indeed, it is projected that we will have a population of about 400million by 2050. This growth is not peculiar to Nigeria. The whole of Africa which has roughly 1 billion in population today is expected to have grown to 4 billion by that time with Nigeria contributing its own quota of 10%!
Recently, Nigeria added $2.86b to its debt stock (November, 2018) thereby moving our total debt stock to about $76b. This is inclusive of states’ $11b+ portion of the debt. The tenor of this new debt are 7years, 12 years and 30years. With the life expectancy at birth in Nigeria, ranked at 178th in the world by the World Health Organization in 2018, currently at about 55 years for male and 56 years for female, most of the current actors in consummating this loan will not be alive by the time the last tranche is paid in 2048. That is if there are no restructuring. The truth is more are on the way when you project our debt profile. For instance, from a foreign-denominated loan portfolio of below $1b up till 1993 when we joined the loan-billionaire club, we have gradually trended upwards to around $76billion. The current foreign-domestic borrowing ratio profile is 86:14. The DMO has the mandate to tilt the ratio to 60:40. The idea behind this is to free up domestic funds available from competition between the private sector and the government. Apparently, the availability of government debt instruments which is almost always well over-subscribe tends to stifle the potential growth of the private sector with its pivotal growth implication on the economy when funds they can use are equally competed for by the government. The flipside to this mission is that rejigging the combination imposes more attention to dollar receivables over a long period as shortfalls may portend danger.
The concern for accumulation of debt is valid. If you review the trend, it is going up perpetually even when oil prices go up. Secondly, the debt to income ratio which measures the tendency for revenue to cover debt is also going-up and it is projected that in about 5 years, revenue will no longer be able to service debt. This, if it crystalizes is a dire situation as the international rating agencies will write our ratings down. Thirdly, there are some doubts about the total capture of our debt stock. What that means is that the debt-GDP ratio of about 18%+ which we currently refer to as a healthy level when compared to the estimated headroom of about 56% for countries of our development status, may be incorrect. If this is so and some local government debts and other uncollateralized debts have been excluded, then our current debt-GDP ratio may be incorrect and we may actually be nearer debt trap than we think. Lastly, there is a concern over our foreign exchange receivables over that length of time. Considering that over 80% of our current foreign exchange receipts come from oil, and developments in the oil markets particularly as it relates to transition to renewable energy, the implication on price in the future is anything but heart-warming.
In order to address our concerns, we need to note that the source of debt is budget deficit. For budget deficit to be bridged, there is the need for borrowing. According to the DMO, in the 2018 budget, there is a funding gap of over N2.1trillion of which N1.6t is to be met with domestic and foreign debts of N750b and N850b respectively.
Sovereign debt is an equivalent of financial leverage for a company. Just as this leads to growth for some institutions which think through, it can be an albatross for others who spend loans on frivolous things. Therefore, debt is not necessarily bad if it leads to development. Conversely, a low level of debt, debt/GDP ratio, such as 21.3% for Nigeria in 2017, is not necessarily good if the debt make-up is not justifiable. After all, since 1990, our highest point was at 75% in 1991 and lowest was 7.3% in 2008. For some countries, debt appears linked to economic growth and development. Cases in point are the US which has $19t in debt and is the largest economy in the world, and Japan, the third biggest economy in the world have debt/GDP ratio in excess of 250%. But the ownership of the public debt gives another dimension to the issue. As seemingly alarming the debt/GDP ratio of Japan is, less than 5% of that portfolio is owned by foreigners while only one-third of the American debt is owned by foreign countries.
Curiously, our current budget deficit looks like the subsidy for fuel. Whether we should and what level of subsidy the country can provide on fuel and the management of oil subsidy is a discussion for another day.
To make debt worth-while, we need to do a number of things. Firstly, it needs to be channeled towards investment as debt that are obtained to fund life-style or towards crass expenses or spending can be akin to smoking a stick of cigarette which gives satisfaction while smoking it but cannot be relied upon to give such satisfaction in medium time. Soon after, you feel like smoking another stick and the remnant you can see is the stub. Snugly tied to this point is that debts should also be project-targeted. For instance, the sum of $350m was specifically borrowed to enhance the Port Harcourt refinery in 1988. This involved the enhancement of production from 60,000 barrel per stream day (bpsd) to 210, 000 bpsd. This approach allows for ascertaining in specific terms the purpose of debts.
The process should not only be transparent, debts should be taken to build capacity. The return on investment should be undertaken. Only when the return is justifiable should such loans be taken. In order words, debts should be tied to project that are not only self-liquidating, but also such that will have multiplier effects on the economy. For instance, a 1995 study of the effect of software producer Microsoft on the local economy revealed that each job at Microsoft created 6.7 new jobs in Washington State, whereas a job at Boeing created 3.8 jobs.
Targeting such multiplier effects are critical.
A rigorous cost-benefit analysis and link to economic growth should be a pre-requisite for obtaining loans. For instance, it seems that over time, for us in Nigeria, there is a correlation between debt pile-up and poverty. Poverty seems to be perpetually increasing with these debts. In comparison, countries like China who had over 750 million poor people years ago now have just about 10 million in that category. This is in contrast with Nigeria with the number of poor people seemingly increasing on a yearly basis. And now, on the World Poverty Clock, 86.9million people live in extreme poverty putting Nigeria as the number one nation usurping India with a population that is more than 6 times Nigeria’s. This will continue to be so for as long as our GDP growth rate, currently below 2% falls short of population growth rate which is currently just below 3% per year which should put Nigeria as the third most populous country in the world by 2050. These two growth rates directly affect the per capita income of a country.
Allowance should be given for maintenance of projects. Currently in Nigeria, such allowances are either not given, not adequately given or consumed altogether with corruption. The maintenance culture is important for us to continue to reap the full benefits of our investment. All our refineries now operate below installed capacity because of this problem and we now find ourselves in the trap of importing what we have the capacity to produce.
A comprehensive plan is critical. Good projection about national budget deficit and projects will give option on timing of debts. For instance, the cost of debt for SA, obtained earlier in the year, is cheaper than ours. An important integral part of this is the institutionalization of a capital budget plan and framework which a new government should put in place within its first 6 months which will run for 3 years with serious accountability responsibility up to the highest level of the national assembly. In this new age of knowledge economy, know-where and know-when are increasingly becoming more important than know-how and know-what (mere facts!). The different timings for Nigeria’s foreign debt as well as that of South Africa this same year comes to mind. Whereas, South Africa obtained loan at 6% in May. Nigeria obtained loan at 9.75% in October. In the space of few months, there has been about 33% increase in the cost of debt. By implication, Nigeria has started a catch-up race with South Africa from Day One in terms of putting the project to use and should then have the potential of earning more in order to compete with the equivalent South African project. This scenario is needless if our administration has a better ‘know-when’ appreciation.
Tied to this penultimate issue is the growth rate of the economy. Comparing our cost of debt with economic growth rate gives a gloomy scenario. If we compare our economy that is expected to grow at 2% by year end with 9.75% cost of debt literarily means that whereas the Nigerian economy, to which the funds is applied will grow at 2%, we will add 9.75% in value to the lender of the funds, whether country or institution.
The engagement of the federal legislators by the populace is critical. The truth is that the total number of legislators in both houses, of 469, in conjunction with the executive, consummate this debts on our behalf. Once the budget is approved, it implies that the 200 million Nigerians have approved it. We need to see representation as a very serious business. The consciousness on the part of the electorates is currently missing. By some of the actions of the federal legislatures on budgeting, you find it difficult to argue that the consciousness on issues of debt is not also lost on the majority of them. We deserve the best people to take decisions at the highest level of consciousness and responsibility.
Waste and cost of governance are also too high in Nigeria. When we engage in needless debate about infrastructure as a major driver of growth which creates an enabling environment for businesses to thrive, we need to acknowledge that the level of waste and cost of governance is too high. This can be attested to by the mind-boggling level of appointments at all levels of executive and a wanton waste of resources. Eradicating waste and drastically reducing cost of governance will unarguably create a healthy headroom to allocate resources to enhance the level of infrastructure.
Expanding our revenue base is of importance. In alliance with the position of the IMF, our tax base may currently be adequate but not efficient as there are loopholes still to be blocked. This concern for an inadequate revenue base is founded in the fact that a budget deficit is inseparably attached to deficit budgeting arising from insufficient revenue to meet budgeted expenditure. For instance, as of May 2017, only 14mio people of 70million taxable Nigerians pay taxes. This means 80% of economically active and taxable Nigerians still evade taxes. Of the big five economies in Africa, Nigeria with the biggest economy, has by far, the least tax revenue to GDP of 6.1%. This compares with 26.9% for South Africa and 10.33%, 11.6% and 18.4% for Angola, Ethiopia and Kenya respectively. Even though this may be a reflection of poverty spread, the 80% of economically active Nigerians which are currently evading taxes shows that there is a huge room for improvement. This leakage adds to the leakage from the grossly under-taxed Nigerians. Again, to compound the situation, corruption cannot be taxed! The issue of tax structure is indeed a discussion for another day. When these tax leakages, which have multiplier effect are combined with the unjustifiable economic-rent- driven government concessions, there comes the inevitable realization that some of our sovereign debts are probably needless as a proper revenue capture would have made these debts unnecessary.
In conclusion, whereas an accumulated public debt in itself and a high debt/GDP ratio is not necessarily bad, the structure of ownership between domestic and foreign should be watched. Most importantly, how transparent the process is in addition to the economic justification of the debt, debt planning, the timing of the debt, paying attention to the revenue base of the country as well as dogged implementation of projects are of utmost importance. The rising debt service as a percentage of revenue which the DMO warned against in its recent Debt Sustainability Analysis (DSA) and which IMF warned as being extremely high at 63% before the last foreign debt, can only be reined in if in addition to the mentioned palliatives, our currency does not suffer depreciation. This looks like a tall order considering the current macroeconomic situation and outlook.
Morakinyo, lectures Economics at the Pan-Atlantic University, Lagos.