The ugly truth: Public finances on a precipice

On the basis of the most recent data available, Nigeria’s total public debt level appeared normal in 2015. The sum of both domestic and external debt of the federal government (the latter including the foreign-currency loans of the states guaranteed by the FGN) results in a debt burden representing 13.0% of GDP; this is relatively healthy by global standards. However, the ratio has likely increased since.

While the stock of public debt is modest, the FGN is aware of the rising cost of domestic debt service. This is the crux of the medium-term debt strategy prepared by the Debt Management Office (DMO) which was released in May 2016. The strategy aims for a 60/40 mix between the domestic and external debt obligations of the FGN because of the far higher cost of servicing the former. The blend has been 77/23 over the past several quarters.

As at end-June 2016, external debt accounted for only 18% of the country’s total debt stock of about N16trn, compared with the maximum of 40% agreed upon in the medium-term debt management strategy (2016-2019). Concessional loans (with estimated average interest rate of about 3.5% per annum) accounted for 80% of total external debt. Essentially, external debt-to-GDP stood at 2.2% as at end-June 2016; well below the international threshold applicable to Nigeria’s peers of 40%.

In terms of debt service, the annual external debt service expenditure over the past few years has been no more than 6.5% of the total public debt service. Understandably so, given that the FGN depends more on the domestic bond market as a reliable alternative source of borrowing to avoid overdependence on external sources.

The fiscal plan from the 2017 budget proposal results in a deficit of N2.36trn, which is about 2.18% of GDP. The deficit is expected to be financed mainly through borrowing. The FGN intends to source N1.1trn (or 46%) from external sources while N1.25trn will be borrowed from the domestic market.
Meanwhile, debt service is expected to hit N1.7trn. This accounts for 34% of projected revenue this year and translates into a huge drain from the government’s purse.

To assist in plugging the projected deficit, the FGN is in the process of issuing a new Eurobond worth US$1bn (its third on the international capital market). Although yields on existing Eurobonds are attractive, given the current macro challenges it is very likely that investors will demand a higher yield on the new issue.

Last year, Ghana, raised US$750m at a yield of 9.25%. The auction was five times oversubscribed. At the risk of sounding rash, Nigeria’s economic indicators are relatively stronger and as such should be able to lure investors into its new Eurobond.

Additionally, the launch of a diaspora bond of US$300m is underway. Hopefully, it offers competitive pricing so that it can raise more than proposed.
As for external borrowing from multilateral agencies, this remains a cheaper option given the concessional rates available. Last year, the FGN sought US$4.5bn of external borrowing but only managed to secure US$600m from the Africa Development Bank (AfDB). This AfDB loan is to be used for power generation and the construction of roads, railways and ports.

However, once this year’s budget is passed by the Senate, the FGN plans to apply for a US$1bn loan from the World Bank. If successful, this should, to a large extent assist with plugging the projected deficit in the budget.

Domestic borrowing is forecast at N1.25trn, and the FGN bond market will again shoulder the lion’s share of the burden. The DMO released its provisional issuance calendar for Q1 2017 last month. It seeks to raise between N340bn (US$1.11bn) and N430bn (US$1.41bn) from the sale of FGN bonds, with provisional issuance peaking this month. The total bid has fallen off markedly since mid-2016 but should be adequate for the DMO’s purposes this year.

The first auction of the year raised N215bn versus the formal offer of N130bn. Unlike December last year, the DMO set its marginal rates at highly attractive levels, approaching 17.00%, and so secured a good chunk of its quarterly funding target.

Notwithstanding, domestic institutions, particularly Pension Fund Administrators (PFAs), expect improved returns on bond yields relative to Nigerian Treasury Bills (NTBs).

On a separate note, given the mismatch between Nigeria’s GDP and revenue structure where the oil sector represents approximately 10% of total GDP but generates over 60% of the country’s revenue, it is worth noting that the debt service-to-revenue ratio would probably be a better measure compared to the debt-to-GDP ratio.

To buttress this point further, the weakness of the Nigerian debt story is the burden of its service and not its stock.
The FGN needs to be cautious with external debt purely on the basis of currency risks. Essentially, the volatility in the exchange rate implies that each time there is a massive depreciation of the naira, additional naira revenue is required by the government to service fx denominated loans.

As for domestic borrowing, a crowding-out of the private sector seems inevitable. Financial institutions will rather lend to the government and earn a risk-free return as opposed to lending to the private sector, thereby denying the real economy access to credit. This results in continued strain for the manufacturing sector, SMEs and general commerce, thus hampering economic growth.

Recently, Fitch revised the outlook on its B+ Nigeria sovereign rating for foreign and local currency long-term obligations from stable to negative. The agency acted in response to the prevailing fx illiquidity, and its impact on growth, public finances and the banking sector.
Chinwe Egwim
Macro-Economist & Fixed Income Securities analyst at FBN Capital