Moral burden of budget deficit financing through borrowing

Every business has its own hazard. A banker or financier is always faced with moral Hazard, which is amplified whenever he has to source debt to fund projects or budget deficit associated with public financing. The moral burden ranges from the purpose of the loan to the burden of repayment on the populace, especially the future generation of the country. The Minister of Finance can source loan but how is he sure the utilization will be towards programs or projects that will generate economic activities that can be ring-fenced towards future payments of the loan. She is not also sure that the projects will result into revenue earning assets, which will catalyze the economic growth or deliver jobs that will pull out substantial percentage of Nigerians out of poverty. The exchequer is challenged seriously, when he does not have fiscal control or when the budget function of government is not under his control. A situation, we currently have, in which budget department is no longer under the Federal Ministry of Finance. This can lead to a long drawn debate because different model operates under different economic jurisdiction. However, this is not the sermon for the present write up. The issue will have to be elevated at another time for all Nigerians to see.

President Mohammed Buhari had presented the 2016 budget proposal of 6.08 trillion Naira to the joint session of National Assembly with a plan to finance the deficit of N2.2 trillion by borrowing N1.84 trillion from domestic and foreign sources. Specifically, the domestic borrowing will be N984 billion while N900 billion will be from foreign sources. The debate generated after the presentation of the budget is whether the budget is based on Keynesian theory or not. There was also an excitement about non-oil source funding the budget irrespective of the fact that this source is just about 15 per cent of the 2016 projected revenue.

Other topical issues generated are the level of capital expenditure to recurrent expenditure and the expenditures devoted to the running of government. Other mundane budget rituals have dominated the academic and industry spaces, as well as the drink joints in the country. Of late, the needless debates have shifted to the disappearance of budget and reappearance of budget or the change of expenditure figures and other rituals without the change of budget baseline figure. The budget disappearance argument does not help the country because it is mere procedural, which a good relationship between Executives and Legislators should be able to handle. Our focus should be on the issue of functionality of the budget and how it can deliver the change highly desired by the Nigerians.

It took the Managing Director of International Monetary Fund (IMF), Ms Christine Largarde to visit Nigeria and focus the debate. Despite being diplomatic, she elevated the budget issues to a 50 feet level above the ground, boom!! At the risk of being misconstrued as attention seeking, the issues need to be discussed by all Nigerians.

First, is the availability of such debt financing, its sources and sustainability. The argument is not whether the country has headroom to borrow or not because Nigeria has the capacity, when you compare the debt to GDP ratio of some countries such as Japan which is at 224 percent, Italy at 128 percent, USA at 107 percent, France at 95 percent, UK at 90percent; South Africa at 44 percent, india at 66 per cent; Brazil at 61 per cent; Kenya at 50 per cent ; Ghana at 68 per cent. Nigeria is at 17 per cent, which means, there is still headroom to raise additional debt financing and the basis for the optimism expressed by the people in charge of finance.

The domestic borrowing of N884 billion will have to come from domestic capital market and someone could easily assume that this may not pose more challenges provided that the monetary policies of CBN during the year create market stability and bond yield that are favorable for domestic investors. However, it is doubtful this will attract foreign investors, who will rather wait for their Naira devaluation expectation to be met first, before bringing in their funds. An expectation that may never materialize as CBN continues to defend Naira because of spiral effect of inflation associated with devaluation of currency. The giddiness of the foreign investors is underscored by their concern on the liquidity of the foreign exchange market, which among other factors has led to the delisting of Nigerian bonds from the JP Morgan Emerging Market Index. Therefore, the local investors will have to bail out the government, if it has to realise its plan to finance the deficit through domestic borrowing. The Nigeria banks are very liquid and with huge amount of cash and near cash amount on their balance sheet. The cash reserve positions of these banks will also support the domestic borrowing but the moral issue is that this route will “crowd out lending” to the private sector and it will perpetuate high cost of borrowing in the system. The other major domestic investors are Pension Fund Administrators (PFAs).

As at October last year, the PFAs held N2.8 trillion in FGN bonds equivalent to about 56 per cent of their assets under management (AUM) indicating the additional potential to snap more FGN bonds, when issued. Also, last year, the Debt Management office (DMO) offered N858.220 billion bonds and ended up allotting N998.740billion, showing the high demand and patronage of government securities by domestic investors. However, the current level of the existing FGN bonds and repayment could become a major constraint to the 2016 debt financing; for instance, the holders of the Aug 2016s FGN bonds with a face value of about N560 billion will have to be repaid this year.

The N900 billion or its $4.5 billion equivalent foreign borrowing is where “the rubber meets the road” considering the fact that the country could only issue one billion Euro bond during its last sovereign bond outing despite the “better than now” foreign exchange earning capacity of its economy then, and the level of the cash reserve, then. Foreign investors will price these risks into the terms of the bond. It will be interesting to see if the country can raise up to $2billion or 1.5 billion euros under its foreign bond issuance program to finance 2016 budget deficit and also it will be interesting to know the borrowing terms. The implication of such is that the Nigerian corporates, who will subsequently approach the international bond market will take serious “whack” to attract monies under very steep terms.

Therefore, the country will have to look in the directions of the multilateral and bilateral development finance partners with favourable borrowing terms. This will take time for an economy that needs cash in the immediate and for optimal application of such funds to the sectors that deliver maximum positive impacts on GDP and that are capable of creating jobs. Where such sources are bilateral, the providers of funds, mostly insist on Export Backed Credit, in which the foreign countries handle the projects and brings in materials, equipment and labour. Such export credit facility does not deliver maximally on job creation to the borrower. The transparency and competitiveness of the procurement processes are also hindered, the possible reputational risks for a government that wears the “anti-corruption toga”. Unless, there are existing pipelines of such funding, the sheer size of $4.5 billion will be gruesome and almost impossible to raise or access from the international debt market. The government needs to start building the network of supports and begin to come up with deal “sweetener” to boost the debt issuance program and to improve the credit worthiness of the country. The sweetener will be in addition to the debt service reserve account created by the previous Minister of Finance and may have to come at a price.

Second, the debt servicing of such borrowing will have to be considered with its long-term sustainability. A situation, where the people will wake up one day and say “Oh God, how did we get here” should be avoided. Already, there is a provision of about N1.475 trillion in 2016 budget to fund debt service reserve account and for the payment of the obligations that will fall due this year. This is huge, when you compare the percentage to the total revenue of 2016 budget, it is about 25 per cent. It is currently greater than the non-oil revenue (taxes), which is about N1.45 trillion. It means our debt service coverage ratio based on non-oil re venue is less than 1.0 (<1.0x) and if the ratio is adjusted for free cash, it could be less than 0.75x. It means if there is a replacement of crude oil as a source of energy or crude oil becomes $20 per barrel, we may have challenges servicing our debt without crowding out the critical and mandatory expenditures of government. The debt to GDP ratio, could be favorable but the Revenue to GDP ratio of Nigeria is one of the least in the world. It is the non-oil revenue to GDP ratio of the nation that matters specifically, the revenue accruing to the government from the internal economic activities of the country such as taxes. Currently, the tax to GDP ratio of about 1.5 per cent is way below the average for the countries in our peer group. Our Fiscal Strategy on medium to long term must address this revenue penetration ratio and other salient issues. The investors or creditors will like to see these and no matter how complex they may be, the government official must explain in simple and clear terms to Nigerians in a manner that will make sense to the generality. As Jega has observed during the presentation of the keynote address of the celebration of BiodunJeyifo’s 70th birthday, “we should constantly strive to meet the challenge of understanding matters in their complex dimensions and then present them in simple terms for others not as professionally trained, or intellectually endowed as ourselves, to comprehend. Simple folks need to understand even complex matters in simplified terms amenable to easy comprehension. It must be one of the required roles of radical intellectuals to endeavor to make this happen (2016)”. Nigeria and the international supporters will need to see and understand the Debt Sustainability Plan backing up the budget deficit financing. Government will need to explain the impact of the borrowing on the long term basis and the projected improvement to the fiscal position of the country. Third, the issue of the cost of borrowing will also need to be addressed. It is expected that the cost of borrowing will be high considering the current US Government plan to exit the quantitative easing regime and the attending increase in interest rates. Our economy has also lost the foreign exchange earning capacity as a result of the dwindling price of crude oil in the international market and the current accretion of our foreign reserve by our uncontrolled appetite for importation, while dollar inflow dwindles too. Government will have to market the debt instrument seriously and think of additional incentives to the investors. . Dr Bolorunduro is the immediate past Commissioner of Finance, Osun State. To be continued.