Elements of Nigeria’s borrowing decision

The Senate President, Senator Ahmed Lawan during a speech titled ‘Beholding the Silver lining in Nigeria’ delivered to mark the 2nd anniversary of the 9th Senate under his leadership, in an attempt to justify the approval for additional borrowing, provided what I will term political justification why Nigeria must keep borrowing. He pointed out that the National Assembly would continue to approve loan requests, which are for the provision of critical public infrastructure, which Nigerians cannot do without and for which the country had no choice but to obtain.

With this justification, NASS went ahead to approve the sum of $6.1bn bringing the country’s total loan stock to NGN107trillion (USD87.239billion) as of March 31, 2021.

Just as the NASS, the executive has attempted to provide a sort of technical justification by claiming that there is a lot of headroom between the country’s debt and the GDP, therefore, we can continue borrowing citing countries in Europe, America and Asia with little or no headroom but has continued to borrow. The Minister of Finance, Budget and National Planning, Mrs. Zainab Ahmed was quoted in 2019 as saying that “Currently, Nigeria’s debt is at N25 trillion; that is about $83 billion. And at $83 billion, we are just at 18.99%…so 19% debt to GDP. I hear people say Nigeria has a debt problem. We don’t have a debt problem. What we have is a revenue challenge and the whole of this government is currently working on how to enhance our revenues, to ensure that we meet our obligation to service government as well as to service debt.” A position she reconfirmed in February 2021 as being under 25% (i.e. debt to GDP ratio). The likes of the Minister of Works and Housing, Babatunde Fashola and other respected individuals have corroborated this position and stressed the need to continue borrowing for critical infrastructure.

In another twist, the world bank country director for Nigeria Dr. Shubham Chaudhuri, was quoted as saying during a panel session at a virtual public sector seminar organized by the Lagos Business School (LBS), that Nigeria’s revenue to gross domestic product (GDP) ratio is the lowest in the world. The Chief Economist for African Region, Albert Zeufack a few years ago was also quoted to have said: “What is good for Nigeria is that debt to the GDP ratio is still low but the debt to revenue ratio is already high”. This introduces another index, the revenue to GDP ratio.

I will attempt to draw a relationship between the three concepts of Debt to GDP ratio, Revenue to GDP ratio and Debt Service Coverage Ratio and the role each plays in making a borrowing decision. I will attempt not to bore you with too many technicalities and figures so please follow me.

Understanding Debt to GDP ratio.
The debt-to-GDP ratio is the metric comparing a country’s public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio reliably indicates that particular country’s ability to pay back its debts. It can also be interpreted as the number of years needed to pay back debt if GDP is dedicated entirely to debt repayment. The higher the debt-to-GDP ratio, the less likely the country will pay back its debt and the higher its risk of default, which could cause a financial panic in the domestic and international markets. The World Bank warns that if it exceeds 77% for an extended period of time, it slows economic growth by about 1.7% for developed economies. For emerging economics, it will only take an excess of 64% to slow economic growth by 2%.

It is therefore critical for an economy to grow at a rate faster than the rate of loss when its debt to GDP exceeds between 64% to 77% depending on the nature of the economy.

It is reported that Nigeria’s debt to GDP ratio is less than 25% so the fear of excess over recommended does not arise otherwise for an economy that grew at 2.2% in 2019 for instance, a 2% loss would have significantly wiped it out.

While the World Bank recommends a maximum of 77% to avoid negative growth, countries like Venezuela, Japan, America and the UK have consistently maintained a high debt to GDP ratio of 350%, 266%, 108% and 100% respectively. A country like America for instance have continued to borrow despite their debt to GDP ratio with countries like China and Japan leading the pack of lenders. Do you see why these countries will never quarrel with America? Nothing must happen to your debtor, as we say in Nigeria. You pray for him.

So it is easy for the above statistics to provide a technical justification for Nigeria to continue borrowing. Let us look at the next concept of Revenue/Tax to GDP and debt Repayment ratio

Understanding Revenue to GDP ratio
The tax-to-GDP ratio is the ratio of the tax revenue of a country compared to the country’s gross domestic product (GDP). This ratio is used as a measure of how well the government controls a country’s economic resources. The higher the ratio the more capacity a country has to invest in infrastructure, education, health etc. The world bank recommends an optimal ratio of 15% to guarantee key ingredient for economic growth and, ultimately, poverty reduction. According to Director-General, Budget Office of the Federation, Mr. Ben Akabueze, revenue to GDP for Nigeria is around 8%. This is about half of the world bank recommended optimal position to guarantee a good life. In 2019, Countries in the European Union had an average of 41.4%, America specifically had 24.5% while OECD countries had an average of 33.8%. African Countries like Algeria (33), South Africa (29), Morocco and Egypt had 26 and 21 respectively. West African countries like Cameroun (16), Ghana (14) and Cote d’Ivoire (20) are all comfortably ahead of Nigeria.

Debt Servicing Coverage ratio
The debt service coverage ratio, also known as the “debt coverage ratio”, is the ratio of operating income available to debt servicing for interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity’s ability to produce enough cash to cover its debt payments. For public debt, there is no recommendation by the world bank of an optimum ratio. However, countries are advised to play within comfortable limits. In personal finance in Nigeria for instance, DSCR must not exceed 33.3%.
Nigeria was reported to have spent 98% of its revenue on service debt between January and May 2021. This figure steadily increased from 2001 (11.96), 2019(59.6%) and 2020 (83%).

My Conclusion
Current indices may show that Nigeria has enough headroom to borrow considering its current debt to GDP ratio (less than 25% against the world bank recommended of 77%). However, a review and proper understanding of its debt servicing coverage ratio of 98%(May 2021) and revenue to GDP ratio (less than 8 against 15 recommended as optimal by the world bank) does not provide any rational ground to support the continued, insatiable propensity for borrowing. In order to boost the revenue to GDP ratio, the government may want to address the low hanging issues of oil theft that compromises the integrity of revenues from the oil sector, ensure completeness in ramping the revenue from gas sales, addressing income leakages in our solid mineral sector. The government should take control of the solid mineral sector to eliminate the influx of ghost players. The average family tax rate in America is 15.5% while that of Nigeria is 24%. America has a combined average top tax rate of 25.8 for corporations while in Nigeria it is 30%(excluding local government, communities etc.) Therefore, rather than consider using increase in tax as a tool to increase revenue, government should review the completeness and integrity of the process of collection of revenue. The number of leakages may as well be synonymous with the relationship that exists between our informal and formal economy size.

Government should refrain from being tempted to use only debt to GDP in isolation when making borrowing decisions but use a combination of Revenue to GDP which should serve as a valve and Debt Service Coverage ratio which should serve as a monitor alongside.