Borrow and spend wisely!

We endorse the expansionary fiscal stance of the FGN since it underpins the prospect of lifting the economy out of recession this year. This is the hope of the authorities as well as a plausible independent view, which happens to be our own. Caution is warranted on two grounds. First, the quality of spending and the value for money has to be better than that of previous administrations. Second, the expansionary stance must have a limited life span if the burden of domestic debt service is not to suffocate the economy and take the said “crowding out” of lending to the real economy to a new level.

The data release for end-2016 from the Debt Management Office (DMO) shows that this burden has soared from N354bn in 2010 to N1.23trn in 2015. Domestic payments account for more than 90% of total debt service because the FGN’s external obligations are predominantly loans from multilateral and bilateral agencies, and far less costly than its domestic borrowings.

The DMO’s medium-term debt strategy seeks a 60/40 split between the FGN’s domestic and external borrowings, compared with the 76/24 blend at end-2016, but that is a detailed subject for another day. The Eurobond roadshow in February was a great success because it told the story of Nigeria’s healthy external balance sheet.

Total debt service last year reached 35.4% of projected total FGN revenue. The ratio is particularly alarming because revenue collection has been so poor. The slide in the oil price since mid-2014 has highlighted the derisory level of non-oil tax collection. The FGN has a number of initiatives in place to boost this level. However, we urge patience. There are some quick wins to be had from closing loopholes but these are small in relation to the challenge of engineering change in the culture of paying tax.

The Economic Recovery and Growth Plan 2017-20 has the total debt service/total FGN revenue ratio rising further to 38.1% in 2018 before easing a little to 34.5% at the end of the plan period. There are two reasons for this forecast trend. The plan does assume stronger tax revenues and tighter spending control so that a primary surplus (before the deduction of interest payments) is posted from 2019. It also shifts the weight of deficit financing from 54% domestic this year to 66% external in 2018, and 72% in 2020. We would welcome such a shift.

Projected domestic financing of the budget deficit is set in the 2017 budget proposals at N1.25trn. Essentially this requires the DMO to raise the funds from its monthly auctions of FGN bonds. It has started the year well by raising N535bn (gross) from just three auctions and so maintained its best practice of front-loading issuance. (In 2016 it could “afford” the auction in December to be a flop because it had already reached its funding target for the year.)

In time the DMO could come to depend less on the auctions due to the development of other domestic funding sources. The new FGN savings bond for retail could be one such route. However, the 13.01% coupon for the first issue of two-year paper last month did not attract the crowds and generated sales proceeds of just N2bn. The DMO naturally wants to keep the FGN’s borrowings down but also wants to diversify funding sources. Other routes under discussion are Nigeria’s first “green” bond and first sukuk (Islamic bond). Looking further ahead, the dependence on the auctions will lessen with the more rigorous management of the public finances.

The question of “crowding out” is not as straightforward as sometimes indicated. The bid at the bond auctions is dominated by the PFAs, which do not have the alternative of direct lending to the real economy. The banks prefer to buy NTBs at yields of 22% and more for the longer tenors than lend to companies with unconvincing credit stories. This choice is the easy option in terms of management time but also meets a day-to-day funding requirement. Loans-to-deposit ratios show that banks could lend more to the real economy and buy NTBs: this is not strictly a case of “crowding out” but a reflection on the flawed skill-sets of banks’ lending officers and, currently, on the fragility of the broader economy.

As a postscript, we should note that the DMO’s data release for end-2016 was not all bad news. We learnt that the FGN’s total debt stock, domestic and external combined, amounted to 14.9% of GDP, which compares very well with Nigeria’s sovereign peers with B+/B credit ratings. The ratio for the public rather than the sovereign debt stock would be about 25% after making generous allowances for the domestic borrowings of state governments, AMCON bonds, the obligations of the NNPC and other public agencies, and FGN debts of N2.2trn unearthed in December by audit by the federal finance ministry (but not covered in the DMO data). This comparison also flatters Nigeria: ratios of 50% and above are prevalent among its peers.

Gregory Kronsten

Head, Macroeconomic & Fixed Income Research FBNQuest