Nigeria’s Fiscal Imperative

Nigeria’s spending party must end

I started this series talking about how Nigeria needs a growth miracle and the gaps in this administration’s growth expectations. This is the third installment. You can proceed with this and read the other two later. If you find my articles useful, please share and subscribe!

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Source: State House

Nigeria is in a deep crisis. Inflation is high and rising, and people and businesses are suffering.

The truth is the pain Nigerians are experiencing today is largely due to the policies of yesterday. Without buffers, we were in trouble when oil prices crashed between 2014 and 2016, and policymakers believed they could spend their way out of it.

The past administration, led by President Buhari, undertook the most aggressive spending in Nigeria’s history. The spending was funded by debt, both external and domestic.

Their argument was that borrowing to fund infrastructure was important and the resulting growth will pay for the debt. I find this argument to be extremely popular, and true to an extent, but it is not compelling in Nigeria. 

First, most infrastructure projects are never fully completed or take too long to reach completion. Meanwhile, investors in government debt expect repayment from day one and don’t wait for projects to be completed. Secondly, we are good at building infrastructure not fit for purpose and where its value cannot be maximised. Think of the Airports Nigerian governors like to build. Finally, ambitious infrastructure spending plans are never realised due to poor budgeting which always overestimated revenues — when revenue suffers, infrastructure spending suffers in Nigeria. 

In reality, they borrowed to pay for everything a government spends money on, from salaries (and the increases) to all kinds of subsidies. 

They partied really hard. But there was no growth to show for it.

When you borrow and there is no growth, from which tax can be collected to settle debt obligations, misery ensues.

This is an account of Nigeria’s current debt crisis.

The Buhari Times: What did the FG spend its money on?

The Buhari led FG spent a record N82.3tn in eight years (2016-2023), compared to N35.0tn between 2008 and 2015. Contrary to claims that they prioritised infrastructure, total capital spending was a paltry 16.1%. 

The largest share of spending at 77.8% was on recurrent expenditure such as salaries, overheads and debt service (mostly interest payments to creditors). Recurrent expenditure was also much larger than overall revenue, at a ratio of 150.3%.

Please note that not all recurrent expenditure is bad. And, like I said in the opening paragraphs, not all capital expenditure provides value. In Buhari’s case, there is no evidence of value commensurate to both recurrent and capital spending.

The Buhari Times: Record Deficits Funded by the CBN

Fiscal deficit to GDP breached the 3.0% limit set by the DMO as the FG ramped up spending. This ratio averaged 3.2% between 2016 and 2023 from 1.5% between 2010 and 2015, and there was no consequence.

One might ask what the point of setting thresholds is in Nigeria. It is a meaningless exercise — there is no enforcer (legislators are servants to presidents), no consequences, only victims (Nigerians).  

The FG’s spending of N82.4tn was funded by sizable borrowings of N39.8tn, which made up 48.3% of all money spent.

The most troubling part of the debt story is that it was mostly funded by the CBN, up to 57.1%. When a central bank bankrolls a government, they encourage reckless behaviour because the government knows they can choose not to pay back the loan or the interest payments. 

It is a classic case of moral hazard. 

If the government relied solely on borrowing from the public through the debt market, they would not have borrowed that much because they have an obligation to repay.

The Buhari Times: How did Nigeria’s Debt Indicators Evolve?

The implication of the debt binge can be seen in today’s worrying debt sustainability indicators. 

Debt service (obligations to creditors) to revenue reached a peak of 101.1% in 2021, and this would have been worse if the FG fully paid the interest (MPR +3%) on CBN’s loans. The FG paid just 7.0% on CBN debt of N17.5tn in 2021 instead of 14.5%. 

Isn’t it interesting that a country as big as Nigeria spent more money on debt service (mostly interest payments, not principal) than it earned in taxes in an entire year? What paid for salaries, overheads, subsidies, and infrastructure? Business continued as usual. 

Debt service to revenue moderated to 72.9% in 2022 and to an estimated 66.9% in 2023. If I exclude GOE (Government Owned Enterprises) revenues, which the Budget Office only started including in 2022, the ratios for 2022 and 2023 would be above 80.0%. Again, if I include the true interest payments the FG should have paid to the CBN, it will be near 100%. The current debt service to revenue is probably worse given the FX volatility in the last quarter of the year, so we have to wait for DMO’s official figures. 

External debt sustainability has also worsened. External debt to exports increased from 23.4% in 2015 to 64.9% in 2023. After all, if you borrow in dollars, you must earn dollars to repay. Even worse is the current state of net external reserves which is estimated to be below $5.0bn or even negative. We pay around $2.5bn on external debt service yearly, so this shows that we are in some form of trouble. We are extremely lucky not to have significant Eurobond maturities in 2024.

Overall, Debt to GDP rose from 11.6% in 2015 to an estimated 38.7% in 2023. The debt figures for 2023 is yet to be released but it has not changed much. In fact, given that external debt is roughly 40% of total debt, 2024 numbers will be much worse. 

The Buhari Times: What are the consequences of all that debt binge?

The FG is walking a tightrope. We are back to Nigeria pre-1999. All the fiscal gains since then have been eroded. We are having the worst debt crisis since the military era.

In 2006, the OBJ administration took us out of a debt crisis (we repaid creditors $12.0bn) that led to credit rating upgrades. Fitch Ratings bumped us to BB- in 2006, but we fell to B- in 2023. With Moody’s, we peaked at Ba3 in 2012 and we were downgraded to Caa1 in 2023.

This basically means that we are now a riskier place to do business and we have not been this risky since 1999. It is now more expensive for Nigeria to borrow in global markets. By extension, it has become more expensive for corporates to borrow since their destiny is tied to the sovereign. Investors consider us more risky than we used to be, so they demand a higher risk premium to invest in Nigeria. Whether you are a startup or a large corporate raising financing, the FG has condemned you to expensive capital raises, both equity and debt. 

The new government has less fiscal space. FG’s Debt to GDP is already 38.7% and the DMO threshold is 40.0% for all governments (FG, States and LGs). The room to borrow to spend is more or less shut, unless they intend to continue the indiscipline. 

This means spending on infrastructure, education, health and subsidies will be affected. 

The miracle of the debt forgiveness of 2006 was that it gave the FG a clean slate to rebuild and make impact. In fact, leaders of the political party that destroyed Nigeria’s finances attacked the FG for cleaning up our mess, insisting that we should have spent the money on infrastructure locally. Yet they were the biggest beneficiaries of the debt clean-up. They ramped up debt to build “infrastructure” and the outcomes were devastating. 

Now, they must do the hard work of restoring Nigeria to a more sustainable debt path.

Renewed Hope or More Misery? The Fiscal Challenges Facing the New Government

It is clear that business cannot continue as usual. To clean up fiscal finances, the FG must spend and borrow less. They must also commit to more discipline by signaling an intention to restore and maintain thresholds on spending, borrowing and existing debt. Basically, spend less, borrow less, and ensure that the Debt to GDP ratio trends downwards. 

The new government started with a bang by removing subsidies. But while they took some steps forward, they took even more backwards. 

The earliest sign of the lack of seriousness is in the 2024 budget and, perhaps, the leadership of Nigeria’s Ministries. But let us focus on the budget, which is building on the reckless behaviour of the last government. 

Spending at N27.5tn is expected to be 60.0% higher than in 2023, and revenues are optimistic at N18.3tn (58.0% higher than 2023). Relative to GDP, spending and revenues will be an estimated 10.4% of GDP and 6.9% of GDP respectively, the largest since at least 2010. While one might argue that they might not eventually spend up to that, signalling matters and if the money is available they will spend anyway. 

Fiscal deficit or planned borrowing is a sizable N9.2tn, increasing fiscal deficit to GDP from 2.3% in 2023 to 3.5% in 2024. For a government that already has a huge amount of debt which it cannot pay for, this is going to raise the cost of borrowing further (even before we look at what the CBN intends to do). 

Without showing that they understood the fiscal issues facing Nigeria and were keen on tackling them, the market was always going to punish them. Fiscal reforms is not only about removing subsidies, it is about showing more restraint in all areas through a coordinated package of reforms. 

Unfortunately, as early reforms were not well complemented, the progress has now been undone. 

The huge FX depreciation and volatility we are seeing today is partly due to bad behaviour on the fiscal side. Now that the CBN is moving to tighten liquidity, which will make it more expensive to borrow, the FG is in more trouble. 

Restoring Nigeria to a Path of Debt Sustainability

For debt to be sustainable, the priority is to bring debt under control by reducing Debt to GDP and ensuring that debt service to revenue is affordable. The DMO set the limit for Debt to GDP at 40.0% and debt service to revenue at 50.0%. 

Considering how bad things are now, the government will continue to borrow. Obviously, they will not be able to pay salaries, pay obligations on existing debt and fund infrastructure if they do not borrow. 

However, the most practical way to reduce Debt to GDP is to do less of a certain kind of borrowing. The fiscal deficit roughly determines government borrowing but there is the primary deficit that tells us how much government is borrowing to fund non-debt items such as salaries, overheads and infrastructure.

To reduce Debt to GDP, the FG must run a primary surplus such that new borrowings will only be repaying debt service. Debt service is based on historical borrowings, which the government cannot do anything about. To contain it in the future, the government must not borrow to spend on salaries, overheads and infrastructure. Recall that spending on these items is what led to the debt crisis in the first place. 

In mathematical terms, the path of Debt to GDP in the future is determined by the interest rate on government debt (r), primary deficit (or surplus) to GDP, existing Debt to GDP, nominal GDP growth (g). 

It is basically [Debt to GDP * (1+r)/(1+g)] + primary deficit, if we assume there is no foreign currency debt. The thinking behind this is that r, which is interest payment on debt, continues to increase Debt to GDP. Meanwhile, g, which is nominal GDP growth, makes debt cheaper. This is why I complained earlier that when there is no growth, there is weak debt affordability. The primary deficit, of course, expands Debt to GDP. 

The r-g differential is extremely popular as what the government should monitor for debt sustainability. When r > g, it is not good, and Debt to GDP tends to increase. When r < g, which is a negative differential, then Debt to GDP can moderate over time. However, this eventually depends on what is happening to primary deficit, which is very important.

If there is external debt, the extent of currency depreciation and the share of external debt are important determinants of Debt to GDP. The equation below expands on the earlier equation to include this effect  — it is roughly derived, so please manage it. 

The Structure of FG’s Debt

Before we explore scenarios, it is important to understand the current structure of FG’s debt. Based on my conservative estimate of 2023 debt stock, 42.0% is external debt which costs the FG around 5.8% annually. Domestic debt is 58.0% of total debt and it costs around 11.0% annually due to the low interest rate on CBN debt. 

Scenario 1.0: How Debt to GDP Evolves with no External Debt

Let us use Nigeria as an example and assume there is no external debt. 

The effective interest rate on the FG’s debt is roughly 11.0%, nominal GDP growth is around 11.5% historically, primary deficit is around 1.0% of GDP, and Debt to GDP is currently 38.7%. 

If we continue on this path in the next eight years, Debt to GDP will rise to 45.2%, which is well above the DMO’s 40.0% threshold for Nigeria.

Assuming that revenue at 5.0% of GDP is attainable in the future, debt service to revenue worsens to 99.0% from 80.0% currently. 

Scenario 1.1: The Sensitivity of Debt to GDP to Changes in Interest Rate, Nominal Growth and Primary Deficit 

We have not accounted for the responsiveness of Debt to GDP to changes in its determinants. 

Let us throw that in the mix. 

Below is a sensitivity analysis of how changes in interest rates, nominal growth, and primary deficit will affect Debt to GDP by 2031. 

Here you can see how more sensitive Debt to GDP ratio is to primary deficit than nominal growth and interest rate. Please note that we are yet to bring external debt and currency depreciation into the equation. We are going to see the effects later, to truly understand how external debt in an unstable macro climate can be devastating. 

Scenario 2.0: How Debt to GDP Evolves with External Debt and the Impact of Currency Depreciation

Let us consider a more realistic scenario. We know we have external debt and we have a currency that loses considerable value over time. 

In scenarios 1 & 1.1, I did not account for the foreign currency component of debt and currency depreciation. The FG has sizable external debt at 42.0%, and depreciation will increase debt and also the interest payments on debt. 

In the first part of this analysis, I assume that all new borrowings will be Naira based. I assume that Naira debt will cost 13.0% on average. When the DMO rolls over debt and finances new borrowing, it will cost more at the current interest rates. This is why the government will be against interest rate increases and the CBN will be under political pressure. The CBN would be reckless if they listen as they enabled the debt crisis in the first place.

The same thing applies to the cost of external debt, even if we issue no new debt. Only that this will be worse because we need to refinance $7.37bn Eurobonds in the next eight years. Unless our debt situation improves before then, we might be in trouble (a possible default if there is no market access and strong FX reserves), or at best refinance at very expensive interest rates. Let’s start with 6.0% as the cost of external debt. 

Eurobond Maturities in the Next Eight Years

Now, let us look at how Debt to GDP will evolve by 2031 if the currency depreciates by a conservative 10.0% annually. 

In this case, Debt to GDP will reach 63.3% by 2031. Below is a sensitivity table showing you potential Debt to GDP scenarios if one variable changes. 

In this scenario, debt service to revenue will reach 135.1%

Scenario 2.1: How Debt to GDP Evolves with Sustained External Borrowing and Rising Interest Rates

What if the government continues to borrow in foreign currency? Let’s assume the new borrowings are 20.0% in foreign currency. 

The outcome in this scenario depends on the cost of external debt and currency depreciation. We know that it is currently more costly for the government to borrow, so let’s us assume that the cost of external debt rises to 6.5%. Also, let’s be more realistic and assume a 15.0% annual depreciation in the Naira. 

In this case, Debt to GDP will reach 79.4% by 2031. In this scenario, we can see how things can get out of hand very quickly if currency depreciation is significant and the cost of external debt marginally increases. 

In this scenario, debt service to revenue will reach 150.9%. 

To end this section, let’s combine all scenarios together for Debt to GDP and debt service to revenue.

Final words: Macroeconomic Stability and better Fiscal Management must be the Priority

In all scenarios, it is clear that the FG must become more fiscally responsible to contain the current debt crisis. 

This means running a primary surplus, where they do not borrow for salaries, overheads and capital expenditure. This is the only thing they can control in the debt equation. 

With interest rates going up due to CBN policy, borrowing locally will become more expensive. They have no control over that. Nor do they have control over growth, as a tighter monetary policy will weaken it, even if temporarily. 

This is not to say that the FG is powerless or without options. In the interim, they can seek to fight theft and restore oil production, which will boost oil exports and revenues. This will make debt cheaper. However, they have been sluggish on this front so I am not so optimistic. Long-term, attracting oil and gas investment will be critical.

That should be the strategy to raise revenue, not what would impose too much costs on businesses and households who are struggling. Neither should we rely too much on government agencies who prioritise revenue over service delivery. Customs is an example. 

What is also critical is that there should be reduced reliance on external debt. The FG has no control over global interest rates. Without macro stability, it can become very expensive as you can see in the scenarios above. The FG should seek to scale down the share of external debt in total debt to derisk the debt portfolio. Or at worst, seek concessional debt from multilateral organisations.

And just to be clear, the FG should stop borrowing from the CBN. The CBN has already lowered the cost of their loan to 9.0%, so that is a lot of reprieve. 

To make any difference in the next four years, this administration must be keen on ensuring macroeconomic stability. This means above average growth, low and stable inflation, and moderate currency depreciation.

It starts with spending less and wisely. The CBN’s efforts, even if they do mostly the right things, will be undermined by an irresponsible fiscal regime.