Revenue Slippages Deepen Fiscal Conundrum

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Saturday, August 20, 2016 01.55 PM / ARM Research

We delve further into the domestic policy review in ARM’s core strategy document – the “Nigeria Strategy Report H2 2016”; looking at the fiscal picture over H1 2016 and the outlook on same for the rest of the year.

After months of legislative and executive wrangling,  President Buhari assented the 2016 budget which proposes fiscal spending of N6.06 trillion (+21% YoY) in May 2016. However, the concerns raised in our H1 16 strategy report that revenue projections, particularly for non-oil, appear optimistic in light of current realities have materialised, with actual receipts in Q1 16 significantly below budget targets. Despite the weak fiscal receipts, the budget was 81% implemented in Q1 16 but, as in prior years, the skew was in favour of recurrent expenditure which accounted for 91%.

For state governments, the lower receipt cut Q1 2016 federal allocation by 34% to N380 billion which, annualised, is 26% of cumulative state government budget for 2016 and covers only 60% of recurrent expenditure for the year. Unsurprisingly, the fallout of the revenue shortfall was another bout of salary backlog that resulted in strike actions in certain states. The dire fiscal position of state governments forced the FG to announce additional N90 billion bailout programme for states, just months after the N300 billion salary bailout. However, unlike the prior bailout, the FG attached 22 conditions targeted at reforming public financial management at state government level over the next year.

Over the rest of 2016, we expect revenue pressures to persist despite the upside from the depreciation in currency. On the oil front, the still bearish outlook on oil prices (H2 16 estimate: $35 - $40/bbl) and sustained spate of attacks on oil installations should level oil output below target. Similarly, we think each major component of non-oil receipts—VAT, CIT and Customs—will continue to underperform target over the rest of the year. Overall, we have cut our prior estimates for non-oil receipts to 60% of projections (N2.5 trillion) from 70% previously, which combined with oil receipts should cumulate to federally collected revenue of N4.02 trillion for 2016 (40% lower than budget projections).

Budget passed after political impasse

After months of legislative and executive wrangling on the 2016 budget, President Buhari assented to it in May 2016. The budget which proposes fiscal spending of N6.06 trillion (+21% YoY) is slightly lower than the version submitted to parliament in December (N6.07 trillion) due to minor revisions to capital spending (-1% from prior). On the revenue side, the National Assembly made no changes to projections for oil (of $38/bbl for oil prices and 2.2mbpd for production) and non-oil receipts which kept FGN retained revenues at N3.85trillion (+35% YoY).

Consequently, the expansionary FGN budget deficit is largely unchanged at N2.2trillion (2.14% of GDP) and is still to be primarily (~80%) financed via borrowing, split almost equally between the domestic credit market and foreign, as well as proceeds from misappropriated funds (16%).

Nigeria’s revenue shy of budget estimates by wide margin
The concern we raised in our H1 16 strategy report that revenue projections, particularly for non-oil, appear optimistic in light of current realities have materialised, with actual receipts in Q1 16 significantly below budget targets.

Specifically, federally collected revenue which dipped to a 30 quarter low of N1.3 trillion (-40% YoY) in first quarter of 2016 is ~35% below projections, with underperformance of non-oil receipts the bigger driver. Non-oil receipts fell ~40% short of projection to N602 billion (-28% YoY) due to lower than estimated VAT, corporate taxes and custom duties. However, given that these components were largely flat YoY, the shortfalls were indeed symptomatic of the aggressive assumptions. That said, oil receipts also fell shy of estimates (-24%) as average oil prices ($35/bbl) and output (2.1mbpd) were both ~8% below estimate. While the dip in oil prices continues to reflect the pressure from lifting of Iranian nuclear sanctions in January, lower output was due to the closure of Forcados export terminal following vandalism that resulted in deferral of nearly 380kb/d of oil export. Indeed, following the closure, oil output dropped to 1.9mbpd in March 2016, the lowest level since April 2009 when pipeline attacks were also elevated).

Table 1: Q1 2016 federally collected revenue (N billion)

Source: Budget Office, MTEF (2016 – 2018), ARM Research


TSA implementation fails to bolster FG’s dwindling revenue profile
As expected, the soft federally collected revenue filtered into the Federal government’s retained revenue (N500 billion in Q1 16), but it was the 90% shortfall in FGN independent revenue—which is projected to account for 40% of FG revenue in 2016—that primarily underpinned the nearly 50% shortfall from FGN budget projections. Quite frankly, given implementation of the TSA late last year, we were a bit sanguine on the FG independent revenue and thus assumed the 2016 targets were achievable despite implying a twofold increase relative to prior years.

However, the Minister of finance noted that a huge portion of the N3 trillion in the TSA have existing commitments, like JV cash calls and FAAC, and thus not available for budget implementation.

Despite the weak fiscal receipts, the budget was 81% implemented in Q1 16 but, as in prior years, the skew was in favour of recurrent expenditure which accounted for 91%. Reflecting higher-than-estimated non-debt recurrent spend, cumulative recurrent expenditure overshot Q1 16 budget estimate by 18% while only half of the capex budget was implemented. Consequently, reflecting the revenue short fall, Q1 16 fiscal deficit came it at N725 billion—32% higher than projections or just at the 3% of GDP threshold when annualised—primarily financed with short and long-term borrowings of N450 billion.

Figure 1: Federal government budget implementation

Budget Office, CBN, MTEF (2016 – 2018), ARM Research

Sub-national governments wallow in financial distress

 

For state governments, the lower receipt cuts Q1 2016 federal allocation by 34% to N380 billion which, annualised, is 26% of cumulative state government budget for 2016 and covers only 60% of recurrent expenditure for the year. Unsurprisingly, the fallout of the revenue shortfall was another bout of salary backlog that resulted in strike actions in certain states. The bad shape of state governments’ finances highlights their over-reliance on the central purse for budget implementation which is reflective of poor internally generated revenue. On the latter, using 2015 IGR numbers, we find only 11 states of the 36 states of the Federation with IGR of 10% of 2016 budget.

Figure 2: IGR to 2016 expenditure ratio for subnational government

Source: OAGF, ARM Research

FG looks to instil fiscal discipline with conditional bailout
The dire fiscal position of state governments forced the FG to announce additional N90 billion bailout programme for states, just months after the N300 billion salary bailout. However, unlike the prior bailout, the FG attached 22 conditions targeted at reforming public financial management at state government level over the next year. The conditions which are contained in the Fiscal Sustainability Plan for Sub-National Governments in Nigeria border on promoting accountability & transparency, managing cost, increasing public revenue and facilitating sustainable debt management.

Amongst other things, states that access the bailout will be required to publish audited annual financials and quarterly budget implementation report. In addition, such states are required to implement versions of some of the on-going reforms at the Federal level, including the Treasury Single Account (TSA), biometric capture of personnel to eliminate payroll fraud, creation of efficiency units and domestication of Fiscal Responsibility Act (FRA). Furthermore, states that access the facility will be barred from obtaining commercial loans and are required to set realistic and achievable targets to improve internally generated revenue as well as certain ratio of capital to recurrent expenditure.

The Federal Government will encourage States to access funds from the capital markets for bankable projects and issue “Fast-track Municipal bond” guidelines to support smaller issuances and shorter tenures. The biggest plus we see is the potential to develop a municipal bond market as state governments will now have to attain and maintain credit ratings. Already, revenue pressures are forcing states to implement these reforms, with more than 6 States already with TSA and over 10,000 ghost workers taken off payrolls of states. Assuming average wage bill of N30,000, that number translates to payroll expenditure savings in excess of almost N4 billion annually.

Fiscal pressures to persist across tiers of government
Over the rest of 2016, we expect revenue pressures to persist despite the upside from the depreciation in currency. On the oil front, despite the nearly 80% recovery from the 13-year trough of late January 2016, prospects for widening global surplus leaves our H2 16 target ($35 - $40/bbl) around the budget benchmark ($38/bbl). For output, the spate of attacks on multiple oil installations suggest outages elsewhere will trump expected recovery in volumes on completion of the Trans Forcados slated for July 2016. The foregoing should level oil output below target. Notwithstanding the pressure on both sides of the oil equation, adjusting for potential increase in naira inflow could push 2016 oil receipts to N1.9 trillion—about 11% above budget estimate. Similarly, we think each major component of non-oil receipts—VAT, CIT and Customs—will continue to underperform target over the rest of the year. Specifically, shrinking disposable income as a result of high inflation should translate to broadly weak corporate sales and ultimately earnings. This prognosis suggests that shortfall of VAT and tax receipts will continue to underperform, particularly as the value from widening the tax net might be minimal under current macroeconomic headwinds. For customs, the contraction in import bill (-30% YoY) year till April due to depreciation of the naira and dollar illiquidity should extend over the rest of the year and ultimately keep custom duties soft. Overall, we have cut our prior estimates for non-oil receipts to 60% of projections (N2.5 trillion) from 70% previously, which combined with oil receipts should cumulate to federally collected revenue of N4.02 trillion for 2016 (40% lower than budget projections).

FG to post record deficit on full implemented budget
For FG independent revenue which was 90% shy of Q1 16 estimate, we have cut 2016 projection by half to a still optimistic— in view of actual receipts in the three preceding years—N750 billion. As a consequence, we now expect fiscal deficit of N3.4 billion on a fully implemented budget (vs. N2.8 trillion earlier). Given that fiscal deficit to GDP is in excess of 3% recommended in the FRA 2007, our prognosis implies that the 2016 budget is unlikely to be fully implemented, with the discretionary capex spend aimed at reflating the economy likely to get the short end of the stick. Furthermore, the fact that the FG‘s revenue projection is only 60% of recurrent expenditure implies an extension of the practice in which sizeable portion of the 2016 borrowing will be for consumption. Regarding funding sources, though the domestic leg is running 9% ahead of offer, we see scope for quicker ramp-up as the FG desperately aims to deliver on campaign promises. On the external leg, we see modest possibility for sizeable inflow as global uncertainty around Brexit continues to stoke risk aversion to emerging markets.

The position is much worse for state government where, using FAAC and 2015 IGR estimate, we find only 10 states able to meet recurrent expenditure as per 2016 budget, potentially leaving nearly N2.5 trillion in capital projects unimplemented. Overlaying with potential funding challenges at the FG and sub-national level, Nigeria stands to miss potentially N3.5 trillion in capital expenditure for 2016, a development likely to worsen aggregate demand expenditure and ultimately output growth.

Table 2: 2016 federation revenue budget vs ARM estimate

Source: Budget Office, MTEF (2016 – 2018), ARM Research

Figure 3: Ability of state governments to meet 2016 budget recurrent expenditure

 

Source: Budget office, Ministry of Finance, ARM Research

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