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External Debt Sustainability: Impact on Nigeria

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Wednesday, March 28, 2018 /12:06 PM /FDC 

Nigeria’s external debt has more than doubled since President Muhammadu Buhari was elected in May 2015. External debt stock in June 2015 was $10.32bn, but by February 2018, it had increased by 102% to $20.85bn1. The Federal Ministry of Finance has been on a borrowing spree since 2015 and in 2017, borrowed up to $4.8bn2 from the international capital market. The rationale was that Nigeria needed to spend its way out of the recession, especially since government revenue from oil had declined significantly following the oil price shock of 2014.

Rationale for Debt - Driven recovery

It is not uncommon for governments around the world to embark on expansionary fiscal policy during recessions. During the five-quarter recession, Nigeria embarked on expansionary fiscal policy evidenced in the 2016 and 2017 Appropriation Acts. The 2016 budget was dubbed the “Budget of Change” with a proposed expenditure of N6.06trn, 34.9% higher than 2015. The expected revenue was N3.86trn with the planned fiscal deficit at N2.20trn (2.16% of GDP). In 2017, the budget was tagged “Budget of Recovery and Growth” with proposed expenditure of N7.44trn, revenue of N4.94trn and a fiscal deficit of N2.50trn (2.18% of GDP).

The crash in oil prices in 2014 and the domestic oil production shocks significantly hurt projected revenues, increased the fiscal deficit and further justified the need to borrow. During the period of low oil prices, the Federal Ministry of Finance borrowed significantly from both the domes-tic debt market and the international capital market. Domestic debt jumped by almost 50% from N8.40trn in June 20153 to N12.59trn in December 2017.

The Finance Minister justified the borrowing on the sub-optimal performance of revenue, the need to plug the fiscal deficit and the need to invest in infra-structure such as roads, railway transport system etc. More recently, the international borrowing ($5.5bn Eurobond) was aimed at refinancing maturing domestic debt which is more expensive than foreign debt. The objective was to prevent crowding out the private sec-tor in the domestic debt market. While the notion of debt-driven recovery is noble, it begs the question, “what is the role of fiscal policy during a recession?”

The role of fiscal policy during recession

During a recession, aggregate demand declines. This leads to a decline in aggregate output (GDP), an increase in unemployment and a declining inflation. The rationale for an expansionary fiscal policy during a recession is to create jobs, stimulate aggregate demand and, through the multiplier effect, engender growth. Although the 2016 and 2017 Appropriation Acts were nominally expansionary, in real terms, they were not (due to galloping inflation). The sub-optimal implementation of the budgets constrained the intended expansionary effect on the recession. Data from the Budget Office showed that the variance between budgeted expenditure and actual expenditure was (25.62%) as at September 20176 and (27.46%) in 2016 (full-year). Unemployment increased significantly during the recession despite the expansionary fiscal policy.

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Arguably, the most important policy that helped Nigeria get out of the recession was the introduction of the Investors’ and Exporters’ Foreign Exchange (IEFX) window by the Central Bank of Nigeria. The window allowed the exchange rate to be determined by market forces. This policy eased the acute foreign exchange (forex) short-age, soothed the frayed nerves of foreign investors and provided the much needed forex for manufacturers. The policy had a multiplier effect on economic activities and eased uncertainty about forex availability and price. This policy, together with higher oil prices in the global commodities market, peace in the restive Niger-Delta region and the strong performance of the agriculture sector, helped Nigeria post positive gross domestic product (GDP) growth in Q2’17, Q3’17 and Q4’17.

Ballooning Deficits and External Debt: Déjà vu?

Anecdotal evidence points to the fact that the main drivers of Nigeria’s recovery from the recession were largely non-fiscal policy factors. Given the state of the economy, the question remains: “What did we use all the debt for, especially the foreign debt?” The Finance Minister argued repeatedly about the need to borrow to plug the budget deficit, to invest in infrastructure and more recently, to refinance domestic debt. The Finance Minister recently stated that the Ministry of Finance disbursed about N1.3trn to capital expenditure in 2017.

Meanwhile, the Minister of Works, Power and Housing also recently stated that no projects were executed in his ministry in 2017. Data from the Budget office showed that in 2016, only N104.82bn was released and cash-backed out of the N1.48trn allocated to capital expenditure. The case was no different in 2017. As at September, only N377.02bn had been released and cash-backed, compared to the budgetary allocation of N2.174trn. The late passage of the 2016 and 2017 budgets and revenue shortfalls were contributory factors to the sub-optimal performance of the budgets. This indicates that the policy has not achieved its intended objective. That is, there are no jobs and/or new infrastructural projects to show for the huge debt. However, Nigeria’s debt has increased significantly, especially its foreign debt.

There has been growing criticism about Nigeria’s growing public debt in recent times.

However, the Finance Minister responded saying that Nigeria’s debt to GDP ratio at 22.3% in 2017 is conservative by international standards and offers room to borrow some more. While the debt to GDP ratio is indeed low as can be seen in the graph, more practical ratios, especially the debt service to revenue ratio and external debt to export ratio tell a different story.

During the recently concluded article IV consultation, the IMF stress tested Nigeria’s debt ratios and observed that public and external debt are vulnerable to oil price shocks and currency volatility. Nigeria’s rising external debt to export ratio suggests that total debt is growing faster than the economy’s major source of external in-come, indicating that the country may have problems meeting its debt obligations in the future.

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Paradoxically, we have been here before. In the 1980s, under the military regime, Nigeria borrowed extensively from external sources until the debt was too much to repay and Nigeria had to seek a debt forgiveness deal in 2005. It appears that Nigeria is on the path to another debt crisis considering the Finance Ministry’s plan to double external debt and change Nigeria’s debt mix to 60:40 domestic debt to external debt ratio from 73:27 as at December 2017.

If nothing is changed, especially Nigeria’s revenue profile, there is significant exchange rate risk associated with the huge foreign debt. This is particularly troubling given the fact that debt servicing expenses have been on the rise in recent years. Another oil price shock can easily double Nigeria’s external debt service cost.

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Outlook For Debt And Fiscal Policy

Borrowing in itself is not an economic evil. The challenge of borrowing is the utilization of the funds. Borrowing to finance recurrent expenditure is not an optimal use of the borrowed funds and leaves a huge debt burden for the future generation. Given the oil price shock of 2014, the resultant decline in revenue, coupled with the sharp increase in public debt, the major challenge for fiscal policy is limiting the likelihood of a debt crisis.

Without any change in the status quo, Nigeria might end up repeating its past mistakes – accumulating debt, until the debt service cost becomes too high or constitutes a huge portion of revenue - a situation experienced from the mid-1980s to the 1990s. The cur-rent strategy of boosting non-oil revenue through taxes looks promising. However, it must be via an efficient utilization of borrowed funds and a reduced pace in the expansion of government spending. For in-stance, the FG should channel its capital spending to more productive projects such as building more and expanding existing international airports to facilitate trade, renovating strategic roads that connect trading zones and investing heavily in mass transport schemes amongst others. These productive projects, if properly implemented, will have a multi-plier effect on the economy and eventually boost economic growth.

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