Tuesday, January 19, 2016 2:07 PM / ARM Research
Today we delve further into the domestic portion of ARM’s core strategy document – the Nigeria Strategy Report. In this piece, present ARM’s review of the fiscal picture over 2015 and outlook expected on same for the 2016.
Federally collected revenue over 9M 15 fell short of budget (-13%) largely on the back of overly optimistic projections for customs and VAT which weighed on non-oil receipts. Similarly, oil revenue was 10% shy of target on lower oil prices and production. Nonetheless, amid a
N211 billion special NLNG tax inflow, FG’s retained revenue of N2.3 trillion was only 9% lower than estimate. This was however much lower than about ~ N3.1 trillion in total expenditure over the period (Recurrent: N2.7 trillion, Capex: N722 billion) with the resulting fiscal deficit financed through CBN loan ( N600 billion) and domestic bond issuance ( N318 billion). Meanwhile fiscal pressures to states were much more amplified as ISPO and other deductions weighed on SGs FAAC revenues which dropped by as much as 40%.
Towards the end of 2015, the President presented the 2016 budget with a planned cumulative expenditure of
N6.1 trillion (Recurrent: N4.3 trillion Capex: N1.8 trillion) which was focused on attaining macroeconomic & fiscal stability such reforming the oil and gas sector as well as social and infrastructure development.
Notwithstanding lower oil price benchmark (-27% YoY to $38/bbl), FG’s revenue is estimated to climb by 12% YoY to
N3.9 trillion in 2016 largely on the back of what ARM sees as optimistic non-oil proceeds (+20% relative to 2015 projections). As a result, they see actual fiscal deficit for 2016 to be much higher than projected N2.2 trillion.
Low customs and VAT underpin revenue shortfall
Federally collected revenue of N4.4 trillion in the first 9 months of 2015 is 13% below budget projections primarily due to lower than expected non-oil receipts of N2.0 trillion (-23% short of projections). The shortfall in non-oil receipts was driven by lower than-estimated receipts from customs (31%) and VAT (40%).
Importantly, both shortfalls are more symptomatic of aggressive projections with 2015’s targets set at least 50% higher than actual receipts in each of the last two years. That said, cumulative non-oil receipts is 10% higher than the corresponding period in 2014. On the other hand, despite further declines in oil prices and output running 10% shy of target, oil & gas receipts of N2.7 trillion (-36.4% lower YoY) is only 6% short of projections, flattered by the cut back on JV cash calls (15% shy of proposed).
Figure 1: Deviation of federally collected revenue from budget projections
…as NLNG taxes buoy FG’s revenue
Although the lower revenue translated into lower FAAC across the tiers of government, FG’s retained revenue (N2.3 trillion as at 9M 15) is only 9% lower than estimate buoyed by N211 billion special NLNG tax distributed in July 2015. However, with nearly ~N3.1 trillion in expenditure over the first nine months (91% budget implementation) fiscal deficit came in at ~N1 trillion. Mirroring historic trends, budget implementation was skewed in favour of recurrent spend (N2.7 trillion) which ran 6% ahead of projections primarily on higher debt service.
This outcome fits the prognosis in our H2 15 Strategy Report where we noted that the refinancing of maturing paper at significantly higher interest rates (15%) would exert upward pressure on FG’s debt service bill. Indeed, actual debt service of N908 billion as at 9M 2015 is 30% ahead of budget estimates but the run rate is in line with our estimate of N1.1 to N1.3 trillion. Also mirroring recent trends is the paltry capex budget (N722 billion) which was only ~36% implemented due to funding challenges. Interestingly, the FG relied on a CBN loan to fund more than 60% of the N1 trillion fiscal deficit with the balance largely sourced from the domestic credit market. Consequently, the FG (via the DMO) issued only about 60% of the budgeted N530 billion new borrowing for 2015. Although terms of the CBN’s advance are not available, the FG’s reliance on this route highlights its disposition on accumulating public debt at “high cost”. Buttressing this cost aversion, the DMO sold only 77% of planned bond offer in Q3 15 due to elevated marginal rates of 15.5% on average, while selling 33% more than was planned in the last quarter, when rates were 400bps lower.
Table 1: 2015 Federally collected revenue: Budgeted (B) vs. Actual (A)
Figure 2: Historical federal government budget implementation
FG’s bailout package eases states’ fiscal dilemma
The tale at the state level was much worse as ISPO deductions for outstanding bonds and, more importantly, similar deductions by commercial banks for their own loans, amplified fiscal pressures. On an aggregate basis, SGs FAAC dipped as much as 40% with the ultimate fiscal impact much worse for states with weak internally generated funds. This resulted in salary backlog which, in some cases stretched up to 8 months, and led the FG to intervene with a N1.1 trillion bailout package. In addition to the ~N200 billion proceed of special NLNG taxes, commercial bank loans of ~N600 billion were refinanced into 20 year FGN bond, even as the CBN opened a N300 billion credit line for the states.
Figure 3: SG’s FAAC allocation
FG’s bailout package eases states’ fiscal dilemma
2016 fiscal thrust appears to hit the right notes
The President presented the 2016 budget to the National Assembly on 23rd December with fiscal policy thrust that will focus on attainment of macroeconomic & fiscal stability, social development and infrastructure development. On macroeconomic & fiscal stability, key areas of focus are reform of the oil & gas sector, economic diversification and zero-based budgeting to enhance efficient allocation of resources. Indeed, the focus on the oil & gas sector is not surprising, given the revenue generation significance of the sector which itself is highlighted by the President’s appointment of himself as the substantive minster. Importantly, reform of the oil & gas sector already kicked off with the renegotiation of offshore processing contracts—due to unfavourable terms—and there are already proposed “alternative” funding structure for the JV agreements.
Under the proposal, JV oil assets will raise funds directly from the capital market and pay taxes and royalties to the government just like the IOCs currently do. Perhaps the most important development is the exclusion of the “contentious” fiscal terms from the newly proposed Petroleum Industry Bill (PIB). This should make for easier passage of a bill that has languished at the National Assembly for almost a decade, in the coming months. Elsewhere, N500 billion is to be set aside for social developments which will include school feeding, conditional cash transfer and post-NYSC grant. Although details are still sketchy, the pilot phase is to commence after harmonization of databases by various government agencies.
This suggests implementation could be pushed deep into 2016. Last, the FG looks to tackle critical infrastructure—energy, transport and housing—via increase in capex and plans to set up a $25 billion (N5 trillion) infrastructure fund. Amidst fiscal challenges, public-private partnership will be the primary funding model. On power, off-grid power supply, that will bypass the national grid for distribution, is to be encouraged even as policies that will engender reduction in cost of building materials are formulated for the housing sector.
Surge in non-oil receipts to ameliorate impact of lower oil prices in 2016
In this guise, the FG has proposed cumulative expenditure of N6.1 trillion for 2016, 22% higher than 2015 budget, primarily due to the tripling of capital expenditure to N1.8 trillion and proposed social investments. On the revenue side, despite the downward revision in oil price benchmark to $38/bbl (vs. $52/bbl in 2015) and modest downward revision in output to 2.2mbpd (-3.4%), FG’s retained revenue is projected to be 31% higher at N3.8 trillion in 2016 as higher non-oil receipts (+20% relative to 2015 projections) is expected to offset soft oil receipts (-50% relative to 2015 projections). The increase in non-oil receipts is expected to be buoyed by sharp jumps in VAT and corporate taxes as well as FGN independent revenue which is expected to triple, and consequently account for ~40% of FGN’s expected FG’s retained revenue in 2016. The jump in the latter is buoyed by expected improvement in collections from MDAs after the FG implemented the Treasury Single Account earlier in the period. Indeed, the vice president’s comment that collections into the TSA had hit N1.4 trillion probably strengthens this optimism, at least going into 2016. In all, largely reflecting higher expenditure, 2016 fiscal deficit is projected at N2.2 trillion (~2.2% of GDP) matching 2015 numbers. According to the budget, the deficit will primarily be financed via borrowing (~80%), split almost equally between the domestic credit market and foreign, as well as proceeds from misappropriated funds (16%).On the latter, the FG expects ~N350 billion in recoveries likely on the back of on-going forensic audit of key revenue generating and collection agencies.
Funding shortfall: the potential clog in the wheel of capex implementation
Given Nigeria’s huge infrastructural deficit, the ramp-up in capital spend to N1.8 trillion is welcome with recurrent expenditure ratio down to (still relatively high) 70% from 87% in 2015. Reinforcing priority areas for the government, capital allocation to economic infrastructure projects is now ~35% of capex budget (vs. 6% in 2015), split between the ministry of works, power & housing (24%) and transportation (11%), even as additional N200 billion (11% of capex) is provided for capital projects related to FG’s social investments. Although the quantum of resources allocated to critical infrastructure reaffirms the FG’s resolve to tackle the current deficit, based on estimated1 required annual spend, there is still a substantial gap of nearly N17.5 trillion. To close this gap, we believe alternative funding models, like the PPP, have to be pursued with more rigour under better frameworks that aim to reduce political risks which, arguably, has hampered a number of PPP funded projects in recent times. Indeed, given limited funds, the short-term strategy of ministry of works, power & housing as articulated by the minister is to prioritise inter-state roads that are near completion. This should facilitate connectivity but more importantly improve regional trade which appear set to attain increased prominence if restrictions on foreign currency subsist.
2016 fiscal thrust appears to hit the right notes
Figure 4: Sectoral allocation of 2016 capital budget
That said, the bigger concern for us is that revenue projections appear optimistic in light of current realities that could push fiscal deficit to record levels. Specifically, 2016 targets for VAT and corporate income taxes (CIT) which are 15% and 32% higher than 2015 are nearly double actual receipts in 2013 and 2014. On the former, VAT collection which has averaged N800 billion in 2013 and 2014 and set to hit this target going by 9M 15 run rate is projected to hit N1.5 trillion in 2016.
Although improvement in collection rate could help improve VAT receipts, we think a more realistic timeline for this target, given the lax compliance over the last few years could, possibly, be up to 3 years. Consequently, we struggle to see how this target will be met, in the near-term, without a hike in VAT rate which in itself could generate negative reaction from the populace.
Our argument on 2016 CIT target tows a similar line in terms of being far above usual run-rate and, indeed, is further strengthened by likelihood of lower tax receipts on weaker corporate earnings in 2016. Concomitantly, we remain cautious on 2016 customs receipts (~20% of non-oil receipts) which are projected to be 50% higher than FY 2014 and 9M 2015 run rate. We think subsisting ban on items by the FG as well as forex constraints which in part has driven contraction in import bill (-17%) over the first 9 months, will continue to weigh. These factors suggest that, like 2015, revenue could easily trail estimates. In view of this, we adopt conservative estimates that assume only 70% of non-oil receipts’ targets are met and arrive at a potential 2016 fiscal deficit of up to N2.8 trillion, 24% higher than budgeted. Notably, while the payment of the N780 billion MTN fine could improve the FG’s fiscal position, current litigation being pursued by the firm makes timing of potential inflow highly uncertain. In the same vein, our analysis shows that the impact of further devaluation of up to 40% only shrinks the budgeted deficit by 14%.
This prognosis suggests 2016 capex budget might be beleaguered by poor implementation like prior budgets; the fact that total revenue target, even if met, will only cover 80% of recurrent expenditure without touching capex highlights the scope of financing required. Thus, despite the FGs lofty plans, Nigeria appears set for an even bumpier road ahead. However, with expectation of Nigerians, arguably at the highest level in recent years, we think the FG might be forced to ramp up borrowing (via capital market, DFIs or CBN) as it fervently tries to deliver on campaign promises.
Table 2: 2015 and 2016 budget projections (N’billions)
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