Will 2015 supplementary budget boost paper supply?


Tuesday, November 24, 2015 12:51 PM / ARM Research

FG’s 2015 deficit doubles on higher expenditure and lower oil receipts 
Last week, media sources reported that the President forwarded a N465 billion supplementary budget for fiscal year 2015 to the National Assembly, bringing cumulative 2015 expenditure to N5 trillion—at par with 2014. Consequently, the FG now expects a bigger 2015 budget deficit of N2.1 trillion vs. N1.0 trillion previously. Aside the higher expenditure, the ~N600 billion balance of the additional deficit comes from downward review of revenue estimates.

According to the reports, 90% of the extra expenditure is to fund subsidy arrears of oil marketers, following return of fuel queues, with the balance meant for security, prison and severance & gratuity for members of legislature. On the revenue side, oil price benchmark was revised lower to $48/bbl (vs. $53/bbl previously) which matches average Brent oil prices over the last three months, while oil production estimate has been cut by 80kbpd to 2.2mbpd—which is still ahead of year-till-August output (2.1mbpd).

Table 1: 2015 budget estimates (N bln)*

Projected fiscal deficit not “entirely” out of place, but points to more worries for state governments
To us, the size of the fiscal deficit is not “entirely” surprising, as we estimated a higher-than-official deficit of ~N1.5 trillion in our H2 15 strategy report, and reality of the new budget simply highlights the carnage caused by lower oil prices. Indeed, the sharp revisions to 2015 revenue estimates, raise questions on the financing of deficit going forward, not only for the FG, whose expenditure is proposed to double next year, but other tiers of government, particularly with bearish trend in oil prices set to extend.

For the FG, in addition to expected improvement in accruals from the on-going reforms of major revenue generating units—including the NNPC and Nigerian Customs but more importantly from the implementation of the TSA—the FG can still easily tap into the domestic debt market given minimal credit risks.  In contrast and more worrying, our analysis of the 36 states of Nigeria, based on September FAAC and IGR estimates, show that nearly half of the states will be unable to meet recurrent expenditure if current revenue pressure trajectory persists.

Indeed, it appears the dark days are not over, particularly for state governments. Without this, the lender of last resort might, yet again, have to step-in to bailout states—a scenario looking increasingly likely in the coming months with state governments already quaking at the minimum wage to N18,000.

Figure 1: Annual recurrent expenditure surplus/(deficit) (N bln)

FG’s 2015 borrowing likely unaltered
That said, the more immediate question is the potential implication of funding the increased deficits implied in the FG’s supplementary budget. According to the reports, the additional deficit (N1.1 trillion) is to be wholly financed through borrowing via the DMO (see Table 1 above) and markets appeared to have reacted as the yield curve widened an average 70bps and 33bps  respectively at the short-end and long end, on the news. Notably, while some modest tightening of the yield curve had occurred by the day after (Friday), it remained above pre-news levels, suggesting markets continue to price in potential for significant additional paper supply. However, for a number of reasons, we have a contrary belief that the wider deficit is unlikely to alter the FG’s borrowing plans for the rest of the year.

First, the Minister of State for Petroleum, Ibe Kachikwu, had earlier characterised the additional subsidy-focused expenditure as more or less a procedural necessity. The idea being that the expense still had to be presented for senate approval since the initial budget amount had been exhausted but that the funds for subsidy payment were already available. Similarly, while the revenue cutbacks seem realistic, the FG’s funding profile seems to have sustainably changed given dynamics that have helped it cope with the sharp revenue reduction in 2015. In particular, implementation of the Treasury Single Account (TSA) which according to the Vice President has pooled ~N1.4 trillion, thus far, has helped the FG manage its finances better.

Lastly, looking at  new borrowings year-to-November which is only half (N265 billion) of projections in the 2015 budget, it would appear that implementation of this year’s budget is significantly behind schedule and with six weeks to the end of the year,  we struggle to see rationale for ramp-up in domestic borrowings. In sum, we believe the deficit numbers simply reflect the accounting outcome based on a fully implemented budget, which is unlikely to be the case in 2015 and therefore may not need to be funded in entirety. Furthermore, anecdotal sources indicate that even if the entire deficit were to be funded, a significant amount could be raised through special issuance to select investors. Overall, we expect bond issuance in the final month of 2015 to remain in line with earlier proposal for December (N80 billion).

For markets, our prognosis suggests that any upswing in yields on additional paper supply will likely be short-lived, and instead, should be viewed as attractive entry points to lock in yields which look set for further declines as the MPC likely formalises its ‘arguably already ongoing’ accommodative stance.

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