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Monday, January
29, 2018 /5:35 PM /ARM Research
The
summary of our sensitivity analysis suggests that the fiscal deficit could
range between N2.9 trillion and N4.8 trillion if the planned expenditure of
N8.6 trillion is fully implemented. However, we do not foresee full budget
implementation as in recent years when it has hovered around 75%.
Thus,
in 2018, we look for a budget implementation of 85% given that the year is the
last chance for the Buhari administration to meet the expectations of the
electorates before the 2019 elections. This, under our base scenario, implies
an expenditure of N7.3 trillion and a fiscal deficit of N2.9 trillion (+45%
increase over budgeted deficit of N2.0 trillion).
Federal revenue growth shows signs of life
Similarly,
total expenditure of N4.1 trillion (+26% YoY), 26% lower than pro-rated budget
estimate and in line with historical trends was tilted towards recurrent
spending (+21% YoY) with the lion share directed towards personnel cost and
debt service (actual: 60% vs 50% allotted in the budget). Pertinently, in terms
of implementation, total recurrent expenditure stood at 96% for the nine-month
period.
Elsewhere,
capital expenditure over the nine-month period printed at a meagre N377 billion
(+2.3x YoY), 77% lower than pro-rated budget estimates for the review period
with implementation for the nine-month period at 25%. Against this backdrop,
the FG’s fiscal deficit amounted to N1.1 trillion1 (-27.4% YoY) vs. N1.8
trillion allotted in the budget and was largely financed by domestic borrowings
i.e. FGN bond issuances of N1.2 trillion (62% of total) and foreign borrowings
of N721 billion (38% of total). Despite the improved revenue picture, the FG
failed to fully implement the 9M 2017 budget, with annualized budget
implementation at 74%. 
States’ financial performance worsen despite higher
FAAC allocations
These
setbacks, in our view, made it difficult for states to pull out of the
challenge of an ever-rising accumulation of unpaid salaries. Against this
backdrop, arrears of unpaid obligations remained rife despite FG’s disbursement
of outstanding London-Paris Club Loan refunds (~N760 billion) to states with
the proviso that a minimum of 50% be directed towards the payment of workers’
salaries and pensions. 
FG pushes to stimulate the economy with another record
high budget
At
an earlier timing than usual (7th November 2017), president Buhari presented
the 2018 appropriation bill to the National Assembly in a bid to speed up
passage before the commencement of 2018 and return the budget cycle to the
January-December calendar. The proposed 2018 budget, dubbed the “Budget of
consolidation”, has the objective to reinforce and build on the achievement of
the last two budgets. To realize this, the FG proposed a 16.0% YoY increase in
aggregate expenditure to N8.6 trillion while retained revenue is planned to
rise by 30.0% YoY to N6.6 trillion which translates to a fiscal deficit of N2.0
trillion (-15.6% YoY).
Focusing
on expenditure, the increase, to a large extent, is planned to go into debt
service (+21.3% YoY) and non-debt recurrent expenditure (+16.8% YoY) even as
other expenditure components including capital expenditure and Statutory Transfers
are projected to increase, albeit modestly. The increase in debt service2 is
most likely explained by the elevated yield environment (+430bps YoY to 17.6%)
and high domestic issuance (+49% YoY to N1.3 trillion) over 2017.
On
non-debt recurrent expenditure3, the breakdown reveals an increase of 12.2% YoY
to N2.1 trillion in personnel expenses earmarked to meet promotion arrears and
recruitments by the Military, Police Force and Para Military agencies. Other
allocations under non-debt recurrent expenditure include special intervention
programmes, Power Sector Reform programme, presidential amnesty programme and
service wide votes which combined increased by 37.7% YoY to N1.2 trillion. 
Elsewhere,
in a bid to complete ongoing projects and consolidate on the recovery, the FG
increased its planned capital expenditure by 11.7% YoY. Of the total planned
expenditure, capital expenditure (inclusive of capital in transfers) accounted
for 30.8%, lower than 31.7% in the prior year. Even with the marginal drop in
contribution, the allocation remains in line with the federal government
objective to set aside minimum 30% of total expenditure for capital projects
every year.
In
terms of allocation, the FG continued to prioritize ministries such as Power,
Works and Housing, Transportation, Special Intervention Programmes, Defence and
Agriculture which combined accounts for 67% of planned capital expenditure. Key
projects and programmes, that are expected to be implemented in the 2018 fiscal
year include;
•
Mambilla hydro power project - N9.8 billion (inclusive of N8.5 billion
counterpart funding)
•
Transmission lines and substations - N12 billion (counterpart funding)
•
National Housing Programme - N35.41 billion
•
2nd Niger Bridge - N10.00 billion
•
Construction and rehabilitation of the strategic roads - N300 billion. 
Ambitious non-oil revenue relative to realities
FG
hasn’t guided to the stake it intends to sell in the JV assets - currently owns
around 60% in joint venture oil assets. Also, in terms of pricing, we think
valuations would be favorable given the improved outlook on oil price and
production. However, it is unlikely it materializes in 2018 given the lengthy
process involved in divesting from a government owned asset as noticed during
the sale of power assets in Nigeria. Thus, in our base case scenario, we
project zero receipts from oil assets ownership restructuring. Further, the
government plans to raise N512 billion from recoveries which in our view is
ambitious given the high unpredictability of receipts even as nine-months 2017
actual revenue revealed zero inflow from recoveries.
On
the other hand, we hold optimistic views on other components under “other
revenue” including signature bonus (N114 billion) and donor funding (N200
billion) with the former looking promising given tough sanctions4 that would be
imposed on companies that fail to remit signature bonuses following successful
bids on oil marginal fields. In sum, we project revenue from other sources at
N705 billion which implies a 57% shortfall of FY 18 budgeted “other revenue”.
Elsewhere,
the modest growth in non-oil receipts (+1.1% YoY) was driven by cut backs in
Value Added Tax (-1.6% YoY to N208 billion) and Company Income Tax (-14.1% YoY
to N795 billion) which, previously, were aggressive in prior years, while
budgeted custom receipts rose 17% YoY to N325 billion. In terms of what can be
fully achieved, we view the planned custom budget as feasible due to a mix of
factors including its plan to raise excise duty rates on alcohol & tobacco
in 2018, our expectation of higher imports (+8.0% to $36.6 billion) this year
and FG’s improved ability to collect custom taxes.
On
VAT and CIT, despite cutbacks, we hold a pessimistic view on full collection.
Precisely, while our expectation for a modest recovery in non-oil output and
consumption in 2018 suggests respective increases in CIT and VAT, we think
currently low tax compliance6 would be drag on FG’s ability to receive its
planned tax revenue from these non-oil categories. We acknowledge that there
are ongoing reforms7 to improve compliance and expand the tax base, however, we
do not think that it would be substantial to generate FG’s 2018 estimated
revenue from VAT and CIT. Overall, we project 2018 non-oil revenue at N991
billion, which translates to a 29% shortfall of FY 18 budgeted non-oil
receipts. 
Higher oil production and price underpin robust oil
revenue projections
On
the flip side, FG’s oil production assumption is slightly optimistic
particularly considering Nigeria’s implementation of the OPEC cap of 1.8million
bpd (excluding condensates8) in 2018 which implies crude production (inclusive
of condensates) of 2.0million bpd. Having modelled our base oil revenue using
an average crude oil price of $60/bbl. and oil production of 2.0mbpd in 2018,
we project FG retained oil revenue at N2.4 trillion, at par with the budgeted
amount. Overall, we estimate fiscal receipts at N4.9 trillion (26% short of
budget estimate). 
In
addition to our base case scenario, we sensitize for other revenue
possibilities. Our bull scenario considers a case where oil prices average
$70/bbl. in 2018 underpinned by higher compliance by OPEC and its allies as
well as increasing geo-political tension. This, coupled with an average
production of 2.2million bbl. is expected to drive oil revenue higher and, by
extension, non-oil revenue – on the back of higher profitability from oil and
gas companies and other corporates who rely on foreign exchange for production.
Our bull scenario also examines a situation where Nigeria raises N710 billion
from the sale of its ownership in JV oil assets which should provide an
additional boost to non-oil revenue.
For
our bear scenario, we consider a case where oil prices fall to an average of
$50/bbl. on account of higher shale oil production as well as poor compliance
by OPEC members. The summary of our sensitivity analysis suggests that the
fiscal deficit could range between N2.9 trillion and N4.8 trillion if the
planned expenditure of N8.6 trillion is fully implemented. However, we do not
foresee full budget implementation as in recent years when it has hovered
around 75%. Thus, in 2018, we look for a budget implementation of 85% given
that the year is the last chance for the Buhari administration to meet the
expectations of the electorates before the 2019 elections. This, under our base
scenario, implies an expenditure of N7.3 trillion and a fiscal deficit of N2.9
trillion (+45% increase over budgeted deficit of N2.0 trillion).
Despite preference for external debt, local borrowing
is still likely to run ahead
On
borrowings, starting off with external sources, the planned amount of $2.8
billion (N850 billion) in addition to $2.5 billion – which was approved by the
National Assembly to be raised in 2018 – suggests that the FG could possibly
raise $5.3 billion this year. We believe a successful issuance of the funds is
achievable in view of 2017 when the FG tapped the Eurobond market three times
and raised $4.8 billion in total with a bid-cover size of 2.4x. Also supporting
our view is the sustained improvement in crude oil prices and output which
bodes well for improved foreign investor optimism towards Nigeria’s assets.
However, it would most likely come at a higher premium than was obtainable in
2017 given new factors such as the recent hikes in the United States benchmark
interest rate and the possibility of further hikes in the region in 2018.
Also,
concerns over the rising debt service to revenue ratio (47%) in Nigeria, and
the risk of default could drive Eurobond yields higher in 2018. With the
above-mentioned established, we played out different scenarios in the table
below to forecast the potential size of domestic paper issue using our estimated
fiscal deficit (N2.9 trillion) for 2018. We estimate that to finance the
budget, the net debt issue could range between N1.5 trillion and N2.4 trillion
which is already higher than 2017 net issuance of N1.3 trillion. In sum, our
scenario analysis guides to higher domestic borrowings in 2018 despite the
federal government preference towards foreign borrowings10 to finance its
fiscal deficit. 
Related News From ARM’s H1 2018 Nigeria Strategy
Report
NSR H1 2018
(9) – Inflation has peaked, but downside risks remain
NSR H1 2018 (8) – Currency: NGN Cautiously Constructive
for 2018
NSR H1 2018 (7) – Balance of Payment
Visibly losing size but gaining weight
NSR H1 2018
(6) – GDP Juggling optimism on a tightrope
NSR H1 2018 (5) - Crude Oil Sunny with a chance of
Rain
NSR H1 2018 (4)- Commodity prices crater from supply glut
NSR H1 2018
(3)- Constructive Flows to EMs But Headwind Prospers
NSR H1 2018 - Africa Economy Back From The Brink
NSR H1 2018 (1) - Growth: Riding on the
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2.
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3.
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4.
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5.
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7.
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8.
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9.
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10. NSR Q4 2017 - Crude Oil: Will Crude Oil ‘Roller Coaster’
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Premium
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