NSR H1 2018 (10) – Nigerian Fiscal: Sharper Picture but still blurry

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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
 
Over the first nine months of 2017, federal retained revenue surged to N3.2 trillion, approximately 49.5% higher than actual revenue in 9M 16 (N2.1 trillion), although 17% lower than the pro-rated budget projections. Looking through provided breakdowns, robust federally retained revenue can be largely attributed to higher oil receipts stemming from recovery in oil prices (average 2017: $58/bbl. vs 2016: $45/bbl.) as well as improved crude production relative to the prior year (2017: 1.9 mb/d vs 2016: 1.8 mb/d). Similarly, non-oil receipts improved marginally by 12% underpinned by improvements in VAT (+18% YoY), custom revenues (+15% YoY) and CIT (+9% YoY). Furthermore, the FG’s retained revenue was also supported by one-off receipts of N33.22 billion, N49.79 billion and N466.82 billion from Miscellaneous Credits, TSA/Pool A/C, and Refund of Paris Club over deduction, respectively. Excluding the impact of these one-off transfers, federal retained revenue printed at N1.9 trillion (+41% YoY) over the review period, a 31% shortfall from budgetary estimates. 

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%.
 
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States’ financial performance worsen despite higher FAAC allocations
 
In sync with the improved revenue picture underpinned by higher oil prices and production, FAAC disbursement to state government came in higher by 40% YoY to N1.4 trillion over January to October 2017. However, annualizing the FAAC allocation comes to only 25% of cumulative state government budget for 2017 (2016: 26%). In our view, weaknesses in finances of sub-nationals is also reflective of poor internally generated revenue which culminates in overdependence on FAAC allocations for budget implementation and meeting obligations. 

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.
 
 

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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.
 

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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.
 
 

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Ambitious non-oil revenue relative to realities
 
From the revenue breakdown, the FG is proposing non-oil revenue of N4.2 trillion (+40.6% YoY) split into non-oil (1.1% YoY to N1.4 trillion), independent revenue (27.8% YoY to N1.1 trillion), and “other revenue” (133% YoY to N1.7 trillion). Consequently, “other revenue” accounts for almost half of the projected non-oil revenue. On this leg, the FG is proposing to generate N710 billion for restructuring of Joint Venture (JV) oil assets and review of oil production Sharing Contract (PSC). Pertinently, the FG aims to reduce its equity stake in JV assets as well as reduce its financial commitments under the PSC. 

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.
 
 

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Higher oil production and price underpin robust oil revenue projections
 
On the oil revenue leg, the FG projects a 15.0% YoY increase to N2.4 trillion, based on assumptions which include a benchmark oil price of $45/barrel (+1.1% YoY), oil production estimate of 2.3million barrels per day (+4.5% YoY) and exchange rate of N305/USD – which remained unchanged from the 2017 budget. The oil price assumption is conservative given current price level of $70/bbl. and our expectation of crude oil prices to average $60/bbl. in 2018. 

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).
  

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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
 
In financing the fiscal deficit (budgeted deficit: N2.0 trillion), the FG plans to raise N306 billion from the privatization of some non-oil assets by the Bureau of Public Enterprises9 (BPE) while the balance (N1.7 trillion) would be financed by borrowings split evenly between domestic (N850 billion) and external sources ($2.8 billion). On the sale of non-oil assets, we see delayed commencement of the sale and lower than expected valuations as likely factors that could drive proceeds lower than the planned amount. 

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.
 
 

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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 Swing of Improved Fundamentals

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1.       NSR H2 2017 (11) - Monetary Indicators Swamped By Hawkish Dogma

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3.      NSR H2 2017 (9) - Trade Balance to Survive Muddy Waters

4.      NSR H2 2017 (8) - Nigerian GDP: Recovery Signal Speaks

5.      NSR H2 2017 (7) - Nigerian Fiscal: One Step Closer, Several More To Go

6.      NSR H2 2017 (6) - REFORMS: Getting Down to Brass Tacks

7.      NSR H2 2017 (5) - New Regulations set sights on increasing gains for Pension Assets

8.     NSR H2 2017 (4) - Nigeria's Socio-Political Milieu: Just Before That Sigh of Relief

9.      NSR H2 2017 (3) - Supply Glut Underpins Broadly Bearish Trends Across Soft Commodities

10.  Nigeria Strategy Report H2 2017 (2) - Crude Oil: US Shale Challenges Anticipated Market Re-balancing
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