22, 2019 11:28 AM / ARM Research
In our H2 18 strategy report, we had estimated fiscal deficit over 2018 to print at N1.8 trillion – from our revenue expectation of N5.1 trillion and expenditure of N6.9 trillion – which basically formed our domestic borrowing expectation of N388 billion over 2018 after adjusting for CBN funding of 50% of the projected domestic borrowing N775 billion. Coming into 2018, actual fiscal deficit in the first nine months of 2018 printed at N1.1 trillion as higher government outlay during the period exceeded FG receipts over the same period. In a deviation from the prior year wherein the deficit was finance solely by borrowings, domestic borrowing came in significantly lower (with net issuance of N84.5 billion, 9M 17: N969.6) with the remaining deficit largely financed by CBN as FGN far exceeded its statutory limit, with net increase in the apex bank’s ways and means advances of N1.19 trillion.
Coalescing our expected average crude oil price of $55.95/bbl. in 2019 and our forecast crude oil production of 2.07mbpd, we project oil revenue of N2 trillion relative to budget estimate of N3.69 trillion. On non-oil revenue, following the kick-off of the divestment process of FG’s equity stake in JV oil assets in 2018, we see some room for completion during the year, albeit at a lower valuation. Overall, we estimate FG’s total revenue of N4.36 trillion, compared to budget estimate of N6.97 trillion. With our modelled budget implementation of 82%, we estimate that fiscal deficit could range between N1.83 trillion and N3.76 trillion with our base case of N2.89 trillion. In terms of financing, on the sale & privatization of government assets where FG expects N210 billion, we forecast no sale and project foreign borrowing of $2.7 billion (N825 billion) over the second half of the year. With regard the balance of N2.1 trillion which should ordinarily be financed through domestic borrowing, we assume 34%-part funding by the CBN which suggests that the government could possibly net issue ~N1.4 trillion over 2019 under our base scenario.
A leapfrog in Federation account amid fudge in assumptions
The first-nine months of 2018 (9M 18) recorded a boost in federation account as gross federallycollected revenue expanded 32% YoY to N6.49 trillion, though lower than the prorated budget estimate of N9.8 trillion. The jump in finances cuts across both oil and non-oil revenue. Oil revenue stood at N4.1 trillion compared to N2.9 trillion in 9M 17 while non-oil revenue printed at N2.4 trillion compared to N2.1 trillion in the matching period of 2017. The drivers for the expansion in oil revenue are higher crude oil prices and relatively stable crude oil production which supported improved crude oil and gas sales, while expansion in VAT, custom revenues and CIT buoyed the increase in non-oil revenue. In terms of the deviation between the budget and actual, this was from both oil and non-oil assumptions. On the oil leg, the shortfall stemmed from petroleum profit & gas taxes, royalties (oil & gas), rent and gas flared penalty – all of which had fallen below the projected revenue by 35% over H1 18. Elsewhere, the shortfall was due to the aggressive assumptions on VAT, and Taxes & Custom duties both of which fell short of projection by N628 billion as at H1 18. Also, expected revenue from government’s investment, mining, and surcharge on luxury items valued at N187 billion came in at zero. In terms of revenue distribution, net distributable revenue among the three tiers of government was N5.7 trillion, higher than N3.7 trillion in 9M 17.
Consequently, the Federal government’s (FG) retained revenue over 9M 18 was N2.8 trillion1, which is 12% higher than retained revenue in 9M 17 of N2.5 trillion. FG share of oil revenue printed at N1.5 trillion (+101% higher than N749 billion in 9M 17) on the back of higher oil receipts from stable production and higher prices. Similarly, FG share of non-oil receipts improved marginally by 12% to N793 billion propelled by improvements in VAT (+5% YoY), custom revenues (+20% YoY) and CIT (+23% YoY). That said, the deviation in projected revenue of N5.4 trillion to actual of N2.8 trillion was on the back of a N733.9 billion and N429 billion shortfalls in oil and non-oil revenue. The deviation stemmed from deductions for PMS under-recovery, delay in the restructuring of FG’s equity ownership in JV oil assets, and other ambitious projections of one-offs in 2017 related to NNPC refund and exchange rate difference.
Fiscal Outlay on a breather
Total FGN expenditure of N3.9 trillion over 9M 18 came in below the level same period in prior year by 14% and fell short of the prorated budget estimate by 43%. On further breakdown, recurrent expenditure took priority in line with historical trends, with the lion share directed towards personnel cost and debt service (~56% of total 9M 18 revenue) with implementation of recurrent expenditure settling at 81% compared to 91% in 9M 17. Elsewhere, following the delayed passage of the 2018 budget, capital expenditure of N514 billion, came in far lower than the prorated budget estimate by 76% and lower than same period in the prior year by 47% – actual implementation for the review period printed at 24% (25% in 9M 17).
Consequently, we estimate that FG’s fiscal deficit amounted to N1.1 trillion (-59% YoY) tracking below N1.5 trillion allotted in the budget. In a deviation from the prior year wherein the deficit was finance solely by borrowings (domestic: N1.2 trillion and Foreign: N721 billion), domestic borrowing came in significantly lower (with net issuance of N84.5 billion, 9M 17: N969.6) due to treasury bills refinancing via $3.0 billion Eurobond issued between 2017 and 2018 which resulted in treasury bills total redemption of N849 billion as at June 2018. Notably, the remaining deficit was largely financed by CBN as FGN far exceeded its statutory limit, with net increase in the apex bank’s ways and means advances of N1.19 trillion.
2019 Proposed Budget: Budget Fudge or Fiscal Splurge?
On the 19th of December, President Buhari presented the proposed appropriation bill for 2019 to the National Assembly. In the proposed budget (tagged “Budget of Continuity”), aggregate expenditure is projected to decline N294 billion to N8.83 trillion due to cut back in capital spending by 27.1%, while retained revenues is expected to decline marginally by 2.8% YoY to N6.97 trillion, translating to a proposed budget deficit of N1.86 trillion (2.6% of our forecast GDP vs 2018: 2.8%). In a slight twist to previous appropriation bills, the proposed 2019 budget incorporated expenditure and revenue by top nine government owned enterprises (GOEs) of N955.36 billion. Also, counterparty funding of key projects of N1.51 trillion was included in the proposed capital expenditure. Thus, including GOE expenditures and counterparty funding of some capital spending (capex), total proposed expenditure for 2019 is N10.34 trillion (+13.4% YoY) and revenue of N7.92 trillion (+10.6% YoY), with fiscal deficit of N2.42 trillion (3.4% of our forecast GDP vs 2018: 2.8%).
Distilling the spending numbers reveals total recurrent expenditure increase by 14% YoY to N6.3 trillion, largely reflecting higher budgeted spending for non-debt recurrent expenditure which expanded 14.9% YoY to N4.04 trillion (to account for 46% of total expenditure) while total debt service) is projected to grow modestly (+2.7% YoY to N2.26 trillion. Elsewhere, statutory transfers (excluding capital projects) declined by 9.9% YoY to N240 billion. Further breakdown of the nondebt expenditure showed an increase of 8% YoY to N2.6 trillion in personnel and overhead expenses (with the percentage proportion of non-debt recurrent expenditure of 63% from 67% in FY 17) and jump in “other allocations”2 to N1.49 trillion (N1.15 trillion in FY 18). While the budget presentation stated appropriate provisions have been made for the implementation of the proposed increase in minimum wage, we note that this is yet to be factored into the proposed budget. For context, following the increase in minimum wage by 140% in 2011 (from N7,500 to N18,000), personnel expense in the 2011 budget increased 85% (from N1.1 trillion in 2010 to N1.9 trillion in 2011). As such, we note that for the FG to implement the promised 67% minimum wage (from N18,000 to N30,000) in 2018, we estimate additional increase in personnel cost of N1.4 trillion from 2018 levels to N3.5 trillion.
For the 2019 budget specifically, as stated above, the FG reduced its planned capital expenditure to N2.28 trillion (2017: N3.13 trillion) with capex contribution of overall spending declining by 848bps YoY to 25.9%. That said, including the capital spending for the top-nine GOEs (N275 billion) and counterparty funded projects of N556 billion, capital spending increases to N3.03 trillion with capex contribution of overall spending of 30.1%. In line with trends over the last four years, the FG continues to prioritize capital spending on power, works and housing, transportation, defense and special intervention programme, which jointly constitutes 45% of proposed capital spending for 2019. While new projects are expected to be funded in the 2019 fiscal year, attention is expected to be focused on the completion of existing projects. Focus on transport reveals that all railway projects expected for counterpart funding in the 2018 budget3 are still ongoing while new projects indicated in the 2018 budget for counterpart funding which were not funded4 and now being included in the 2019 budget.
Another Flowery revenue assumption
The FGN in the proposed 2019 budget projects oil revenue of N3.69 trillion, which is 30% higher than the budgeted oil revenue in the 2018 budget and 83% higher than annualized nine-month 2018 oil revenue of N2.01 trillion, due to oil price and production assumption.
Further breakdown proposes total non-oil revenue of N3.28 trillion (84.7% higher than nine-month 2018 annualized numbers). The quantum leap in the projection stemmed from aggressive expectation on “other revenue” of N1.27 trillion (+305.6% YoY to 2018 estimate) following expected proceeds from the completion of restructuring of FG’s equity ownership in JV oil assets of N710 billion, recoveries of N203 billion, signature bonus of N84.2 billion and grants of N209 billion. Non-oil revenue from the federation account is forecast to expand 25% from 9M 18 annualized numbers to N1.3 billion reflective of an aggressive expectation on VAT collections of N229 billion (71% higher than annualized 9M 18 number), CIT is expected to grow by 19.6% to N800 billion, while a modest decline of 1.2% is expected for customs remittance to N303 billion. Elsewhere, independent revenue is projected to touch an historic high of N624 billion (higher than 9M 18 annualized numbers by 76.4%) compared to average annual remittance of N246 billion.
Actual revenue will come in shy of projection
Following the kick-off of the divestment process of FG’s equity stake in JV oil assets in 2018, we see some room for completion during the year, albeit at a lower valuation. However, in our base case scenario, we project a haircut from current valuation to N500 billion. On recoveries, with details of the source of such remittance unavailable and zero inflow as at 9M numbers, we do not expect any revenue on the line. Also, we expect zero balance on signature bonus and donor funding following absence of both in 2017 and nine-month 2018 numbers. On the positive, we expect positive values on VAIDS, and special levies. In sum, we project revenue from other sources at N813 billion which implies a 36% shortfall of FY 19 budgeted “other revenue”.
Elsewhere, the deliberate efforts of the FG to increase the tax collection base amidst improving corporate profits have resulted in steady increases in FG’s share of non-oil receipts (with 5-year CAGR of 5.9%). However, we think projected numbers are overly optimistic. In terms of realistic estimate, we are slightly more optimistic on custom revenue compared to the proposed budget as we expect the increase in excise duty rates on alcohol & tobacco which came into effect mid-2018 to take its full course in 2019 and additional increase starting 2019. However, we made slight downward revision to import duties following our expectation of lower imports ex-one offs (-6.9% to $35.45 billion). On VAT and CIT, we share a different view from the proposed budget estimates. While we are also bullish on CIT following our expectation of improved performance of the non-oil sector and consumption in 2019, the projected income on CIT and VAT suggests shortfall of 15.5% and 35.8% respectively in 2019 from our estimates. Overall, on our base case scenario, we project 2018 non-oil revenue at N2.3 trillion, which translates to a 29.1% shortfall of FY 19 budgeted nonoil receipts.
Oil revenue assumptions, a delusion of grandeur
We believe the oil price assumption is aggressive given the free fall in crude prices in the last few months and our expectation of mean crude oil price of $56/bl. in 2019. While noting the additional 200kbpd production from the new Egina oil field and the relative calm in the oil producing areas, we believe FGN’s oil production assumption is highly optimistic. On OPEC’s recent production cut agreement, we expect Nigeria’s share of the cut of ~43,000bpd with full implementation expected from March 2019. Coalescing our expected average crude oil price of $55.95/bbl. in 2019 and our forecast crude oil production of 2.07mbpd, we project oil revenue of N2 trillion relative to budget estimate of N3.69trillion. Overall, we estimate FG’s total revenue of N4.36 trillion, compared to budget estimate of N4.32 trillion.
Elsewhere, given the historical partial implementation of the budget (especially capital expenditures with average of 58.9%), we assume budget implementation of 85.7% (average: 85.8%). Thus, we estimate total expenditure of N7.57 trillion (excluding capital expenditures by top top-nine GOEs and counterparty funded projects) in 2019. Overlaying the projected expenditure on our revenue scenarios suggests that the fiscal deficit could range between N1.83 trillion and N3.76 trillion.
Optimal debt ratio, looks like a stone throw away
Following the issuance of the last Eurobond in 2018, the FG made an improvement in its debt mix to 33:67 split between external and domestic borrowings (vs 30:70 prior to the Eurobond issuances) from 31:69 split in 2017. The increasing optimal debt mix is in line with FG’s Debt Management Strategy (2016-2019) aimed at rebalancing total public debt stock to achieve an optimal ratio of 60:40 for domestic to external debt, and moderate debt service costs. In financing the fiscal deficit of N1.86 trillion, the FG plans to improve on its optimal debt mix, with part funding via borrowings of N1.65 trillion expected to be funded 50:50 by domestic and foreign borrowings.
With the excess of N210 billion expected to be funded from the privatization of some non-oil assets by the Bureau of Public Enterprises (BPE).
Dissecting planned borrowings, the share of the external borrowings suggests additional $2.7 billion to the current foreign debt stock of $24.45 billion. We believe market reception at the last Eurobond in 2018 (with 3.2x over-subscription), suggests a successful issuance of the additional borrowing is achievable, even via the Eurobond, albeit at a relatively higher cost compared to the last issue. For context, despite the oversubscription at the last issue, average spread between Nigeria’s Eurobond rates and comparable US treasury expanded to 576bps compared to 442bps at the February 2018 issue. Also supporting our view of relatively higher cost of borrowing is the free fall in crude oil prices and the possibility of two more rates hike in the US (after four hikes in 2018) in 2019, both of which could have severe impact on the gross external reserves (both from lower revenue and exits of offshore funds) which could overstate valuation for Nigeria’s foreign issues. Also, concerns over the rising debt service to earned revenue ratio (55.9% as at 9M 18) in Nigeria, and the risk of default could drive Eurobond yields higher in 2019.
While noting the reported fiscal deficit by FGN, we played out different scenarios of possible domestic paper issuance to finance our estimated fiscal deficit under our base case scenario of N3.36 trillion for 2019. We estimate that to finance the budget, the net debt issue could range between N1.57 trillion and N2.23 trillion which is already higher than 2018 net issuance of N189 billion. In sum, our scenario analysis guides to a significantly higher domestic borrowings in 2019, which could in a deviation from the proposed debt mix.
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