Friday, May 04, 2018 10:16 AM / Fitch Ratings
Fitch Ratings has affirmed Nigeria's Kaduna State's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B' and National Long-Term Rating at 'A+(nga)'. The Outlooks are Stable.
The affirmation reflect Fitch's expectation of an improved revenue mix for the state, driven by improving local tax revenue and fees that offset declining statutory allocations. The ratings also factor in the state's growing debt, although servicing requirements will be moderated by government subsidies, concessionary terms and a long grace period. They further take into account the state's developing economy focused on agricultural and service activities and low GDP per capita by international standards.
The 'A+(nga)' rating reflects Kaduna's low risk relative to the country's best risk, given strong financial and revenue support from the central government.
The Stable Outlooks factor in Fitch's expectation that growing direct local taxes and a flexible expenditure framework will allow Kaduna to weather structurally declining statutory oil-related transfers in the medium term.
Key Rating Drivers
Institutional framework (Weakness/Stable)
Kaduna's finances are affected by low predictability. Over 50% of operating revenue depends on allocations of oil revenue, which are transferred monthly from the Federal Accounts Allocation Committee (FAAC). Waning FAAC transfers amid the oil sector down-cycle have provided a stimulus to improve local tax collection of internally generated revenue (IGR for which the states bear full responsibility for settlement and collection). This is aimed at consolidating the state's tax administration and taxpayers' compliance, but structural benefits may only be visible with time.
In addition more than 50% of annual budgeted capital spending is often rolled over into the following financial years due to insufficient funding and limited implementation capacity.
Debt and Liquidity (Weakness/Negative)
Kaduna's debt funds an ambitious capex programme in the power, transport, water supply, education and healthcare sectors that should sustain GDP growth and diversify revenue sources. Total debt at end-2017 amounted to NGN114 billion or 135% of current revenue. Fitch understands from the administration that the deadline to contract the USD350 million loan with World Bank has been extended to October 2018. Without this loan, Kaduna's debt would increase at a slower pace than our base case's projections, reaching 200% of the budget size in 2020. Should this debt be ultimately contracted, Fitch has calculated a debt burden of around 2.8x current revenue.
Poor collection rates and declining statutory allocation have compromised Kaduna's overall liquidity profile, thus requiring repeated access to the Budget Support Facility (BSF) for paying rigid expenses such as staff costs and debt service. For the second year in a row, Kaduna has leveraged on remittances that are bound for local governments; therefore Fitch views year-end liquidity in 2017 of NGN8.3 billion as earmarked for current liabilities.
Foreign currency loans are credit-enhanced by an irrevocable standing payment order (ISPO) issued by the central government. However, this does not represent a full guarantee of Kaduna's obligations. Interest charges on foreign currency debt are deducted from the statutory allocations for the states on a monthly basis.
Fiscal Performance (Neutral/Stable)
Results for 2017 confirm the increasing trend of IGR, with a 13% yoy growth. However, 50% of Kaduna's current revenue still consists of statutory allocations closely linked to oil revenue, which dropped to NGN42 billion in 2017 from NGN62 billion in 2013.
In its base scenario, Fitch projects a decrease in Kaduna's operating margin towards 25% in 2020 from 35% in 2017, on the assumption that the structural decline of FAAC allocations would not be fully compensated by IGR growth. Under our rating case scenario, a combination of declining FAAC and stagnant IGR due to sluggish economic growth lead to an operating margin below 14% by 2020.
Within the national context, Kaduna's fast-growing 8.2 million residents and a traditionally strong primary sector contribute to weak socio-economic standards, including a growing unemployment rate of around 30% and a poverty rate above 60%. In Fitch's scenarios, the public sector will continue to be a key employer in the state, directly and through its planned investment programme. A large informal economy hinders private sector development, which ultimately affects the IGR tax base. Although dominant agricultural and service sectors drive the economy, Kaduna's 2016-2020 development plan is focusing on the state's rich minerals resources by attracting foreign investors to key industrial projects.
Management & Administration (Neutral/Stable)
Kaduna's administration is committed to improving transparency and disclosure, emphasising the availability of statistical data and information while working on the transition from a cash-based to a more sophisticated accrual-based accounting that, in Fitch's view, will be credit-positive as it restricts the scope for discretionary initiatives. Among the administration's goals, Fitch views positively the modernisation of tax administration through Kaduna State Board of Internal Revenue empowerment.
An upgrade could materialise if the operating margin sustainably strengthens towards 30% and debt levels are restored to 1x the budget size. Further improvement of the local economy giving an additional boost to IGR would also be positive for the ratings.
Conversely, an operating margin below 12% or financial debt growth leading to debt-to-current revenue ratios being consistently above Fitch's expectations could result in a downgrade. Unrest damaging economic prospects or undermining oil-related revenue could also lead to a downgrade.