October 11, 2019 /03:17 PM / By Fitch Ratings / Header
Image Credit: Dailynigerian
Fitch has affirmed Nigeria's Kaduna State's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B' with a Stable Outlook.
The affirmation reflects Fitch's assessment of Kaduna's risk profile as Vulnerable, with a revenue structure highly dependent on oil transfers amid internally generated revenues (IGR) that are increasing below expectations. The ratings also factor in the state's growing debt to fund necessary capex for the development of basic infrastructures and social services.
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 Outlook reflects our expectation that Kaduna will improve its tax administration while maintaining a flexible expenditure framework, which will leave some margin to adjust to macroeconomic or social downturns.
Key Rating Drivers
Revenue Robustness: Weaker
Kaduna's revenue sources are sensitive to oil prices swings, since 50% of operating revenue depends on allocations of oil revenue 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 IGR including fees, for which the states bear full responsibility for settlement and collection, but structural benefits may only be visible with time.
Revenue Adjustability: Weaker
Kaduna's revenue potential depends on the state's ability to expand its tax bases, both in terms of broadening the pool of taxpayers and enforcing tax compliance. The main fiscal revenues are pay-as-you-earn taxes, on which Kaduna cannot set the tax rate, and land charges. The ability to enlarge the pay-as-you-earn tax base is limited by the low level of income of the population, with over 50% living below the poverty line.
Kaduna's main responsibilities include education, healthcare, economic development, energy and environment. Past expenditure dynamics show a good track record of cost control, with operating revenue and expenditure growing on average at the same pace in 2010-2018, around 7.5%-8.0%. However, Fitch expects expenditure to grow above revenue in the medium term due to planned minimum wage increase for public employees, squeezing the operating margin to 20% from last years' 30%, further declining below 15% in case of economic downturns.
Expenditure Adjustability: Midrange
Kaduna's cost structure is moderately flexible, as an average 40% of expenditure is capex, which are largely financed with operating balance and can be delayed in case of need. Kaduna has significantly strengthened the legal framework for fiscal accountability and it is committed to achieving a 60:40 balance between capex and opex. In Fitch's view, expenditure reduction is moderately affordable given the high potential to increase the existing level of healthcare and infrastructural services, while improvements in the procurement process could improve expenditure allocation.
Liabilities and Liquidity Robustness: Weaker
The national framework for debt is evolving and thus borrowing limits are quite wide. There are no restrictions concerning debt maturities, interest rates or currency exposure. Over 90% of Kaduna's debt is served through deductions from the statutory allocation, including loans with local banks for salaries bailouts, while the remaining part is made of intergovernmental loans.
At end-2018, 65% of Kaduna's NGN160 billion debt, when included pension arrears, was in foreign currency and the figure is expected to increase towards 80% for a debt burden hovering around NGN300 billion in 2023, after the disbursement under the USD350 million loan from the World Bank. The historical average cost of debt is below 1% for multilateral foreign debt, while domestic debt carries interest rates around 10%. Kaduna's debt amortisation profile is smooth with long maturities and a sustainable debt service well below 1x the operating balance.
Liabilities and Liquidity Flexibility: Weaker
Kaduna's liquidity is weak and Fitch prudentially considers cash as restricted for payables. Emergency liquidity may come from the federal government, as happened in 2015-2016 with the Budget Support Facility helping states to tackle pressures due to liquidity shortfalls, supporting payments of salaries and pensions. Liquidity may also come from domestic banks rated in the 'B' category, which tend to limit final maturities to a few years.
Debt Sustainability: 'bb'
According to Fitch's rating case, Kaduna's debt payback ratio (net debt-to-operating balance) - the primary metric of debt sustainability assessment - could deteriorate to 23.4 years in the medium term, incorporating the effects of an economic downturn, corresponding to a 'bb' assessment. Secondary metrics - fiscal debt burden measured by net adjusted debt-to-operating revenue - could move above 300% and is assessed at 'b', while its actual debt-servicing coverage ratio of 1.6x is assessed at 'a'. This justifies the state's overall debt sustainability assessment at 'bb'.
Fitch assesses Kaduna's standalone credit profile (SCP) at 'b', reflecting a combination of a vulnerable risk profile assessment and a 'bb' assessment of debt sustainability. The SCP also factors in Kaduna's high debt burden compared with international peers, in particular South-American states and provinces. Fitch does not apply any asymmetric risk or ad-hoc support from the central government and assesses intergovernmental financing as neutral to Kaduna's ratings. The 'B' IDR reflects Kaduna's own payment capacity, while debt-service support from the central government through deductions from the statutory allocation is factored into the debt framework.
Fitch's key assumptions within our 2019-2023 base and rating case for the issuer include:
A weakening debt amortisation profile or financial debt growth leading to consistently higher debt-to-current revenue ratios and an operating balance insufficient to cover debt service with respect to Fitch's expectations could result in a downgrade. Unrest damaging economic prospects or undermining oil-related revenue could also trigger a downgrade.
Fitch deems an upgrade of Kaduna's ratings as unlikely given the Nigerian sovereign rating (B+/Stable). However, a higher overall assessment of its risk profile and a payback below five years would be positive for Kaduna's ratings.