At the end of 2012, Nigerian state governments owned a total of $2.38 billion (₦369.55 billion) in external loans. There is about ₦545.50 billion in outstanding subnational bonds issued by 15 of the 36 state governments. An additional ₦270 billion in subnational bonds could be attributed to eight of the remaining states who are in advanced stages of issuing bonds. In addition, the state governments have varying levels of exposure to commercial banks which cumulatively could run into hundreds of billions of naira. On the aggregate, the subnational governments’ debt could currently be in excess of ₦1 trillion.
For most states, over 90% of government revenue comes from the monthly Federal Account Allocation Committee (FAAC) which also depends largely on oil proceeds. And with the exclusion of Lagos State, perhaps very few others, no State has been able to generate enough revenue internally to cover its most basic recurrent expenditure. This suggests that almost all states in Nigeria cannot be sustained solely on internally generated revenue (IGR).
Diverse Exposure to Debt amongst the States
Based on the available data on subnational debt in Nigeria, an average Nigerian state government owes ₦9.90 billion to multilateral agencies. Fifteen state governments with outstanding domestic bonds owe an average of ₦36 billion to investors in their bonds. However, this average masks the diverse nature of the debt profiles of the states. Lagos State accounts for 31.4% of the total estimable susbnational debt in Nigeria, making it the most indebted state in the country. Its outstanding external and domestic debt at ₦274.74 billion at the end of 2012 exceeds the cumulative debt of the lowest 26 states on the debt ranking. Isolating Lagos State from the subnational debt pool reduces the average state government debt to ₦16.6 billion from ₦24 billion; with the highest borrower owing ₦58.8 billion (Ondo State) and the lowest with only ₦2.1 billion (Borno State) in external loans from multilateral agency.
Significant Increase in States’ Debt Due to Bond Issuance Programmes
The inter-temporal analysis of state governments’ debt also provides some interesting insights. The total state government debt rose by 32.5% in 2012 from ₦660.50 billion at the end of 2011 driven primarily by the increase in subnational bond issues which rose by 55% over the period. In the last five years, subnational debt has grown by 246% from ₦252.57 billion in 2008 (which was primarily external) to ₦875.05 billion currently. Domestic debt, in the form of bonds, now account for 58% of the total state governments’ debt. In other words, like the federal government debt profile, domestic debt overtook the external debt component of the state governments’ debt portfolio during the period. However, there are a significant number of states that still rely mostly on external debt and perhaps commercial bank loans.
Public Debt Should Be Used to Finance Developmental Programmes
The characteristics and purpose of the debt are important in determining the likelihood of debt sustainability. Primarily, state governments should augment their revenues with debt to fund developmental projects with the hope that such projects would improve the standard of living of the residents of the states, and in the medium term enhance the capacity of the state government to increase IGR.
The extent to which this scenario plays out in Nigeria is debatable. Given the supervisory role of the Federal Government (FG) to partially guarantee all debts (domestic and external) undertaken by the states, it is arguable that all debts are tied to specific developmental projects. Most of the external debts from multilateral agencies are granted for programmes involving health, education, employment generation and/or other human development purposes.
Similarly, the proceeds of all subnational bonds are tied directly to specific developmental projects in the issuer’s state. In addition, the governance structure includes periodic monitoring of fund utilisation and application as a prerequisite to gaining approval for continuation of bond issuance programmes at the Securities and Exchange Commission (SEC). In other words, in many of the states that have issued bonds or taken external loans from multinational agencies in the past, a number of developmental projects must have evolved to the benefit of residents which arguably may have taken longer if funded through the limited monthly allocation.
Lagos State Is A Showpiece on the Positive Impact of Debt Financed Development
Typically, Lagos State offers a good example of the positive impact of subnational bond usage with the number of completed and on-going infrastructure projects that are linked to the 1st and 2nd tranches of the ₦275 billion debt programme. The on-going works on the Lagos Badagry Expressway being funded partly with the recently concluded first tranche of ₦80 billion from the ₦165 billion domestic bond programme of the state is also an indication of debt driven infrastructure development.
In addition, the myriads of projects linked to the Lagos Metropolitan projects, which is part funded by the World Bank, are feasible. It is therefore reasonable to argue that Lagos State is a good example of developmental spending tied to increased government IGR. This needs to be replicated in other states of the federation.
State Governments’ Revenue and Cost Structures Present Concerns for Sustainability
With the exception of Lagos State which sources over 62% of its income internally, all Nigerian States depend on federal statutory allocation. This overdependence poses great challenges to state administrations because in most states, the cost structures are skewed heavily towards recurrent spending on personal cost and overheads. On the average, both account for over 50% of the total revenue in most states, getting as high as 70-80% in some cases. This development will stifle capital spending over an expanded period of time without an ingenious way of financing capital projects. It is this gap that state governments are filling with debt despite the fiscal sustainability risk as the size of the debt portfolio increases.
The issue therefore is whether the Nigerian state government generates enough revenue not only to meet interest payment on these loans, but also to pay back as maturity. In addition, these loans are partially guaranteed by the Federal Government of Nigeria, hence, their inclusion as part of national public debt calculation. The extent to which this loan posed fiscal sustainability risk to the FG is worthy of concern as it provides insights into future viability and pricing of additional loans to the state government.
The Debt Metrics Suggests That Nigerian States Are Fiscally Sustainable
A sustainable debt level is that in which the present value of all current and future cash outflow in the form of debt service payments is equal to or lower than the present value of the revenue of the state. While it is difficult to estimate these parameters as a result of the non availability of the full characteristics of the entire debt portfolio of the state governments in terms of their maturity and repayment terms, the aggregate proportion of the outstanding debts and inferences from past debt service payments show that subnational debts are fiscally sustainable. On an individual state government basis, a different scenario may be the case. However, possible cases of unsustainable debt among the 36 states and the FCT are minimal.
A review of available state government data shows that the combined annual debt service payment on external and domestic loans in the last six years (2007-2012) is significantly lower than the aggregate IGR of the states. The debt services payment to IGR ratio averaged 22% during the period and reached a high of 47% in 2011. It declined to 40% in 2012. The above suggests that on the average, the state government generate enough revenue internally to service their current outstanding debts. The proportion of the total debt to IGR averaged 88% during the period under review, but total debts surpassed IGR in 2011 and 2012 with a debt to IGR ratio of 129% and 142% respectively. The debt to total revenue ratio however remained significantly low at an average of 20% over the period.
Cheap External Loans
The states have benefitted in the low interest rate on external debt significantly over the period under review which accounted for the robust debt service payment to IGR ratio. The External debt to IGR ratio averaged a mere 3.7% during the period, and maintained a consistence decline to a low of 2.0% in 2012. The implied interest rate per annum based on the value of external debt service payment compared to the total external debt outstanding fell to 3.4% in 2012 from 12.7% in 2007. It average 7.3% between 2007 and 2012.
During the same period, especially starting from 2010 where there is available data on domestic debt service payments by states, the states appeared to be paying significantly higher cost on domestic debts. In 2010-2012, domestic debt services payments accounted for 95% of the total debt services payment made by states despite the fact that domestic debt accounted for only 50% of their total debts in that period. The high domestic interest rate environment on the back of tight monetary policy might be pretty responsible for this. The overall size of the domestic debt portfolio of state governments may also be significantly higher than the value of the outstanding subnational bonds on which information is publicly available.
Room for More Debt
The above, in addition to other factors, suggests that state governments in Nigeria are fiscally sustainable. The levels of debts on the aggregates are comparatively low leaving significant room for increased leverage that could be channelled to developmental projects. Another factor that support the fiscal sustainability profile of the state governments is the low IGR status of many of the states which suggest that there is significant room to expand the IGR frontier using appropriate public sector investments with potentially high direct and/or returns.
Risk Factors to Consider
This is however not to say that there are no risk facing these governments from the current debt profile. There is the interest rate risk which could come from a sudden change to the current global quantitative easing position on the back of the need to jump start growth in the developed economies, especially in Europe, United States and Japan. We must quickly note that such a sudden change is unlikely in the short term and the world is likely to enjoy the era of easy money through 2014-2015. It is one of the reasons why the Debt Management Office (DMO) is currently encouraging locking in a low interest rates and highly concessional external loans for developmental projects rather than expensive domestic debts.
There is also the exchange rate risk from high external loans regardless of the advantages in the pricing and repayment concessions. The Nigerian economy remains highly exposed to a volatile exchange rate environment irrespective of the stability witnessed recently. A sudden and significant loss of value of the naira as a result of domestic or external shocks could erode all the benefits of low interest rates and comfortable moratorium on external loans. However, the DMO believes that Nigeria’s subnational external reserves, held in US Dollars, provide a strong hedge against the exchange rate risk.
Another source of risk is the increasing threat to federal fiscal sustainability from the combination of sustained security challenges in the country, and high oil revenue losses due to vandalism, theft and insurgencies in the Niger Delta. In the current year, the federal government’s gross revenue has consistently fallen short of the budget, and monthly allocations have had to be augmented from the excess crude account. An estimated shortfall of ₦1.018 trillion in revenue, compared to budget, was recorded in the first quarter of the year due to these factors. Therefore, a major decline in monthly statutory revenue of state government could impact significantly on their sustainability.
Governance of State Governments’ Debt by the Regulators
With all the aforementioned risks considered, state governments in Nigeria remain fiscally sustainable. They have significant room to address this risk through the expansion of the IGR potentials. Achieving this would require additional investment in public goods and infrastructure targeted at opening state specific investment opportunities.
In other words, the state governments have the opportunity to explore additional debt options that are targeted at these projects. Although there may be need to improve on governance structure of this debt-linked projects by the regulatory authorities such as the SEC for subnational debts and the DMO for external debts, we believe that there is significant room for state governments to fast track developments at the state levels with debt-financed public investment at minimal risk to all stakeholders; as long as the projects ultimately help to expand the IGR of the states.