The 2016 fiscal year has been largely synonymous with a sharp slowdown in economic activities largely as a result of lower oil earnings which constrained fiscal revenue and foreign exchange supply, as well as underwhelming policy responses and a brooding sub-national fiscal crisis which peaked in H1:2016. With a change in monetary policy tact to inflation targeting in Q1:2016 – demonstrated by 2 rate hikes - in a bid to bolster FX supply, the FGN has been clear on its intent to counterbalance monetary tightening by utilizing available fiscal space to buoy expenditure as a strategy to deepen economic diversification and stimulate economic activities.
Hence, against the logic of fiscal consolidation in a period of depressed revenue, the FGN proposed an expansionary budget in 2016 with expenditure projected at N6.1tn, 40.0% higher than actual in 2015. Yet, the economic stimulus expected from the 2016 budget has been imperceptible due to militancy in the Delta region which whittled down oil production to 1.4mb/d as at September 2016 (36.4% lower than budget benchmark), the long lag in passing the budget, underperformance of non-oil revenue generating agencies and delayed adjustment of exchange rate.
Despite government’s intent to diversify revenue base and relegate oil earnings to the 3rd most important in 2016, data compiled from H1:2016 budget performance puts oil revenue’s contribution to 42.6% of total, the highest amongst all sources. Indeed, all non-oil revenue sources ran below projected run rates in H1:2016. Income from corporate income tax (CIT) was 62.7% less than expected while independent revenue was only 14.2% of projections for half year. Thus, the FGN has largely relied on deficit financing to balance its books, with fiscal deficit as at H1:2016 reported at N1.5tn (66.6% of total approved for FY:2016), implying a fiscal deficit to GDP ratio of 3.2% compared to 2.1% legislated and 3.0% ceiling for a full fiscal year. Of N1.5tn deficit raised, only N159.1bn was released to cash-back capital projects in the period. We largely expect revenue to improve in H2:2016 - as observed from FAAC allocations in Q3:2016 – due to translation of oil earnings at lower exchange rate, but still expect fiscal deficit (as percentage of GDP) at year end to exceed 2016 target by a minimum of 0.7%.
Nevertheless, last week, the FGN submitted the Medium-Term Expenditure Framework (MTEF) and Fiscal Strategy Paper for 2017 – 2019 to the National Assembly with ambitious expenditure targets. The MTEF provides the framework for the 2017 budget and illuminates the expenditure outlook and revenue expectations for the period. Aggregate expenditure in the proposed 2017 budget is projected to surpass the N6.1tn in the 2016 budget by 13.3% (circa N805.9bn) to N6.9tn in line with objectives to reflate the economy. Non-debt recurrent expenditure and capital spending (exclusive of special intervention programmes) are estimated to increase by 9.3% and 11.2% to N2.6tn and N1.8tn respectively. Debt servicing is also projected to grow N277.3bn from N1.4tn in the 2016 budget to N1.6tn (39.3% of revenue) in 2017 and Statutory Transfers by 5.5% Y-o-Y to N370.1bn. The budget is expected to be 60.7% revenue funded (from 63.6% approved for 2016) and 39.3% by borrowing (higher than 36.4% in the 2016 budget).
The aggregate revenue to fund the 2017 budget is projected at circa N4.2tn (8.1% higher than the 2016 budget revenue estimates) with about 32.9% ( N1.4tn) expected to come from Oil sources while Non-oil revenue (36.3%), Independent revenue (29.0%), NLNG dividend (0.3%) and Others (1.4%) are estimated at N1.5tn, N1.2tn, N0.14tn and N0.59tn respectively. Oil revenue assumptions were broadly conservative with oil price benchmark set at US$42.5/b (exchanged at N290.00/US$1.00 rate), higher than US$38.50/b adopted for 2016 but less than current price of US$51.9/b. While Customs revenue was marked down by N48.9bn to N277.6bn, Value Added Tax (N282.2bn, up 42.4% Y-o-Y) and Company Income Tax (N902.8bn, up 4.1% Y-o-Y) were targeted as quick wins to drive growth in Non-oil revenue, suggesting VAT rate might be raised in 2017. We nonetheless view both the non-oil and independent revenue assumptions optimistic given recent performance of both income lines. Despite the reported addition of about 700,000 companies into the tax base by the FIRS in 2016, the slowdown in economic activities coupled with largely informal structure of the economy will continue to be a challenge for the FIRS.
Fiscal deficit is projected to grow by 22.3% from N2.2tn in 2016 to N2.7tn in 2017 fiscal year, thus Deficit/GDP ratio is expected to settle at 2.5% in 2017 from 2.1% in 2016. Whilst the government’s decision to aggressively borrow from the local debt market to fund the budget deficit in 2016 reduced its susceptibility to exchange rate risk, the MTEF for 2017 suggests that over the medium term, the federal government will be more skewed towards external financing options, in order to free up local funds for private sector investment. However, high debt servicing cost to revenue ratio remains a constraint on ability to continue running below 2.5% fiscal deficit to GDP ratio notwithstanding low debt to GDP ratio (17.0%). Also, given the bearish outlook for the Naira, the plan to redirect attention towards external financing options suggests the projected amount for debt servicing will shoot up in 2017 - depending on the performance of the Naira. Inadvertently, various measures of economic liberalization policies (including privatization) would need to be pursued to improve efficiency of the public sector and generate cash flow needed to invest in capital projects and increase borrowing capacity.