Contemplating Risks ahead of a proposed $500 Million 10 year Bond Issue
Current Ratings: B+ (S&P downgraded from BB+ August ‘09); Moody’s - NR and BB- _ Stable (Fitch June ’06)
Nigeria Naira (NGN) Official Rate 148.60
GDP at Current Prices 3Q 2009: NGN 22,729Bn ($151.6Bn)[1]
Gross External Reserves (January 29, 2010): $42Bn of which $2.1Bn is blocked[2]
CPI Rate December 2009 (Y-O-Y) 12.4%; CPI less food: 9.4%
Monetary Policy Rate (MPR) @ 6.00%
OPEC Oil Basket ($/barrel) 71.40 (01-28-10)
90 Day T- Bill Rate: 2.69% (01-29-10)
Interbank Call Rate 2.46 (29-01-10)
Strengths:
· Central Bank of Nigeria (CBN) intervention within the banking sector in mid-August and subsequent bank audits have improved risk management controls and financial transparency.
· CBN response to credit crisis caused Net Domestic Credit (November y-o-y) to explode rising 173% (Y-o-Y) to NGN 7,496,539MM. Credit provided to the government declined 31% over the same period to NGN 2,493,442MM.
· Ample debt capacity as total external debt amounts will likely amount to $7.665BN. Principal amortizations and interest expense are forecasted to be $1.2Bn for 2010
Risks:
· Vulnerability to world hydro-carbon prices that generate foreign exchange income has pronounced influence on fiscal balances
· Poor availability of timely statistical information from Government entities
· A 2010 Federal Budget that proposes a 31.2% increase in appropriations with little to no concomitant increase in non-oil revenues (VAT, Corporate income taxes, improved customs revenue monitoring)
· Government intervention in local financial markets in conjunction with infrastructure improvements will exacerbate federal deficit that expects to reach 6.2% of nominal GDP in 2010.
· Government 2010 Budget projected real GDP growth of 6.1%. IMF places real growth at 5% asserting that the economy has been hit hard by the global financial crisis, decreasing hydro-carbon production and a banking sector already weakened by over-extended credit to financial intermediaries.
· Government debt has significantly grown over the 2009 with little abatement expected in 2010. Aggregate Government debt through September 30 2009 has grown 31.8% to Naira 3,058,185 Trillion ($20.387Bn)
· President Umaru Yar’Adua’ physical absence from the day to day Federal Government management exacerbates the already lengthy policy making initiatives. President Yar’Adua has been receiving treatment in Saudi Arabia for a heart ailment since the end of November. As of this writing both houses of the Nigerian Congress have voted to remove President Yar’Adua and transfer the Presidency to the Vice President Dr. Goodluck Jonathan. The legality of the transfer, however, is under question.
· The Nigerian press reports (February 12th) indicate that support for interim President Goodluck Jonathan was predicated on his promise to disburse $2 Bn from the Excess Crude Account to 12 state governors whose individual states are in fiscal deficit.
Summary:
Nigeria’s rarely lacks the opportunity to be to place itself among the forefront of sub-Saharan economies. However like Sisyphus, the Nigerian government finds itself stymied, revisiting financial reforms that had been previously addressed. Financial institutions over-leveraged their balance sheets and failed to implement appropriate CBN recommended risk controls. The CBN ultimately rescued five banks and intervened with an injection of Naira 420 BN (USD 27MM). In an effort to rebuild confidence, the CBN may have over-stimulated the money markets. Since the mid-August bank intervention, inflation has risen steadily. December CPI has reached 12.4% after showing a period some moderation.
Nigeria’ challenges in 2010 will relate to social welfare issues, such as poverty, infant mortality, and maternal health, which are steadily eroding. Infrastructure development while prioritized and approved is slow to undertake. Corruption is both blatant and insidious, conspiring to weaken confidence in the local and regional government.
The 2010 Budget is predicated on the assumptions that oil production will be 2.088 million barrel per day (mb/d) and that benchmark oil price will be $57/barrel, while Joint Venture cash calls will be $5billion. The Budget expects an average exchange rate of N150 to the US dollar, targeting Gross Domestic Product (GDP) growth rate at 6.1 percent, and putting target inflation rate at 11.2 percent.
Finally, the uncertainty over President Yar’Adua’s health and awaited return as head of the government adds more uncertainty and confusion over the function of the republic. Public expectations that the central government can address the myriad of challenges facing Nigeria are low. [3] The unequal distribution of revenues is causing deep anger that can erupt in serious social unrest. If these trends are not addressed, Nigeria will remain entangled in the octopus of poor governance and unrealized potential.
Trade Balance
Nigeria’s dependence on oil for over 90% of its foreign exchange earnings makes its capital account vulnerable to the fluctuations in crude oil prices. This, in addition to its high import bills contributed to the fluctuations in the level of reserves over the years and consequently the way the reserves are being managed. During the oil boom of the mid-seventies which has resulted in the build-up of reserves, the external reserves were diversified into an array of financial instruments including foreign government bonds and treasury bills, foreign government guaranteed securities, special drawing rights (SDRs), fixed term deposits, call accounts and current accounts. This provided significant investment income as well as liquidity. However, during the glut in the global oil market which led to collapse in the crude oil prices and consequently a drawdown in the reserves, the reserves were held mainly in current accounts and treasury bills. This underscored the need to diversify the sources of foreign exchange inflow of the country
Debt Sustainability
Nigeria has a low risk of returning to previous distressed debt levels. Total external debt at the end of 2009 will likely reach $7.665 Bn, a figure representing 13.6% of total exports including services and income.[4] The International Bank for Reconstruction and Development (IBRD) is the single largest creditor having lent roughly $3.8Bn through 2009. Bilateral creditors which are mostly Export Credit Agencies (ECAs) are owed an additional $1.64Bn. Commercial bank credits and other private lenders have the least aggregated exposure with $1.2bn. There are no outstanding Nigerian Government Eurobonds.
Domestic public debt is projected to reach 12 percent of GDP at the end-2009. Deposits at the Excess Crude Account (Nigeria’s windfall oil savings) have provided a substantial cushion to the economy. The Government has drawn down liberally during 2009. At the end of 2008 the Central Bank recorded a reserve of $18 billion (almost 10 percent of GDP). On February 8th 2010 junior Finance Minister Remi Babalola was quoted that the Excess Crude Account’s reserves were now closer to $6.2Bn. The government spent nearly $12Bn to counter the impact of the global downturn on the Nigerian economy.[5]
Government debt has significantly grown over the 2009 with little abatement expected in 2010. Aggregate Government debt through September 30 2009 has grown 31.8% to Naira 3,058,185 Trillion ($20.387Bn)
Source: Office of Debt Management Nigeria
Abraham Nwankwo, director-general of the Debt Management Office, has stated that Nigeria plans to sell 867.5 billion naira ($5.74 billion) worth of bonds, about a fifth of planned expenditure this year, to fund the budget deficit.[6] Overall, Nigeria’s debt I predominately domestic issues accounting for 85% of total debt outstanding. The great majority of international debt is owed to large multi-lateral institutions, in particular the EBRD. Nwankwo also envisions a return to the international bond market later this year. The government has proposed to the Parliament a ten year $500 Million USD bond.
Nigeria’s public debt ratio to nominal GDP (Naira 22,729 Bn – USD 151.5Bn) is comparatively low at 13.45%. In the past this ratio has been as high as 50% prior to 2005 and the restructuring of Paris Club debt. Nigeria’s financial press has pointed out on several occasions that the proceeds from the debt issuance has not been effectively distributed or monitored despite Government claims to the contrary.
The Office of Debt Management indicates that sub-national borrowing (Nigerian state borrowing) has also grown to Naira 20.788Bn. While individual state borrowing is limited, there are indications that State Governments are expanding their exposure to domestic creditors, underscoring the need for improved monitoring of sub-national debt.
Oil Production and the Niger Delta Strife
Nigeria’s proven oil reserves are estimated to be 36 billion barrels of predominately low sulphur content. Natural Gas reserves are thought to be over 100 trillion cubic feet.[7] Despite the potential, oil and gas production has been steadily falling (see graph). Nigeria draws a good portion of its on shore oil and gas from the Niger Delta region where there has been serious security issues effecting production. Nigeria has largely ignored OPEC production quotas set a t1.65MM bbls/day, removing quotas as a reason for falling production. Production has averaged about 2MM bbls/day million barrels a day in recent months—20 percent below its 2005 peak and well below estimated capacity of 2.8 MM bbls/day. Nigeria is expected to export $52.5Bn worth of crude oil in 2010 down some $22 Bn from 2008.
Security in the Niger Delta region continues to limit the ability of the both the oil firms and the Government to extract revenues. The Government’s lack of a coherent plan to address oil smuggling and to implement a fair distribution of the region’s wealth to the local population has contributed to the decline in security and thus the ability to grow oil revenues. The major oil firms operating in the Niger Delta have, according to corporate websites [8]acted independently of the Government to facilitate local community development.
Fiscal Balances
The 2009 fiscal budget was poorly implemented. The government will likely record a larger than expected shortfall of $2.2Bn. From the beginning the 2009 budget ran into difficulty. The Government presented the budget in early December 2008 for Congressional debate. In mid-December the Senate hastily passed an expanded 2009 budget shortfall that the House of Representatives did not endorse. By mid-April 2009, President Yar’Adua requested a review of the 2009 budget in light of projected fall in oil revenues and OPEC mandate quotas.
The government had approved a NGN836.9Bn 2009 budget deficit representing 3.2% of GDP. In reality the deficit grew to 9.1% of GDP. The deficit would have been even worse if the Government had not drawn down from the Excess Oil Credit Account (that is the windfall earnings between actual and budgeted oil revenues). A junior finance minister estimated the drawdown to be $12Bn.[9]
The 2010 Federal budget will have to address several immediate and wide ranging concerns. The banking crisis and subsequent loss of faith in the financial sector has affected private credit outlays. The government stepped in to facilitate with loan guarantees and ramped up expenditures. The Budget Office has proposed a Naira 4,079,654,724,257 ($27.2Bn) appropriation. The appropriation is a 31.5% increase over the 2009 approved budget of Naira 3.102Trn. The budget is built around real GDP growing by 6% and a weighted average crude oil price of $57bbls/day. Oil production is forecast Expected 2010 government revenues are Naira 2.517Trn, leaving a financing gap of Naira 1.562Trn ($10.4Bn) or 38.29% of Government expenditures. The 2010 Budget envisions distributing Naira 180.28Bn or Statutory Transfers, Naira 517.07 Bn for debt service, Naira 2,011Bn for non-debt related expenditures and Naira 1,370Bn for capital expenditures.
The Government will have to invoke several options in order to plug the deficit hole. President Umar Yar'Adua, in his budget speech, gave hints on what the public can expect from the tax regime. "Government is also forging ahead with key public-sector financial management reforms, with greater emphasis on increasing non-oil revenue through the reform of the Customs Service and the Federal Inland Revenue Service, as well as the audit of independently generated revenue." Clearly President Yar’Adua will be relying on the government agencies that have not met important standards previously.
Effective national growth policies are predicated on targeted expenditures to worthy projects that will sustain employment and enhance the efficiency of the economy, Nigeria suffers from a lack of transparency. Timely and accurate information on government websites are not available, leaving outside monitors to make broad assumptions. Comparative data from the National Statistics Bureau is outdated. Information from the Budget Office is designed more to confuse and obfuscate. Ascertaining the effectiveness of fiscal expenditures applied to infrastructure projects: rail transport, power generation, roads, telecommunications, port facilities, is not available on any government website.
Concluding Remarks:
Nigeria appears to be in for a rough ride in 2010. Fiscal expenditures are growing significantly necessitating a strong government attempt to allocate funds judiciously and to increase the ability to raise revenues. At the current expenditure trend rate Nigeria will likely issue significantly more internal debt which may have a crowding out impact should non-government entities need to raise funds. Nigeria is not yet in a fiscally perilous situation. However, the Government response to falling oil revenues and poor revenue gathering
John T. Sullivan
Kerry Emerging Global Opportunities LLC
February 15, 2010
E-mail: jtpsullivan@gmail.com
[1] Source: Ministry of Finance, Nigeria
[3] Poll conducted by The Guardian January 6-9th 2010
[4] Central Bank of Nigeria, International Institute of Finance
[5] Nigerian Guardian February 8th 2010
[6] Bloomberg interview February 12th 2010
[7] U.S. Department of Energy EIA estimates
[8] See Shell UK – Nigeria http://www.shell.com/home/content/nga/responsible_energy/shell_in_the_society/
[9] The Guardian ibid
