Culled—Proshare

December 16, 2016/Renaissance Capital

Nigeria’s strategy to get the economy out of recession is captured by the following phrase: ‘grow what we eat, and consume what we make’. With this phrase, President Muhammadu Buhari presented a FY17 budget outlining expenditure of NGN7.3trn, a 20% increase vs the FY16 projection.

This budget is premised on an ambitious 28% increase in revenue to NGN4.9trn. As revenue in September was 25% below the pro-rata full-year projections, we struggle to see how the Federal Government of Nigeria (FGN) will meet this projection.

‘Grow what we eat and consume what we make’
With the FY17 budget, the FGN plans to pull the economy out of recession and wean it off crude oil, via agriculture (by ultimately making Nigeria self-sufficient in food) and manufacturing (by producing what Nigerians consume, including petrochemicals, cement and light manufacturing products). We like the plans to focus on “rapid” infrastructure development, particularly rail and power.

Buhari promised “tangible benefits” from 2017. We take this to mean we should see the stimulatory effects of the capex spend in the short term, which we find encouraging. We think the Presidential Enabling Business Council mandate of making it easier to do business – which Buhari mentioned – is critical, because the economy needs substantial private sector investment to help restore sustainable growth.

Budget provisions to clear outstanding electricity bills and debt of NGN2.2trn owed to contractors and other third parties should improve liquidity, which is positive for growth.

Ambitious revenue target
The flaws in the FY17 budget emerge when we look at the revenue projections – an ambitious 28% increase to NGN4.9trn in FY17 – particularly when the FGN has failed to meet its FY16 target, due to low prices in 1Q16 and disruptions to crude oil production.

At September, revenue was 25% below the pro-rata FY16 target. To the FGN’s credit, it revised down its independent revenue projection for FY17, which at NGN807bn is almost half that projected for FY16. Even the non-oil revenue projection is 5% lower.

However, this pragmatism was countered by a 140% increase in the FGN’s oil revenue projections, to NGN2trn. This may in part be due to an optimistic assumption of oil production of 2.2mn b/d, which the country has failed to achieve since 2014 (Figure 2).

This assumption is partly mitigated by a modest oil price assumption of $42.5/bl.

80% of budget will go towards capex, wages and debt servicing
The FGN plans to raise spending in FY17 by 20% to NGN7.3trn ($23.2bn at official FX rate). The biggest allocations will go towards capex (NGN2.2trn, or 31% of the budget), personnel costs (NGN1.8trn; 25%) and debt servicing (NGN1.7trn; 23%).

Education, defence and health services will get 7%, 5% and 4% of the budget, respectively. The main capex recipients will be power (24%), transportation (12%) and housing (4.5%).

Buhari pointed out that despite capex suffering from project formulation delays and revenue shortfall, in May-October 2016 the FGN released a record-high amount of capex.

Because of this, work resumed on some stalled projects, including the construction of new airport terminals, several road projects, key power transmission projects and completion of the Kaduna-Abuja railway.

• Budget deficit target of 2.2% of GDP. The FGN is targeting a flat financing gap vs its FY16 projection. However, at June 2016, the deficit came in wider than projected at 3.2% of GDP, by our estimate. This was largely due to a shortfall in revenue.

As we expect revenue to come in below the FGN’s FY17 projection, we forecast a wider deficit of c. 3% of GDP in FY17. This implies that borrowing will be higher than the FGN is currently projecting – suggesting further upside risk to debt servicing costs, which were already at two-thirds of revenue in June, a proportion we find concerning.

Notably, the FGN did not reveal how it planned to finance the FY17 budget. Given the FGN’s resource constraints, we expect a marked increase in foreign borrowing compared with the days when former finance minister Ngozi Okonjo-Iweala, who was averse to raising foreign debt (which she could afford to be, because revenue was high), was in office.

• Stabilisation of sub-national government. Only one of Nigeria’s 36 states – Lagos – has internal revenue collections that allow it to be self-sustaining. The other states depend on allocations from the Federation Account for their administrations to function.

The collapse in oil revenue and the recession have significantly hurt their finances. Buhari said that stabilising the states is a key objective. In June, a conditional budget support programme was introduced, which offered state governments NGN566bn ($1.8bn at today’s official FX rate) to address their funding shortfalls.

To participate, state governments were required to subscribe to certain fiscal reforms centred on transparency, accountability and efficiency, including publishing audited accounts and introducing biometric payrolls that will help them to eliminate ‘ghost’ workers. We think the conditions the FGN put in place for states to receive funding will play a positive role in helping to root out corruption at state level, and create more efficient and productive sub-national governments.