July 25, 2022/Cordros Report
The Ministry of Finance released the 4M-22 fiscal performance report during the recently concluded public presentation on the 2023-2025 Medium Term Expenditure Framework (MTEF). One of the key takeaways from the report is the FGN’s aggregate revenue inability to cover debt service obligations, with the debt service to revenue ratio settling at 119.0% in 4M-22. In this report, we update our views on the medium-term implications of this development amidst the continuous reliance on CBN’s monetary financing.
FGN’s 4M-22 Finances: Fiscal Position in a Precarious State
According to the 4M-22 fiscal performance report, the FGN’s aggregate revenue (including GOEs) settled at NGN1.63 trillion – underperforming the prorated target (NGN3.23 trillion) by 50.9%. The gross underperformance was primarily driven by weaker oil revenue (NGN285.38 billion; 60.9% underperformance), given the combined impact of (1) low crude oil production volumes and (2) elevated PMS subsidy costs even as crude oil prices exceeded USD100.00/bbl. Elsewhere, even though Company Income Tax (98.6% performance) and Value-Added Tax (97.5% performance) collections improved, we highlight that non-oil revenue (NGN632.56 billion) underperformed the prorated budget (NGN752.80 billion) by 16.0%. The preceding was due to significant revenue underperformance across customs revenue (24.5% underperformance) and federation account levies (36.5% underperformance). Moreover, other revenue (NGN664.64 billion) underperformed its prorated budget by 62.5%, as all sub-revenue sources underperformed. The most notable underperformances were recorded in independent revenue (54.8% underperformance) and GOEs retained income (76.1% underperformance).
Meanwhile, aggregate expenditure (NGN4.72 trillion vs prorated budget: NGN5.77 trillion) underperformed by 18.3% primarily due to softer non-debt recurrent (27.4% underperformance vs prorated budget: NGN2.36 trillion) and capital (57.6% underperformance vs prorated budget: NGN1.82 trillion) expenditure. Nonetheless, we highlight that the FGN spent 47.0% more on debt services (NGN1.94 trillion) than it envisaged (NGN1.32 trillion) during the review period. The preceding puts the debt service-to-revenue ratio at 119.0%, indicating that revenue generation can no longer cover debt service obligations. The higher debt service compared to revenue also implies that the FGN is borrowing to service parts of its debt. Consequently, it suggests that all non-debt and capital expenditure of the government now come from borrowed funds.
Overall, the fiscal deficit printed NGN3.09 trillion. At this run rate, the fiscal deficit would settle at NGN9.27 trillion in 2022E, which is c.5.0% below our base case expectation (NGN9.74 trillion) as highlighted in our H2-22 domestic macroeconomic outlook. Accordingly, we envisage increased domestic borrowing and reliance on the CBN’s Ways & Means (W&M) as external borrowing conditions are presently unfavourable. Indeed, the actual W&M in 6M-22 was NGN2.45 trillion, according to the CBN.
Medium Term Implications of Higher Debt Service than Revenue
The delicate situation the FGN has found itself implies higher borrowing from domestic and foreign sources in future periods. However, we maintain that it is unlikely that the FGN will access the external market to issue Eurobonds, given the current level of yields. Instead, we expect borrowings will be channelled to the domestic debt market (through FGN bond sales and NTB overallotments, primarily), while the synergy between the CBN and fiscal authorities implies continued and increased usage of the Ways & Means balance.
On foreign borrowing: Higher foreign borrowing implies higher interest rates on the debt over the medium term. However, it could lead to a point whereby higher rates will not be enough to appease foreign investors. In that case, investors could demand further devaluation of the local currency, leading to unabating pressure on the local currency. In addition, higher foreign borrowing also increases the risks to Nigeria’s future debt repayments, with the loans susceptible to interest and exchange rate risks. That said, we recognise that the country could match foreign currency borrowings to foreign currency earnings from crude oil receipts in a worst-case scenario.
On domestic borrowing: The significant implication of the increased domestic borrowing is that the medium-term expectation for yields in the fixed income market would remain biased to the upside.
On increased CBN’s monetary financing: We highlight the implications of the persistent CBN financing of the FGN’s fiscal operations in our report titled: Implications of Continued Extension of Ways & Means by the FGN. In summary, these include (1) reduction in CBN’s asset quality, (2) difficulty in attaining price stability mandate and (3) worsening of currency and external sector pressures. Aside from that, given that some parts of the W&M come from CRR debits, we envisage that the banks could face liquidity challenges in the medium term, thereby dampening their profitability as net interest margins are compressed, other things being equal. Lastly, as the banks plug the liquidity deficit, it also suggests that money market rates are biased to the upside in the medium term.
Overall, we think persistent CBN’s financing of the FGN’s deficit would further deteriorate the overall macroeconomic stability conditions of the country over the medium-term if not urgently addressed.
