On the federal government’s debt strategy

The minister of finance was recently in the news talking about the federal government’s debt strategy. To paraphrase her, they realised that our infrastructure was seriously lacking even though our debt to GDP ratio was very low. The strategy therefore focused in increased debt to finance key infrastructure. While acknowledging that the debt servicing costs as a share of revenue was high, the focus was to restructure debt towards longer term foreign debt and to focus on increasing revenues.

All sounds very good in theory but the reality is somewhat different. On the debt side things have gone according to plan. Between the end of 2014 and March 2018 federal government domestic debt has gone up from about N9.5tn to about N19.3tn, a 103 percent increase in Naira, although only a 10 percent increase in dollars. The revenue performance has however not gone according to plan. Federal government revenue in naira has remained flat at about N3.2tn in 2014 to N2.9tn in 2016 and N2.7tn as at Q3 of 2017. In dollars though that represents a 60 percent drop in revenue. In short, debt has gone up, but revenue has gone in the opposite direction.

You may argue that the benefits of the debt for infrastructure plan will not have instant impacts but results that manifest over time. That may be true, but two factors come to mind. First Nigeria has long history of raising debt for infrastructure that results in more debt but without the commensurate improvement in infrastructure. Indeed, if you dig down deep in the current numbers, a significant part of the debt is going towards paying salaries and other recurrent expenditure. Secondly, whatever infrastructure built is priced so low that it could not possibly raise enough revenue to repay the debt used to build it. For instance, the Abuja Kaduna rail which was partly built with concessionary loans is priced so low that it cannot possibly generate enough revenues to repay the loans used to build it.

If the infrastructure cannot pay for the new debt, then maybe broad increases in tax collection could. The minister mentioned that the second part of the debt strategy is doing what is needed to increase tax revenue so maybe that is the plan. Unfortunately increasing taxes is easier said than done. Nigeria officially has a low tax to GDP ratio but that depends on a lot who you count as the tax collector. It may be low if you count official taxes flowing to the federation account, which is what is used to make up the official tax to GDP numbers, but once you think about taxes collected by other non-state actors then it is anyone’s guess. Collecting taxes by a state is less about systems and processes and more about power. Power to force all entities within a domain to pay up. Unfortunately, the Nigerian state has probably never been as weak since independence. How the weak state can effectively displace other non-state actors and collect taxes is not very clear. Especially without any kind serious tax reform on the agenda.

In summary the debt strategy is basically betting the house on the ability of Nigeria to effectively collect taxes, something which is has not really managed to do since independence. I don’t know about you, but if I was a betting man I would not make that bet. Not because I’m unpatriotic but because, given all the threats to its existence, Nigeria becoming an effective tax collecting state seems like a low probability event.

The debt strategy also includes restructuring debt away from short term instruments to longer term foreign debt. The minster argues that foreign debt is cheaper, but it is not. The bad thing about borrowing in dollars is that you must pay back in dollars and it is anyone’s guess what the exchange rate will be in 2028. Back of the envelope calculations show that the naira depreciates by about 15 percent a year on average relative to the dollar. Once you add that 15 percent average exchange rate change to the 7 percent interest rate in dollars then foreign debt is not cheaper. Although the move away from short term instruments should be applauded.

The shift towards foreign debt also means the costs of failure of the strategy are likely to be more severe as the Central Bank will be unable to bail the federal government out. As we learned from our experience between 1980 and 2005, foreign debt liabilities can be a pain. I doubt there would be a Paris club bailout for a second time.

The good news is that none of the chefs of this debt strategy are likely to be in office when the debt soup is ready. They will probably be long gone with a new set of chefs saddled with the responsibility of dishing out the soup. Unfortunately, Nigerians will still be here to eat whatever is served. And that soup may not taste very nice. Or is that bad news?

Thanks to Richard for the chart.