Concerns rise over FG’s funding as investors shun local bonds

There are clamours from reputable organisations, including the World Bank, for the Central Bank of Nigeria (CBN) to reduce its lending to the federal government through the “ways and means” window. Interestingly, local institutions, especially opposition political parties have joined the frenzy. However, here comes the dilemma of the managers of the economy. The rising […]

There are clamours from reputable organisations, including the World Bank, for the Central Bank of Nigeria (CBN) to reduce its lending to the federal government through the “ways and means” window. Interestingly, local institutions, especially opposition political parties have joined the frenzy. However, here comes the dilemma of the managers of the economy. The rising interest rate in the global market has spurred a sell-off on emerging market bonds, with Sovereign Eurobonds of African countries, including Nigeria, trading at double digits, a development which has cowed many African sovereigns from borrowing from the international debt market.

Unfortunately, the tap for bilateral loans from development finance institutions and partner countries, which are often relatively cheaper, is drying up very fast, as both developing and developed nations battle with the new global realities threatening to throw the economies into recession.

Nigeria, which had planned to raise more debt through the Eurobond market a few months ago had to backtrack given the elevated interest rate environment, as it would have had to pay close to 14% for a 5-year Eurobond, a pricing that would balloon the country’s already stretched debt service burden. So, the Eurobond market is a no-go-area for Nigeria at this time, as it may be more expensive than the local bond market.

Coincidentally, official oil production remains low at 1.2 million barrels per day, as the “cabals” seem to have democratised and formalised theft. The unending spate of oil theft is a major unspoken reason for the divestment of a few international oil companies, as they continue to exit their operations from Nigeria’s oil sector. So, oil revenue is not likely to improve any time soon. Activities in the non-oil sector are dwindling, hence the weak outlook on non-oil revenue. More worrisome is the multi-sector request for tax reduction or wage increase.

Local bread makers are threatening to halt production if the government does not accede to their request for waivers and grants, just as airlines are seeking intervention in their rising cost of operation to avoid closure. The Academic Staff Union of Universities  (ASUU) has been on strike for months, as they press for more money. It’s uninterestingly complex to unravel Nigeria’s fiscal puzzle.

So, for Nigeria, it’s a paradox of lower revenue and rising cost for the government. Incidentally, like many African governments, the only way Nigerian economic managers know to bridge the gap is to borrow more and this time it can only be from the local market. The two major channels for the government to borrow locally are through the Debt Management Office Auction of Bonds and Treasury Bills, as well as the Central Bank’s ways and means.

With the reported N19 trillion borrowing from the CBN as of April 2022, far in excess of the statutory threshold of five per cent of CBN’s previous year’s revenue, that source of funding may be difficult going forwards.

More importantly, as the monetary policy committee tightens up the system with interest rate hikes, the CBN may seek to minimise its ways and means, which has indirect implications on inflation. So, the main option left for the government may be the local debt market.

Incidentally, foreign and local investors may be shunning the federal government’s bond, as reflected in the abysmally low subscription at the recent bond auction on July 18, 2022, where the Debt Management Office offered a total of N225 billion bonds of three different series, with term to maturity of 2 years, eight months; 9 years, 9 months; and 19 years, 6 months.

Unlike the previous auctions, where investors oversubscribed for the Sovereign Notes, the total subscription came at barely N142.3 billion or just 63.2 per cent subscription rate. In the end, the DMO only raised N123.8 billion or 55 per cent of the target amount.

As Dr. Lizzie-Kings-Wali, Chief Executive Officer of Blackstone Capital, puts it, “the reason for the low subscription level is clear. Foreign investors seeking Nigeria debt market exposure have shifted attention to the Sovereign Eurobond, which offers better return with zero exchange rate risk.”

According to her, simple finance theory dictates that capital flows to where the return is highest. “As a foreign investor, it’s easier to access the Eurobond market, and that has no foreign currency risk, especially at a time when foreign currency scarcity and concern over probable devaluation risks continue to scare foreign portfolio investors.”

For foreign investors to return to the local debt market, the yield would have to rise enough to offer a deserving premium that compensates for the higher cost and risk of accessing the market, compared to the Eurobond market.

“Unfortunately, the Eurobond market may not cool off soon, as it is reflective of the rising global interest rate environment and non-investment grade bonds, such as those issued by African Sovereigns like Nigeria and Ghana would have to be priced at a huge discount to low-risk securities from investment-grade rated issues from developed countries.”

Abiola Rasaq, a Lagos-based financial analyst, attributes the low subscription recorded at the bond auction to a number of factors influencing investor appetite. First is the yield level, which is not only below the inflation rate of 18.6 per cent but also at a discount to comparable yields on Nigeria’s Sovereign Eurobond. “For instance, the April 2032 local currency bond was issued at a yield of 13.0 per cent at the auction, even so, the FGN Eurobond maturing February 2032, closed at 14.4 per cent in the secondary market. So, foreign and local investors with interest in Nigerian Sovereign exposures are rather attracted to the Eurobond market, which provides a natural hedge against unforeseen devaluation risks, especially at a time when low liquidity of the Naira in the FX market continues to undermine appetite in Naira-denominated assets,” he pointed out.

On the day of DMO’s auction, Nigeria’s 7.625 per cent $1.118b Eurobond due in 2025 gained $1.25 at a yield of 13.23 per cent (bid) at a price of 85.25. The 9.248 per cent $750 Eurobond maturing in January 2049 gained $3.5 to close at a yield of 14.32 per cent (bid) and a price of 65.5. Similarly, the 7.696 per cent $1.250b Eurobond due in February 2038 gained 2.625 to close at a price of 58.75 and a yield of 14.40 per cent.

“Also, with the hawkish stance of the monetary policy authority and limited alternative scope to finance the budget deficit, investors expect rates to rise faster in the months ahead, hence the bearish sentiment for bonds at this time. Though some PFAs and some investors were bullish on the July 2042 Notes, which are the longest maturity offered at the auction, market sentiment on long-dated naira-denominated Notes is broadly bearish at current yield levels,” Rasaq said.

Incidentally, the current dynamics of low subscription have implications for the debt burden, as a likely rise in yields in the months ahead may balloon the debt service cost of the federal government, an almost inevitable circumstance that reinforces the need for fiscal consolidation.

“Tightening the fiscal belt along with the seemingly aggressive monetary stance would be a hard nut for the government, especially at a time when households and businesses across different segments are seeking palliatives to cushion the impact of the inflationary pressure,” says Rasaq.

This is an inevitable reality that needs to start with a long-overdue genuine and impactful reduction in the bogus running cost of the government at all levels and tiers if the government is really serious about addressing the fiscal imbalance.

“The judiciary has ruled in favour of itself for higher pay, just as legislators have perhaps learnt to saliently negotiate a jumbo package for themselves as a condition to pass the appropriation bill and the Executives are perceived to be living large on scarce public funds, in addition to likely opaque procurement and recruitment practices. Blocking at least the obvious revenue leakages and wastages would give strong moral justification for macro consolidation, including removal of subsidies on petrol prices and other unaffordable indirect benefits,” Rasaq added.

With waning productivity, analysts believe that the incoming administration will face a tough job to reposition the economy, especially in the area of upscaling government revenue and stabilization of the macroeconomic system. The government seeks to bridge infrastructural gaps for the long-term sustainability of the economy but the shortage of revenue continues to undermine development.

With the expectation of a global recession, analysts posit that state governments may once again have challenges financing their budgets, including meeting recurrent expenditures such as monthly payroll, an unfortunate incidence that plagued many of the 36 states in 2014/2015 when even oil-producing states could not afford to pay salaries of civil servants.