The coming high cost of funds as government borrows

It is no longer a question of whether the cost of funds will rise in Nigeria this year. The question is not even when the rise will come. The rise has already started. The federal government has entered the market to borrow, and the consequences are inevitable. Rather, the more relevant questions now are how […]

It is no longer a question of whether the cost of funds will rise in Nigeria this year. The question is not even when the rise will come. The rise has already started. The federal government has entered the market to borrow, and the consequences are inevitable.

Rather, the more relevant questions now are how high the rise will get, and what its implications will be for the health of the economy, especially the private sector. Would this borrowing wave lead to the displacement of private-sector borrowers in the scramble for funds? Would it tighten liquidity to the point where productive investment is crowded out by public debt issuance?

The Central Bank of Nigeria captured this inevitability in its economic outlook for the year. It noted that out of the projected fiscal deficit of N12.14 trillion, as much as N7.02 trillion, or 57.9 per cent, would be financed through borrowing from the domestic market. Only N1.76 trillion, or 15.5 per cent, is projected to be sourced from external borrowing, while the rest is expected to come from multilateral and bilateral project-tied loans.

“The financing mix indicates a preference for local debt markets, which may tighten private-sector liquidity, raise domestic interest rates, and minimise exposure to foreign-exchange risk,” the CBN observed.

That single paragraph neatly summarises the policy trade-off confronting Nigeria. On the one hand, domestic borrowing reduces exposure to exchange rate volatility and foreign currency debt traps. On the other, it places intense pressure on local financial markets, where government demand for funds competes directly with the private sector.

Beyond borrowing to fund new deficits, Nigeria also faces the daunting task of servicing its existing debt stock. Debt service is projected to gulp as much as N15.52 trillion this year. Against projected total revenues of N34.33 trillion, this translates into a debt service-to-revenue ratio of 45.2 per cent.

Some government agencies present this burden as a ratio of GDP, arriving at a debt service-to-GDP ratio of 34.68 per cent, an obviously lower number, and one that provides some measure of comfort. However, people and governments repay debts from their actual revenues, not from GDP figures. Seen from that more practical perspective, the fiscal picture takes on more than a symbolic meaning. It tells us in plain language that close to half of government revenue could be spent on servicing debt alone. And this is happening in a year in which the government is also borrowing heavily.

This is how the borrowing story began. But the borrowing binge is only just beginning, and it is expected to last deep into the year because of the sheer volume involved. As issuance continues, Nigeria will increasingly confront the classical “crowding-out” theory, which describes the displacement effect of government borrowing on private-sector access to credit.

The early signs are already visible. In January, the government offered a seven-year bond maturing in February 2031, with a coupon of 18.50 per cent. Investor bids ranged between 15.85 per cent and 18.50 per cent. In the end, the government allotted N398.19 billion—well above the N300 billion targets—at a marginal rate of 17.62 per cent.

This episode is illustrative of the dynamics that are likely to define Nigeria’s local financial markets this year. Heavy public borrowing, strong investor demand, and rising yields will combine to set a new benchmark for the cost of money. For banks, pension funds, and asset managers, government securities offer a compelling mix of safety, liquidity, and increasingly attractive returns.

Investors’ determination to beat inflation will play a critical role in this evolving financial market contest between the state and the private sector. Having lost the battle to the corrosive effects of inflation for much of last year, investors are keen to make the most of their funds in the current environment. With inflation now easing to 15.15 per cent, bondholders can finally heave a sigh of relief that they are no longer losing real value to that unseen destroyer of wealth.

This renewed confidence is likely to accelerate flight safety. Government securities, especially at higher yields, will continue to attract strong demand, ensuring oversubscription of future bond and Treasury bill offers. While this may ease the government’s funding concerns, it raises harder questions for businesses seeking credit for expansion, working capital, and investment.

In this environment, the cost of funds for the private sector will almost certainly rise. Banks, faced with the choice between risk-free government paper and lending to businesses in a fragile economy, may prefer the former. The result could be slower private investment, weaker job creation, and a more subdued growth outlook—even as the government succeeds in financing its fiscal operations.

The rise in the cost of funds, therefore, is not just a financial market story. It is a broader economic signal, one that underscores the difficult balance between fiscal necessity and economic vitality in Nigeria’s evolving macroeconomic landscape.