Budget deficit: Experts caution govt on bond market reliance

Since the official introduction of bond market by the Debt Management Office (DMO) the debt instrument has largely phased out the Ways and Means and greatly relegated the Treasury Bills to a far background in the Nigerian financial system. While officials of DMO insist that even when government did not actually need to borrow money because of its positive financial position, there was still need to raise bonds regularly in order to deepen the emerging market. The situation has changed however, and a much battered economy occasioned by slump in crude oil prices now necessitates governments both at the national and sub-national levels to rely on debts to finance widening budget deficits.

Government’s financing options are to run a balanced budget for its expenditure to equal its revenue, issue bonds or print money. Although it almost became a norm especially among states, governments do not normally borrow money directly from domestic bond market. Where a country has a developed market for its government bonds, then it will generally avoid borrowing from banks. This boomeranged recently when total revenue shared by Federation Accounts Allocation Committee (FAAC) was  much less than N300 billion. Some state governments, which already had irrevocable standing orders went home with less than N300 million that month. The Federal Government was forced to intervene by asking banks to forgo that months’ repayment.

In the N6.03 trillion 2016 Federal Government budget, the N1.8 trillion deficits is expected to be funded through various forms of borrowing. Out of this, both Minister of Finance, Kemi Adeosun and her Budget and National Planning counterpart, Udoma Udo Udoma, have explained that N900 billion would be raised domestically while the balance would be sourced internationally. Last week alone, DMO raised N110 billion from the bond market. Various aspects of the bonds would mature in 2021, 2026 and 2036 respectively.

Aside funding its own budget, the Federal Government is also raising an additional N510 billion from the bond market on behalf of states to help them get through current financial difficulties. Most states are not able to pay salaries because of dwindling revenue from FAAC. According to Adeosun, this will come in form of N50 billion per month for the first three months, and N40 billion per month for following nine months.

She said 35 states had applied as against erroneous claims in some newspapers that “only seven or five states have met FG’s conditions. This is factually wrong.  FSP reforms will take 18 months to fully implement,” and the states are in the process of submitting the required documentation, which are being reviewed.

Before this time, DMO had helped to restructure bank loans for states which submitted requests for the bank loan-to-FGN bond restructuring. Phase I of the process consisted of eleven states which had completed and submitted all necessary documentations, including the submission of jointly authenticated balances with banks. Bank loans of those states were restructured into 20-year FGN bonds effective August 17, last year. Phase II of the restructuring consisted of 12 states whose bank loans were restructured into 20-year FGN bonds effective September 16, last year.

The second phase, which concludes the restructuring exercise, showed that 14 banks were involved in phase I debt restructuring operation and their total loans to the 11 states which were restructured amounted to N322.788 billion. In phase two, 12 banks were involved with total loans restructured amounting to N252.728 billion bringing the total restructured amount for the 23 states to N575.516 billion.

Cameron Hume, notable financial expert, said governments borrow money to cover the shortfall between the amount they raise through taxes and duties and the amount they spend. In the long run the amount a government borrows is a result of political choices, in the short run it is influenced by unexpected events, such as weak growth.

According to him, “governments typically finance the great majority of any expenditure from taxes but tend to have persistent budget deficits, i.e. to spend more than they raise. A budget deficit of 10% of GDP is exceptionally high, and such a deficit is generally the result of an economic shock, which causes both tax revenue to fall and government expenditure to rise.

In summary, governments fund most of their expenditure through taxes, but bond issuance is the principal secondary source of finance. Other means of financing deficits such as printing money or borrowing from the banks have a history which suggests that they have adversely, and on occasion materially, distorted the way an economy works.

Three economists cautioned seriously on over reliance on the bond market to fund budget deficits.

Chief Executive Officer of Time Economics, Dr Ogho Okiti told the Nigerian Tribune that now, “government is borrowing money basically because it needs to”. He however, said there is limited amount to borrow because borrowable fund is fixed.

Ogho warned nonetheless that in approaching the bond market, government should be careful so as not to crowd out the private sector.

With monetary policy rate currently standing at 14 percent, the cost of bank loans is currently prohibitive and Governor of Kaduna State Ahmed el-Rufai said at a conference organised by Women in Business in Abuja recently that only illegal businesses can thrive at the current bank lending rates in Nigeria. As such, the bond market becomes a more convenient source of credit to businesses and once government begins to compete with the private sector in that segment of the market, the private sector will certainly lose out.

Ogho also explained that government will determine its debt sustainability based on GDP and percentage of debt.

On his part, Professor Badayi Sani of the Bayero University, Kano also agreed that “borrowing is an important aspect of financing development.” He declared that while there is nothing wrong with borrowing, it must be utilized for the purpose for which it was procured. “As an elementary example, assuming you borrowed N10,000. That borrowing is economically beneficial so long that that N10,000 is able to generate a direct return of another N10,000 or even N15,000 or indirectly if the money borrowed is able to generate other services and goods.”

He also observed that when government borrows through the bond market, such borrowing may not be limited to the domestic fund as foreigners may also take advantage by importing capital and benefiting from the market, which he described an advantage to the economy.

“The other implications are that when governments borrow too much, what is left for the private sector may be less and that indirectly defeats the objective of government to make the private sector a partner in developing the economy. This crowds out the private sector. This is because fund managers rely on returns on what they may get so, the real sector suffers to some extent because the private sector would have used their borrowing to expand businesses and create more jobs and services. But the presence of government in the market will crowd out private sector borrowers because there is the guarantee that government will not fail in payments.

“At the same time, if government revenue falls as we are witnessing because of the fall in oil prices, fall in production and devaluation of the currency then government is constrained to borrow in order to fund its activities. This is perfectly in order. Sometimes Economists tend to look at the net effect of this on the economy. If the net effect is negative, government may not achieve its objective and so the economy may suffer. It all depends on how serious and committed government is in utilizing the borrowed funds to finance development”, Badayi declared.

Also speaking with this newspaper on the same issue, a former Deputy Governor of the Central Bank of Nigeria (CBN), Dr Obadiah Mailafia, agreed that the bond market is a verifiable and sustainable means of bridging government revenue shortfalls. He however, dismissed the view that government’s presence in the bond market is a threat to the private sector also assessing funds to enhance operations.

“It is one of the tools that governments have to fill the financing gap with funds from the bond market,” Mailafia stated while adding that government has the additional option of either borrowing domestically or from the international bond market. He cautioned nonetheless, that “we should emphasise more on naira denominated bonds.”

The international financial consultant disclosed that “a lot of foreign investors are now showing interest in bringing money into Nigeria now that the Monetary Policy Rate has increased to 14 percent” while also noting that “so far, our net debt to GDP ratio is still below 10 percent and it is under control.”

While reiterating that the liquid finances available to government has dwindled, he urged caution, saying government has to be careful. “There are several advantages with bond financing. Starting with the private sector, the repayment process is slow and the risk profile are less. Mailafia advised that there should be a vibrant bond market that would create the right curves that will be instrumental to the growth of the economy and also ensure quickened maturity of payment system.

“First it is advisable for emerging markets to quicken the yield curve by not only having interesting results from the bonds but also having a primary as well as a secondary market. That is the sign of maturity in any capital market.

“Bond financing holds several advantages: it can deepen the financial market; it is much more liquid; it can also create secondary market opportunity that will be quite active in the market. It can also help strengthen the transition mechanism for the monetary policy. On the downside, we have to be careful about the yield especially when it involves foreign currency because when the payback time comes. When foreigners hold your assets, you have to pay them back promptly for the sake of country reputation,” he observed.

On the possibility of government crowding out the private sector from the bond market, the former Deputy Governor of the apex bank disagreed. “All capital markets are managed by the private sector. It is not really a government market. There is corporate bond financing in every system for big corporations to have their own bond issuance. Nobody is stopping them. It is just that the market is not so matured enough and the people who manage the private sector are not so confident.

“But we should encourage the big business to continue to talk about corporate bond issuance. It will be good for the system; it will be cheaper for them than go to the banks for a loan.  I don’t see how government can prevent the private sector businesses from accessing the bond market because a lot of people have money and they are looking for credible investment outlets regardless of whether it goes to the private sector or government. It is just that we have to package them carefully so that the risk will be highly minimised.

For the Director-General of West African Institute for Financial and Economic Management (WAIFEM), Prof. Akpan Ekpo, with declining government revenues from oil, budgetary allocations alone may not be enough to finance the infrastructure deficit in the country. He said the debt option is still the most viable at this time. Nigeria, he said, could borrow up to 40 per cent of its GDP externally, adding that the DMO has in the past, demonstrated good negotiation skills in dealing with the country’s debt matters, either with internal or external creditors.