Public Debt: How Much Is Too Much?

The Federal Government’s proposal to borrow $30 billion from external sources to finance the 2017-2019 Medium-Term Expenditure Framework (MTEF) was met with criticism. Some commentators suggested that the country is in danger of falling into another debt black hole, just a decade after securing a hard-fought debt relief package through the Paris Club.

More diligent analysts have pointed out that the proposed $30 billion loan is almost three times as much as the country’s current total external debt of $11 billion.

While criticism of the proposed borrowing plan is not unfounded, the counter argument is that Nigeria’s infrastructure deficit is a huge barrier to a sustainable economic recovery and large-scale borrowing is necessary to bridge this gap.

The Current State of Affairs

The latest report from the Debt Management Office (DMO) revealed that of Nigeria's total debt stock of $62 billion in June 2016, $11 billion (18%) represented external debt. Within this category, concessionary loans (loans with no interest or a rate of interest below the market rate) accounted for about 80% of the total. This puts the value of Nigeria's commercial debt obligations to bondholders abroad at roughly $2 billion.  

As at June 2016, the country's external debt to GDP ratio stood at 2.3%, lower than the internationally defined 40% threshold for Nigeria’s peer group. Furthermore, according to the DMO’s baseline projections, this value is only expected to rise to 5.3% and 6.1% in 2017 and 2018 as total debt to GDP increases to 15.5% in 2017 and 16% in 2018. These are all still beneath the country-specific threshold of 19.4%.  

Based on these figures, the DMO suggests that the FG can borrow up to $22bn in 2017. 

While this recommendation makes sense in light of the debt to GDP figures, it may not be entirely appropriate for Nigeria. The country's low tax to GDP ratio limits the relevance of these ratios as it loosens the link between the ability to service debt and size of the economy. In other words, GDP ceases to be a useful gauge of debt sustainability as government revenues are not closely tied to it through taxes. Instead, it is worth looking directly at government revenues when analysing Nigeria's long-term ability to repay its debt. For this, there are two indicators: debt to revenue ratio and debt service as a proportion of revenue.

An Alternative View

The FG’s external debt to revenue ratio stood at 66% by the end of 2015. Baseline projected values of this ratio for 2016, 2017 and 2018 are 106%, 136%, and 166% respectively, compared to the international recommended threshold of 250%. However, the baseline projected values of total debt to revenue ratio are 395%, 400%, and 438% for the same period. To put this in context, the Eurozone crisis was precipitated by similar debt to revenue ratios. In 2013, Greece had a debt to revenue ratio of about 351% while Ireland and Portugal had respective ratios of 340% and 302%.

Besides, total debt service to revenue ratio for 2015 stood at 35%, while the projected values of this ratio for 2016, 2017 and 2018 are 50%, 49%, and 48%, already more than double the recommended threshold of 20%. 

Therefore, even though debt to GDP ratios are still within acceptable limits, more relevant measures – debt to revenue and debt service to revenue ratios – ring alarm bells.  

In fact, the DMO acknowledges that the FG is already over the recommended threshold for both measures. To account for this, the agency points to an expected rise in tax revenue. However, with Nigeria in a recession, and in light of historical struggles to increase tax revenues, such a premise is slightly baffling. 

Finding a balance

In conclusion, while borrowing to finance spending could be an option to combat the recession, such a move must be exercised with caution. The fiscal authorities, along with the DMO, must publicise spending plans as well as proposals for loan repayment and debt servicing. Transparency, disclosure, and extensive monitoring at all levels of government and for all proposed projects are essential. 

It is important to stress that there is nothing wrong with taking on debt, particularly to finance infrastructure. There must, however, be a concrete repayment and servicing plan. Besides, it is crucial that debt funding actually goes to the targeted projects and is not diverted towards government running costs, as is the usual practice. The Federal Government must commit to using the loans for the earmarked projects. 

Ideally, future cash flows from these projects would help repay the loans, to prevent another unsustainable debt build-up. This will be tricky for infrastructure projects that are likely to support economic growth without directly generating revenue. Such projects have become the focus of the present administration, but worryingly, such projects have been the most difficult to monitor. 

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