Nigeria: Analysis - CBN's Financing of Nigeria's Deficits, the Defiance and Risks

24 February 2021

The central bank has dismissed concerns it should stop funding the federal government's deficit beyond statutory limits.

The Nigerian government's repeated decision to turn to the Central Bank of Nigeria (CBN) for deficit financing of its budgets continues to generate ripples about the state of public finance management and fiscal stability in Africa's largest economy.

Apart from its struggles to stabilise the foreign exchange market and control inflation, the Nigerian apex bank has remained a source of cheap deficit financing for the Nigerian government in recent years, leaving analysts concerned about what the practice portends for the economy.

The government reported a revenue shortfall of about 27 per cent in 2020, as the coronavirus pandemic affected global demand for oil and prices slumped. The attendant lockdown, flight restriction, and related disruptions affected the nation's mainstay, raising the need to borrow to fund the budget.

At a public presentation of the 2020 approved budget in January, Nigeria's Minister for Finance, Zainab Ahmed, revealed that revenue shortfall and increased expenditure resulted in a fiscal deficit of about N6.1 trillion as against the N4.6 trillion budgeted by the government.

The minister revealed that the deficit was financed with a N2 trillion borrowing from the domestic market, a N1.2 trillion from foreign markets, and a N2.8 trillion obtained from the CBN. The CBN's intervention came in the form of Ways and Means, as provided for in the CBN Act.

Fiscal Risks

The CBN's funding of a widening fiscal deficit remains the focus of experts, global financial institutions, and rating agencies.

In a publication in January, Fitch Ratings, a global provider of credit ratings, said Nigeria's repeated recourse to its Ways and Means facility (WMF) with the central bank raises risks to macroeconomic stability. In light of the nation's weak institutional safeguards, it said sustained use of direct monetary financing highlights weaknesses in public finance management.

The rating agency said monetary financing of the fiscal deficit raises challenges to monetary policy implementation, because tight management of domestic liquidity is a key tool under the CBN's policy of prioritising the stability of the naira. The practice could complicate the CBN's efforts to bring inflation back under control, as high inflation in Nigeria is a credit weakness, it said.

Earlier, another rating agency, Moody's Investor Service, in its annual report, noted that Nigeria's B2 negative credit rating is a confirmation of its increasing exposure to fiscal and external shocks amid weak government finances and a narrow revenue base that constrain fiscal consolidation.

The International Monetary Fund (IMF) on its part said that due to sharp revenue decline, fiscal deficits and debt-servicing risks are projected to stay elevated. Consequently, the IMF said the government's deficit is projected to widen to 5.9 percent of GDP in 2020 and drop below 5 percent thereafter, driven by higher non-oil revenues from full impact of the value added tax (VAT) increase implemented in 2020, some improvement in administration, and expenditure savings from removal of power sector subsidies and COVID-19 related support.

In its report penultimate week, IMF told the apex bank to stop financing the government's budget deficit, and called for a phased elimination of measures to contain the nation's inflation rate.

Earlier in 2019, the IMF had warned that elevated fiscal deficits that rely on central bank financing complicate monetary policy.

Nigeria slipped into its second recession in five years last November, as the nation's GDP recorded negative growth of 3.62 per cent in the third quarter of 2020, having recorded a 6.10 per cent contraction in the second quarter.

It however staggered out of recession in the final quarter, after posting a GDP growth of 0.11 per cent.

Earlier in the second quarter of 2020, unemployment rate reached 27 per cent, with youth unemployment at 41 percent.

Headline inflation rose to 16.4 percent last January, reflecting core and food inflation increases emanating from supply shortages due to the lockdown effected to curb the spread of coronavirus.

To increase revenue collection, Nigeria raised its VAT from 5 to 7½ percent last year.

Government's position fuzzy

Although Fitch Ratings said it expected the Nigerian government to reduce its use of the CBN facility in 2021, it remains unclear whether the apex bank would back down on its continued financing of the government's deficit.

The government's complicated position is reflected in the conflicting views of Mrs Ahmed, Nigeria's finance minister, and Godwin Emefiele, the CBN governor.

While Mrs Ahmed had earlier maintained that the government planned to limit the use of central bank financing to cover its fiscal deficit, CBN governor Godwin Emefiele dismissed the calls for caution.

In his reaction to Fitch's report in January, Mr Emefiele justified CBN's continuous funding of government's widening fiscal deficit via Way and Means.

"If government cannot finance all its obligations," Mr Emefiele said according to a report in Guardian newspaper, the central bank would offer support as a lender of last resort.

"It is unfair and very unfortunate that Fitch, which is known to be a first-class company, would hold such views on what we are doing," he said.

Efforts to get clarity from the CBN Thursday evening proved abortive as the known phone number of its spokesperson remained unreachable.

Déjà vu?

This is not the first time that concerns around CBN's funding of government's fiscal deficit and the danger it portends for the economy are coming to the fore.

In 2017, an external member of the CBN monetary planning committee, Adedoyin Salami, painted a gloomy picture of the extent of the government's financing by the apex bank.

Mr. Salami, a faculty member at the Lagos Business School, took the CBN to the cleaners in his assessment of its monetary policy which, he argued, was pushing the country towards a serious economic crisis. He warned at the time that the conduct of the government and the CBN was limiting the organised private sector's access to credit.

The economist, now chair of the Federal Government's Economic Advisory Council, flayed CBN's "massive injections of cash" into the government's purse and accused the bank of serving as a "piggy bank" for the government, ostensibly against its own rules.

The CBN Act 2007, Section 38 (1) of the Act empowers the bank to grant "temporary advances to the Federal Government in respect of temporary deficiency of budget revenue." However, subsection 2 of the same section stipulates, "the amount of such advances outstanding shall not at any time exceed five per cent of the previous year's actual revenue of the Federal Government".

The CBN at the time dismissed Mr Salami's claim, claiming there was no cause for alarm.

Since Mr Salami raised the alarm, CBN's funding of the government's deficit, which should not be more than five per-cent of the previous year revenue, has since shot up.

From about N600bn in 2010, FGN borrowings from the CBN have since skyrocketed.

Fiscal Concerns

Since the coronavirus pandemic broke out, revenues of governments around the world have plummeted and many have devised unorthodox monetary policies in stabilising their economies.

This implies that the adoption of unconventional policies to address major economic shock is not peculiar to the CBN, nor is the practice new.

In the wake of the financial crisis in 2008, many of the world's largest Central Banks, including the US Federal Reserve, the Bank of Japan, the Bank of England, and the European Central Bank, adopted unconventional monetary policies to mitigate the impact of the crisis. These policies comprised mostly quantitative easing programs.

A Lagos-based financial analyst who declined to have his name in print told PREMIUM TIMES that there was nothing wrong with the CBN's intervention on the fiscal side, especially in the wake of coronavirus pandemic and its disruption of global economy.

But when reminded that the CBN intervention predates the coronavirus, he called for "more caution".

Printing of money to fund fiscal concerns was quite common in parts of Africa in recent decades, although it came with devastating consequences for many economies, notably Zimbabwe.

At the height of its economic crises, the Zimbabwean government went on a reckless drive by printing money, pushing inflation to a cataclysmic position, with a loaf of bread costing millions of dollars. The southern African nation still grapples with the effect of those decisions till date.

As part of measures to address the potential risks associated with fiscal deficit financing by the apex bank, the Nigerian government says it would securitise the CBN's loans accumulated over the years, put at N10 trillion.

In January, the government announced plans to convert the CBN money to 30-year debt, but there are concerns that the move would impact the fixed income market and trigger a rise in yields. There could also be negative consequences for liquidity in the equities markets, perhaps the biggest beneficiary of the drought in fixed income securities.

Kalu Aja, a financial analyst, suggested that there is potential "naira liquidity" underway. "The pathway to dollarization of the Nigerian economy is being laid," Mr Aja noted.

Already, money printing has impacted excess liquidity in the market, forcing the naira downward, with attendant run-away inflation.

The IMF opined that liquidity-based indicators, such as the interest payments and gross financing needs, will continue to constitute a high share of government revenues, putting Nigeria's fiscal space at risk and making its low debt-to-GDP ratio highly vulnerable to macroeconomic shocks.

Seun Onigbinde, co-founder of civic advocacy group BudgIT, wondered what the political implication of the government's securitization plan could be in the nearest future. He said Nigeria will be printing money again to service domestic debt, thereby attracting inflation. "This should be top on the opposition agenda but we know folks just want power in Nigeria," he noted.

PREMIUM TIMES' analysis showed that beyond its effect on the market, the secutitization plan would also increase the nation's debt-service costs.

Debt-Service Implication

At about 30 per cent, Nigeria has a fairly moderate debt-to-GDP ratio, considered well below the World Bank's prescription, which states that countries whose debt-to-GDP ratios exceeds 77 percent for prolonged periods experience significant slowdowns in economic growth.

However, Nigeria has a debt-service problem, heightened by poor revenue, as servicing cost already consumes almost a third of the nation's actual revenue.

The situation was worse in the first quarter of 2020 when Nigeria's debt service as a percentage of revenue rose to a whopping 99 per cent. According to the Medium-Term Expenditure Framework and Fiscal Strategy (MTEF/FSP) report released by the Federal Ministry of Finance, Budget, and National Planning, Nigeria incurred a total sum of N943.12 billion in debt service while the actual revenue stood at N950.56 billion within the period.

Over the years, poor revenue has not only resulted in an increasing budget deficit for the country, it has led to increased borrowing from both domestic and international markets and institutions. As of Q4 2020, Nigeria's public debt stood at a total of N32.2tn and with the planned borrowing of N4.69tn to finance the 2021 budget deficit, total public debt is expected to rise to N36.89tn by the end of 2021.

For the 2021 fiscal year, the nation also plans to spend c.24% of its N13.5trn ($35.7bn) budget on debt servicing.

Yet, the nation's revenue challenges persist, amidst ballooning government expenditures and infrastructure deficit.

Abel Akeni, a budget analyst and BudgIT's Head of Research and Policy Advisory, explained that the current 2021 debt servicing budget of N3.34 trillion is more than two times what it was in 2016. He added that servicing of the CBN loans (like other loans) will continue to increasingly crowd out other development projects the country could otherwise embark on.

The IMF says weak revenue mobilization poses significant risks to debt-servicing capacity, adding that even though interest payment is only 1.7 percent of GDP in 2019 and is projected to average below 2 percent of GDP over the medium term, about 60 percent of federal government revenues were absorbed by interest payments in 2019 reflecting poor domestic revenue mobilization capacity.

The FG interest-to-revenue ratio is expected to exceed 90 percent in 2020 and rise steadily from about 60 percent in 2021 to surpass 90 percent again by 2025.

Nigeria is often criticized for its huge size of government and poor budgeting system, both of which encourage wastage and stifle creativity in revenue generation. The nation runs a large, expensive government, according to Vice President Yemi Osinbajo.

Last year, a PREMIUM TIMES report showed that while many Nigerians demanded a reduction in the cost of running the government, especially the legislature, as the country battles reduced income, the National Assembly increased its 2021 budget by N6 billion.

Interestingly, President Muhammadu Buhari signed the 2021 Appropriation Bill into law and overlooked the increase in the budget.

Already, Nigerian lawmakers are among the highest paid in the world, earning millions of naira monthly as allowances separate from their salaries, even amid widespread poverty and want.

Are there Solutions?

In its last report, the nation's statistics bureau revealed that food inflation climbed 20.5%, dangling at a crisis point, while Core Inflation rose to 11.85% in January 2021, from 11.37% in December.

Amid poor purchasing power, skyrocketed prices and a weakening currency, the need for the government to grow revenue and keep the nation's run-away inflation at bay has become most imperative.

In its appraisal of the 2020 budget performance, BudgIT noted that the money-printing support from the CBN continues to disincentivise revenue growth as well as escalate inflationary concerns.

"Nigeria's fiscal position is on the brink and it requires an immense response from its political leadership," BudgIt said in its 23-page report.

"The courage to rationalise costs, ensure brutal efficiency in management of capital expenditure and expand revenues by intentionally investing in economic growth, needed especially in periods of boom and mild recovery has been grossly lacking."

The advocacy group also warned that CBN's continuous intervention on the fiscal side was "becoming huge", saying the apex bank acts like a "super Ministry of Finance." It warned further that its interventions, under the guise of providing support to cushion the effect of coronavirus, does not bode well for the economy.

Last March, the Central Bank of Nigeria (CBN) announced a N1 trillion intervention in all critical sectors of the economy, and it has since continued to intervene since then.

Fitch in its position said the Nigerian government's revenue and expenditure projections for 2021 were broadly realistic, which should preclude further significant borrowing from the CBN facility this year.

"The government may nonetheless use the facility more extensively if the deficit proves wider than forecast or if external financing falls short of planned amounts," it advised.

BudgIT further called on the government to address its budgeting structures, fix waste in fragmented capital expenditure, and address statutory transfers and overheads. It also called for transparency and accountability on the part of the National Assembly, adding that the legislators could consider reducing their oft-criticised, opaque, and over-bloated budgets.

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