Inherent Risks in Debt Restructuring Hide Original Message
Glenn Ubohmhe cautions against the risks associated with Nigeria’s debt restructuring
The federal government, through the Debt Management Office (DMO), recently signalled its intention and indeed commenced the restructuring of its total debt portfolio with a view to securing an “optimal” mix of local and foreign debt components. The scope of the exercise involves refinancing part of the existing local debt with proceeds of new Eurobond issue as well as preference for foreign currency loans in financing budget deficit up to a defined “optimal” threshold of about 60/40 per cent share respectively from 73.36/26.64 percent as at December 2017.
The economic rationale for a sizeable mix of foreign debt component in the total debt stock is quite tantalizing, not difficult to measure and seem to make a great deal of sense. One of the overarching objectives for embarking on debt restructuring, as outlined by the DMO, is to reduce the huge interest burden on debt servicing occasioned by high interest rates in the domestic market. An extraction debt service cost can easily be made from the 2018 budget in order to put the argument in perspective - N1.76 trillion was earmarked as interest payment on domestic public debt in addition to interest on external public debt of N254 billion. These are mind boggling sums for debt servicing alone. Other key extenuating factors for this policy direction centre on the need to taper the size of government participation in the domestic debt market for enhanced accessibility by the private sector, moderate heightened pressure on interest rates which government borrowing usually precipitates and also boost foreign reserves through capital account component. These are very compelling arguments, indeed.
However, there are more forceful countervailing arguments why the decision to ramp up our foreign debt may be counter-productive as there are plausible reasons why the eventual policy outcome may veer off markedly from expectations. To start with, the assertion that a switch from local to foreign debt will reflect in reduced cost of debt servicing is somewhat questionable. That assertion would be correct if the naira equivalent of total debt stock is not significantly higher, or even less, post-restructuring. True, government will appropriate the benefit of interest rate differentials between domestic and international debt markets debt on the substituted portion of local debt but as long as the total debt stock trends upwards, budget allocation for interest servicing may not reduce. Therefore, what is required to sustainably manage interest and overall debt burden is a more frontal strategy of reverence for fiscal discipline - 26% allocation for debt servicing as projected in the 2018 budget is inimical to growth (please reserve your comment on debt to GDP ratio). It is against this backdrop that the admonition by Abraham Lincoln on March 4, 1843 to the people of Illinois fittingly finds expression - “the system of loans is but temporary in its nature and must soon explode. It is not only ruinous while it lasts, but one that must soon fail and leave us destitute. As an individual who undertakes to live by borrowing soon found his original means devoured by interest and next, no one left to borrow from, so must it be with government”.
A perceptive appreciation of Lincoln’s statement should nudge us towards some sort of enlightened introspection. Rather than a blanket rebuttal of the crucial role that debt plays in financing critical infrastructure, Lincoln’s statement is more pointedly a rebuke of unbridled accumulation of debt. Debt-to-asset transformation is an ideal but sometimes such transformation is illusory especially in a jurisdiction where public accountability is in short supply and where consumerism takes precedence over labour-for-posterity.
Again from another and crucially important perspective is the potential risk factor of excessive foreign currency exposure. Significant foreign currency loan exposes the economy to external shocks and creates vulnerabilities that could upend macroeconomic stability. Low interest rate has often underpinned excessive exposure to foreign currency borrowings (whether by the private or public sector) and constitutes a key trigger to most financial and macroeconomic crises – the Emerging Market Economic (EME) of 1997 and the more recent Greek debt crises are classic reference points. Therefore, the bias for foreign currency loan (and debt in general in this instance) may not be an optimal one, if there is no sustainable strategy around it and developmental outcome is by every stretch doubtful.
Understandably, the size of government borrowing from the domestic debt market could potentially influence the direction of interest rates but it is by no means the only factor. The level of money supply in the economy, inflation, exchange rate, overall external stability and other macroeconomic factors feature prominently in determining interest rates trajectory. Substitution of local debt with foreign debt will not reduce money supply. In fact, foreign currency borrowing exerts more expansionary impact on the monetary base in this particular instance.
Given this scenario, what will therefore be the likely policy response by the monetary authority to excess system liquidity induced by fiscal expansion as is currently the case? Other variables to bear in mind include economic imperatives and political expediency of maintaining stable exchange rate in or close to an election year, accentuation of demand for the greenback to oil the political machines, heightened political risk perception by investors as we approach the forthcoming elections, the possible reversals of foreign portfolio investments and ultimately the potential adverse impact on foreign reserves. It will be interesting to see the reaction of the monetary and macro-prudential authority – the CBN. In my view, the monetary authority is most likely to maintain its liquidity sterilisation policy using both conventional and nonconventional tools based on aforementioned reasons and also sustain relatively attractive premium on yields to retain foreign investments and mop up excess system liquidity.
Notably, the pervasive influence of international oil price will also weigh considerably in determining the direction of interest rates. This brings into sharp focus the immediate threat to crude oil price in the ensuing geo-economic tariff war between US and China. While the impact of the impending trade war (if elevated beyond rhetoric) on Nigeria’s non-oil trade balance is yet unclear, a depressed global trade arising from tariff war could have far reaching consequences on global output and by implication global oil demand and Nigeria’s external balance. In that event, policy intervention will be required to increase capital account buffer for improved reserves with recourse to attractive yield on domestic market instruments to spur foreign inflows in order to achieve external balance objective. In the final analysis, CBN’s response with respect to rates will largely depend on prioritisation of policy choices but my bet is that rates are not likely to trend down below the current corridor, in the short to medium term. Therefore, debt restructuring may not have the desired impact on domestic interest rate as envisaged. As matter of agreeable necessity, finding that optimal debt mix may become secondary if fiscal prudence takes centre stage in resource management. In conclusion, since there is no one-handed economist like Harry Truman (a former American president) famously quipped, I will also conclude this article by saying that debt restructuring may be beneficial on the one hand but on the other hand there are potential risks especially if there is the developmental impact is hazy. We may end up in another (foreign) debt trap without realising the much envisaged benefits of debt restructuring.
-Glenn is a chartered member of the Institute of Chartered Accountants of Nigeria (ICAN) and Chartered Institute of Taxation Nigeria (CITN). He obtained B.Sc. (Accounting – 2nd Class Upper) from Ambrose Alli University, M.Sc. (Energy Studies with specialisation in Energy Finance) and LLM (Petroleum Taxation & Finance) both from the Centre for Energy, Petroleum and Mineral Law and Policy (CEPMLP), University of Dundee, UK and holds an Executive MBA of the Lagos Business School