Sunday, 31 January 2016

3e Actuaries - A Critical look at The Nigerian Budget 2016.

Olawale Opayinka
CEO 3E Actuaries


The Nigerian Budget is set at just over N6 Trillion with a budget deficit estimated at N2.2 Trillion approx. $11 Billion USD at the official exchange rate of approx. N198:$1 with Oil price benchmarked at an average of $38 per barrel of Oil in 2016.

The Budget suggest the Federal Government of Nigeria (FG) is looking to spend its way out of a severe downward pressure on the economy as a result of dependence on and fall in the price of its major revenue earner Oil.

One of the aims of the 2016 Budget is to diversify the economy as well as provide jobs. It is allocating exactly 30% to Capital Expenditure.

Critical Concerns -Assumptions

The size of the deficit is heavily influenced by the price of Oil as well as the Naira value of the repayments on foreign debts.

1.       The benchmark for the Price of Oil at $38 was very optimistic when set and when the 2016 Budget was read late in December 2015 it has since dropped below $28 within 30 days of the 2016 Budget being presented. The prudent estimate which can allow for Excess Crude Account Funds is an average of $25 per barrel of Oil in 2016. It the effect on the quantum of the Budget Deficit that is notable.

2.       The Naira is under immense trading pressure against other major currencies. There is a lack of supply of Foreign Exchange to meet demand. It is currently trading at N300:$1 on the parallel Market. The true market value of the Naira is arguably close to between N250:$1 and N320:$1 in2016 as opposed to the arbitrarily set N198:$1 by the Central Bank of Nigeria (CBN) or thereabouts. The downward pressure on the Naira can only be reversed if the Current Account improves which will see Nigeria exporting less than it is importing. This is unlikely to be achieved within the next 10 years given that this has always been the national objective for more than 40 years. The period can be lower than a decade if there is an unexpected upward trend in Oil Prices. De facto Devaluation has occurred. It is understandable that official devaluation of the Naira is definitely not palatable and will constitute political suicide for the Government of the Day. That said, a rapid depletion of the foreign reserve currently around $29 Billion will occur within 24 months at the current rate which would be more damaging politically and economically. The subject of what should happen to the Naira is not the aim of this intervention but it is difficult to see how the 2016 Budget can be passed with uncertainty surrounding the true value of the Naira. An attempt to push on regardless with passing the 2016 Budget can best be seen as an attempt to bury once head in the sand and wish the problem away.

The compound effect of the uncertainty around the Naira is as follows: it will affect the Naira cost of borrowing on the International Market as well the interest rates on borrowing locally. These will both affect the consequential true cost of borrowing to finance the planned deficit. It is the effect on the immediate and future cost of borrowing that is being considered in this piece rather than the CBN policy of the Naira.

Critical Concerns –The DEFICIT and its Financing

1.       The 2016 Budget Deficit is not a one off. Once the 2016 Budget has been set at just over N6 Trillion, any reduction in real terms for future budgets will inflict further pain on the populace. Reducing the Budget deficit in future will have to result in a reduction of services and uncompleted Capital projects. It is therefore reasonable to assume that the deficit will be maintained at a minimum of N2.2 Trillion ($11 Billion USD per year) for the next four years. This assumes that all other things remain equal. Therefore, the Budget deficit over four years will be N8.8 Trillion ($44 Billion) based on current estimates.

2.       The actual Budget deficit is more likely to be closer to $14 Billion rather than the estimated $11 Billion as a result of the difference between the benchmark of the price of oil at $38 per barrel as opposed to the prudent assumption of $25 per barrel. This is because a reduction in the price of Oil means a drastic reduction in any profits available for sharing between the Oil Companies and the FG and thus its revenue expectation, if the suggestion that the cost of producing a barrel of Oil is closer to $30 per barrel then there is little profit available.

3.       The fall in the value of the Naira will also increase the Naira cost of financing the current foreign debt and thus increase the planned deficit. The additional adverse effect on the deficit will also come in the reduced purchasing power of the Naira and the consequential effect on the rate of Inflation.

4.       The large deficit in itself as well as the falling Naira will necessarily fuel inflation and thus widen the already large deficit as project cost increase in nominal terms.

5.       The major concern is that an average annual deficit of $14 Billion USD will lead to a loan book of $56 Billion over four years. By 2019, the cost of borrowing will be an additional $7-8 Billion USD. Presently Nigeria is spending 35 Kobo of every N1 it earns on funding its existing debt. This will increase to at least 60 Kobo of every N1 it earns by 2019.

Critical Concerns –The Way Forward

1.       Any borrowing must only be on investments that will generate direct revenue which will be used to pay back the money borrowed. Any borrowing for consumption is not advisable. The Nigerian economy will crumble under another heavy burden of debt. As part of the Nigerian generation that helped campaign for a debt write down in 2005, we would be going back to the situation we came out just over 10 years ago.

2.       Any borrowing should be term capped at say $20 Billion for four years, with a clear demonstration of how the interest and repayment will be financed. The approved level of borrowing should also be linked to the projected cost of borrowing. At the moment, international financial analysts suggest Nigeria cannot borrow at less than 10% from the International markets due to depleting Oil revenues and the associated risks of default. The cost of borrowing locally will also be over 15% and that depends on the stability of the Naira and control of inflation. It is reasonable to expect the interest rate of borrowing to be around 18% locally.

3.       Financing of Capital projects should be Private sector led under a Public Private Financing (PPF) arrangement. The National Assembly (NASS) should consider each project on its own merit. While it can authorise the projects, it should reserve the right to authorise the funding arrangement on a case by case basis. Alternatively, it can approve an Infrastructure Fund which will be used to fund FG contribution in a PPF arrangement. Essentially, borrowing should only to be for projects with a clear revenue generating capacity to repay the funds borrowed.

Overall, the intervention is to draw the attention of NASS to:

A.      the level of the deficit that will be generated from the proposed 2016 Budget

B.      the cumulative effect of the deficit from the budgets of: 2017, 2018 & 2019 and its impact on the cumulative cost of borrowing thereafter

C.      The need to revisit the unstable value of the Naira as a result of its knock on effect not only on the budget deficit but also on the Nigerian economy as a whole

D.      the fact that NASS not only needs to review the budget deficit but also the true cost of borrowing from the local and international markets given the pressure on the Naira and the increasing level of inflation.

This is my humble submission to the current debate on the 2016 Budget. It an opinion, it is not meant to be exhaustive. It is meant to draw serious attention to an aspect of the 2016 Budget which is pivotal for its whole.

The watchword is that what may appear politically expedient today is likely to be economically and politically damaging as a result of the hardship it will bring to an unforgiving electorate.

God Bless Nigeria.

The Oloja Blog Fan Box