A Call to Action: Refinancing Domestic Short-Term Debt with Cheaper Dollar Sources

In what could be considered a strategy to address Nigeria’s rising debt servicing cost brought about by high domestic interest rate environment and sizeable increase in fiscal deficit over the years, the Federal Executive Council (FEC) on Wednesday this week approved a restructuring plan for public debt by way of refinancing maturing Treasury Bills obligations with cheaper and longer term external debt. Since the 2006 debt forgiveness by the Paris Club, successive administrations in Abuja have deliberately pursued a strategy of financing more than 50.0% of annual fiscal deficits from the domestic market. Hence, Nigeria’s debt profile has in the recent past largely favoured local sources of borrowing which in Q1:2017 constituted 80.8% of FGN’s total debt with 24.3% of these in form of Treasury Bills.

According to the Finance Minister, the proposed plan involves issuing US$3.0bn Foreign Currency (FCY) debt in the international capital market, with 2 to 3 year tenors, for principal repayment of maturing Treasury bills. By our estimates, this restructuring will reduce the contribution of Domestic debt to total FGN debt from 80.8% to 74.1% (using official exchange rate), thus slightly altering the structure of public debt and lengthening the maturity of aggregate debt profile in order to free up more space to take on additional leverage. Though this new directive is yet to be approved by the National Assembly, our initial thoughts on the proposed plan as highlighted below, are largely positive. 

Our View: A Good Move but Jury Still Out on Impact on Yields and Lending Rates
The move by the FGN to refinance its existing debt portfolio with cheaper external debt is positive for the economy given the prevailing high servicing cost of debt – estimated at 66.6% of revenue in H1:2017 – which has raised debt sustainability questions. Notwithstanding the recent monetary policy tightening course of most advanced central banks, interest rates still remain at very low level in most developed markets and the FGN could take advantage of the huge demand for high yield emerging market bonds to raise capital at relatively cheaper rate. For instance, Nigeria’s recently issued US$300.0m 5-year Diaspora bond was priced at an effective yield of 5.6% while a similar Local Currency (LCY) bond with same tenor was issued at a yield of 16.2%. Apparently, debt servicing burden could ease by reducing LCY leverage for FCY borrowings but this also comes with a downside risk of increased fiscal balance exposure to Naira volatility. We note that Nigeria’s US$13.8bn external debt as of Q1:2017 is mostly comprised of concessionary multilateral and bilateral loans (up to 78.3%); there is still scope for more commercial FCY borrowings.

Furthermore, increasing fiscal deficits over the years has crowded out private sector borrowers with local Commercial banks shunning risk assets for high yield and risk free treasury securities. This is reflected in 3-year average private sector credit growth which our estimates suggest may have fallen below 3.0% in real terms (ex-Naira devaluation impact). However, whilst we are convinced the proposed plan by the FEC will lower government borrowing cost, the jury is still out on likely impact on domestic interest rate, the yield curve and private sector credit expansion. Our pessimism is based on the fact that:

  • The CBN’s policy instruments – OMO and Discount Window rates – are more potent drivers of yield curve movement and lending rates than the FGN’s borrowing cost;
  • Risk assessment of the real economy, to a large extent, determines credit policies of banks. Hence, our view is that the FGN’s debt refinancing will at best achieve a lower borrowing cost in the interim without necessarily moderating domestic interest rate environment nor buoying loans to private sector;
  • More importantly, the monetary policy authority will necessarily need to signal a departure from its current hawkish stance by guiding OMO rates downward before interest rate environment normalizes and becomes attractive for corporate issuers;
  • Finally, domestic and external macroeconomic conditions have to sufficiently improve for the CBN to ease monetary policy while structural reforms must be deepened to de-risk real sector lending.