Sub-Nationals on the Blink: A Case for Fiscal Restructuring

President Muhammadu Buhari met with members of Nigeria’s Governors Forum (NGF) yesterday, 28th April 2016. Expectedly, the state governors requested for more palliatives to ameliorate their fiscal challenges. The proposed palliatives include: an 18-month moratorium on loans before resuming servicing, direct financial intervention and commitment of the Federal Government (FGN) to a Fiscal Restructuring Plan for Federating units which is yet to be made publicly available.

This comes as no surprise to us as we had earlier noted in a previous report that most of the sub-national units (State and Local Governments) are not economically nor fiscally viable. According to a statement attributed to the President at the 2nd National Executive Committee meeting of the All Progressives Congress (APC) in Abuja in the previous week, 27 states in the country are said to be having difficulty paying basic salaries to workers. Yet, as we mentioned in the report, restructuring the states to be fiscally and economically viable is crucial to stimulating the economy and improving business and investment confidence.

Nigeria, at the moment operates a centralized revenue generation and sharing mechanism whereby revenue from mining and major types of taxation (Company Income Tax, Education Tax, Custom Levies, Value Added Tax and Customs & Excise Duties) are administered and remitted at the federal level, jointly pooled into a federation account and distributed to all federating units (Federal, State and Local governments) based on a sharing formula. In effect, the sub-nationals are limited in scope (in terms of tax administration and resource ownership) in raising revenue from their governing territories, creating a perverse incentive structure tilted towards central dependence and lack of creativity in raising IGR. States generated only N3.5tn in IGR between 2010 and 2015, about 0.8% of GDP. Meanwhile, 52.6% of the statutory revenue is committed to funding the federal government while the sub-national entities, with the exception of oil producing states that collect 13% derivation from crude sales, share the remaining 47.3% of statutory allocation disbursed every month.

If sub-nationals are limited in scope to generate revenue, the Federal agencies have been ineffectual in leveraging on their wider scope to raise enough to finance the federating units. Over 76.8% of federally collected revenue between 2010 and 2015 came from oil sources (including PPT and CIT for oil & gas companies) and with the recent 58.3% slump in crude oil prices between June 2014 and April 2016, all federating units are faced with a fiscal crisis. But the FGN has fared better by leveraging on its sovereign status to raise debt capital and saving operating surpluses from its MDAs. For sub-nationals, the problem is 3-fold;

Leverage is too high relative to IGR. The oil boom between 2010 and 2014 spurred lots of borrowing by municipals. Foreign and Domestic debt of sub-nationals went from US$2.0bn and N1.2tn in 2011 to US$3.4bn and N1.7tn in 2014; while IGR improved from N401.4bn to N707.9bn within the same period. Total debt stock of sub-nationals in 2014 was 3.2x of their IGR in the period. Removing Lagos and Rivers States from the computation of debt and IGR, the ratio becomes 4.6x.

Increase in minimum wage in 2011 and unchecked spending have increased the operating expenses of sub-nationals. Data dating back to 2011, pre-implementation of minimum wage increase, suggest recurrent spending represents 58.0% of total spending. We suspect the data will be much worse if Lagos State (which has high capital vote) is excluded and also adjusted for current spending structure. Indeed, many State Governors have complained of not having higher revenue receipts relative to operating costs and we think the mounting wage deficits affirm our suspicion.

Lack of a sovereign status and weak municipal debt market further complicates the fiscal health of sub-nationals with creditors unwilling to grant credit access to indebted States to refinance their debt obligations. We think the municipal market is also too short term in nature, and has heightened the servicing and payment burden (the highest tenor for a municipal bond is 7 years against 20 years for sovereign).

We think the recent efforts to tackle the problems have been piecemeal; earlier bailout fund from the CBN to 19 states totalling N338.0bn and sharing from Excess Crude Account and NLNG dividend proceeds have not improved the fiscal health status and also raise moral hazard questions as they came with few strings attached. We believe that, in the short term, a comprehensive arrangement needs to be made to reduce leverage and free up cash flows to service obligations but they must be at the instance of the Federal Government with a covenant by sub-nationals to restructure operational cost structure via haircuts and increase in taxes. Monetary Policy adjustments in exchange rate and interest rate could help cushion the impact of discretional tax increases by improving investment spending and government revenue, ultimately supporting consumption spending. However, in the long term, restructuring the current centralised model of ownership of resources and generation of revenue will be needed. Additionally, a Sub-national bankruptcy law stipulating how to restructure and manage cash-strapped federating units will further strengthen the incentive structure for building fiscal resilience at all levels.