TUE 27 JULY, 2021-theGBJournal-Analysts at Cordros Research in their latest note seen by theGBJournal highlighted the implications- of continued extension of Ways & Means by the Federal Government and suggested in their conclusion that Structural Reforms are urgently needed to reverse the trend.
On the other hand, they expressed pessimism in the Federal Government’s ability to reduce its reliance on the CBN over the medium to long term, given that the tepid economic conditions will hinder the implementation of much-needed reforms.
‘’In our opinion, the government will sustain its current expansionary fiscal policy to support economic recovery. As a result, the imbalances in the fiscal accounts are unlikely to show any meaningful improvement,’’ Cordros said.
Cordros says, the only way out is the implementation of structural reforms and fiscal consolidation measures to improve the fiscal position over the medium term.
Some of the critical reforms highlighted as needed to enhance government revenue, moderate the growth in recurrent expenditure, and ultimately improve the management of public resources include;
-removal of subsidies in the energy sector, which has always been on the front burner,
-increased flexibility in determining rates at the Importers’ and Exporters (I&E) window to support oil revenue inflows and boost capital inflows,
-strengthening of the tax administration framework and expanding the tax net to boost non-oil revenue,
-enhancing the operational efficiency and revenue-generating capacity of Government-Owned Enterprises (GOEs),
-deliberate efforts to eliminate duplication of roles in MDAs and ultimately reduce the size of the public sector,
-improve governance practices and consistency with policy formulations to enhance public-private partnerships (PPP), and
– stepping up efforts in addressing security issues in the country. For the sake of emphasis, we highlight that the various recommendations in the 2011 report of the Presidential Committee on Restructuring and Rationalisation of Federal Government Parastatals, Commissions and Agencies, under the Chairmanship of Mr Steve Oronsaye are a good starting point in reducing the cost of governance.
Lastly, preservation of the independence of the CBN through compliance with stipulated rules on overdraft facilities from the apex bank will enhance the credibility of monetary policy.
Since the economic recession in 2016, the growing imbalance between the revenue generated and expenditure has generated widespread attention given the rising fiscal deficits and weakening debt sustainability metrics.
Although the fiscal authorities have made efforts in improving revenue (CAGR of 7.5% between 2016 and 2020) through improved tax administration practices, the faster growth in expenditure (CAGR of 18.3% within the same period) has resulted in increased reliance on Central Bank financing to bridge the gaps.
As a result, outstanding overdrafts (Ways and Means Advances) to the federal government rose from NGN2.63 trillion (2.6% of GDP) in 2016 to NGN8.72 trillion (6.0% of GDP) in 2019. In this report, we examine the budget implementation report for 5M-21, the growing reliance of the FG on CBN’s W&M advances and its medium to long-term implications, and our views on policy measures to improve the weak fiscal position and reduce deficit monetisation by the CBN.
Fiscal Slippages Have Increased FGN’s Reliance on CBN Financing
It is common practice for governments to make recourse to the debt market to finance budget deficits. However, developing countries with large fiscal slippages and weak debt markets tend to rely on their monetary authorities to bridge fiscal deficits. In the case of Nigeria, continued underperformance in revenue sources in the face of ballooning expenditure has forced the government to rely on overdrafts from the CBN to meet its obligations.
Central Bank Financing Required During Periods of Economic Stress
During the economic recessions in 2016 and 2020, we observed increased reliance on Central Bank financing due to the need to reflate the economy. This may be justified given the large size of the public sector and the need for an expansionary fiscal policy. For instance, due to the magnitude of the shocks in 2020, the actual amount of borrowing from the W&M stood at NGN4.39 trillion – the highest since 2007 when the CBN started keeping the data.
However, we observed that during periods of relatively stable macro conditions (GDP growth of 1.91% in 2018 and 2.27% in 2019), the FGN still relied more on the CBN to finance its operations than tax revenue.
The preceding stemmed from underperformance in actual revenue compared to budgeted revenue amidst a persistent increase in total expenditure. Consequently, the actual fiscal deficit widened ahead of budget.
To provide a better context, the average yearly W&M of NGN2.45 trillion to the FGN over the past five years (2016 to 2020) was 127.0% above the average yearly tax revenue (NGN1.08 trillion) during the same period. When viewed as a percentage of total revenue, we note that the average W&M to the FGN was 58.6% between 2017 and 2019 – significantly above the averages of 0.0% and 0.8% for Ghana and Kenya, respectively.
5M-21 Fiscal Operations Leave Little to Cheer
Based on the 5M-21 Budget Implementation Report (BIR) from the Ministry of Finance, Nigeria’s actual revenue (NGN1.84 trillion) during the first five months of the year grossly underperformed the prorated budgeted revenue (NGN3.33 trillion) by 44.6%.
The preceding was primarily due to a 49.5% decline in oil revenue (NGN423.00 billion vs prorated budget: NGN837.92 billion) as lower oil production volume capped the gains from oil prices during the period.
The total expenditure (NGN4.86 trillion) during the review period was 14.2% below the prorated budgeted expenditure of NGN5.66 trillion. On a year-on-year basis, total expenditure increased by 23.3% y/y above the level in 5M-20: NGN3.94 trillion.
Analysing the breakdown, we note that recurrent non-debt expenditure (NGN1.87 trillion vs prorated budget: NGN2.35 trillion) constituted 38.5% of the total expenditure while debt service (NGN1.80 trillion vs prorated budget: NGN1.39 trillion) was 37.1% of total expenditure during the review period. The increase in the debt service was due to the interest on W&M (NGN480.52 billion) paid during the period, which was not provided for in the 2021FY budget.
The revenue and expenditure performance led to a fiscal deficit of NGN3.01 trillion – 29.1% above the prorated budgeted deficit of NGN2.33 trillion and an increase of 19.9% y/y compared with the same period of last year.
In financing the deficit, we estimate the government net issued NGN1.23 trillion in bonds and treasury bills in 5M-21. As of Q1-21, the additional borrowings on the W&M balance to the FGN was NGN1.47 trillion – 79.9% of the total revenue generated in 5M-21, giving a total of NGN2.70 trillion used to finance the NGN3.01 trillion. We imagine that the balance of NGN310.00 billion constitutes grants, recoveries and fines collected during the period which was not booked in the fiscal accounts.
Implications of the FGN’s Growing Reliance on CBN’s Financing
Considering the flexibility associated with Central Bank financing, particularly in repayment conditions compared to commercial borrowings, the government tends to recourse to the Apex bank to shore up fiscal deficits. Consequently, this breeds fiscal complacency as efforts and initiatives required to strengthen tax administration and expand the tax net may be delayed.
Asides from that, there are other systemic and macroeconomic implications associated with sustained Central Bank financing, which are examined below:
Reduction in CBN’s asset quality:
One major challenge that deficit monetisation presents is that it weakens the balance sheet of the CBN – increased lending to the FGN without periodic repayment and or securitisation reduces the apex bank’s asset quality, which has a negative impact on shareholders’ funds.
Difficulty in attaining price stability mandate:
Ordinarily, a one-off deficit financing by money creation may only generate a one-off increase in the price level without any material impact on long-term inflationary trends. However, if deficit monetisation becomes a recurring theme, it could lead to sustained inflationary pressures that will make the attainment of price stability more difficult.
Worsening of currency and external sector pressures:
Given the potential impact of continued CBN’s overdraft facilities on inflationary pressures in the economy, real returns on naira-denominated investments would remain negative or low in the medium to long term.
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