95345 ISSUES IN SUB-NATIONAL BORROWING IN NIGERIA Akpan H. Ekpo March, 2015 ISSUES IN SUB-NATIONAL BORROWING IN NIGERIA Akpan H. Ekpo 1 I. Introduction Many countries across the world have moved toward the greater decentralization of fiscal revenue and spending responsibilities because of the important role they play in the implementation of public policies aimed at social and human development. In Nigeria the trend is no different, especially since 1999 when the country returned to democratic governance with the state government’s assuming increased responsibilities enshrined in Nigeria’s 1999 Constitution drawn up that year. Since 1991 the share of sub-national outlays in total government spending has increased, reflecting their active role in service delivery and greater autonomy in policy-making and implementation. As a result, sub-national economic policies have taken on an increasingly important role in ensuring macroeconomic stability. The rising share of sub-national finance, including Sub-national Governments (SNGs) debt as a share of general public debt abundantly reflects this trend of greater devolution of spending responsibilities, revenue– raising authority and the capacity to incur debt. Of importance is the reality, in Nigeria’s context, of the mismatch between states’ increased responsibilities and the available funds to finance them. Borrowing enables SNGs to capture the benefits of major development projects immediately, rather than waiting until sufficient savings from current income and transfers from the Federal Government Federation Account can be accumulated for the financing. In this regard, sub-national governments have issued bonds which have attracted private capital which is emerging to play an important role in sub-national finance. The bonds now feature along side traditional bank loans in SNG public finances in many countries including Nigeria. Consequently, if SNGs finances are not well managed, the fiscal component of the national economy could be in disarray (Ekpo and Englama, 2008). The growing importance of SNG finances and the recognition that the trend could pose dangers to macroeconomic stability have informed different institutional responses to the difficulties of decentralized decision-making, especially addressing the need to improve policy coordination across levels of government and contain sub-national borrowing. As at the end of December 2014, total public debt of Nigeria stood at $67.84 billion, of which the state governments (36) accounted for $14.4 billion or 21 per cent while the Federal Government absorbed $53.6 billion or 79 per cent. The external debt components of the total public debt stood at $3.3 billion or 34 per cent for states while the Federal government, at $6.5 billion accounted for 66 per cent of total external debt of $9.71 billion. The 36 states accounted for $11.0 billion or 19 per cent of total public domestic debt component while the Federal government incurred $47.0 billion or 81 per cent (See table1 (Annex)). 1 Professor of Economics and Director General, West African Institute for Financial and Economic Management (WAIFEM), Lagos. Email: ahekpo@waifem-cbp.org; web: www.akpanhekpo.com I acknowledge the assistance of Debt Management Department of WAIFEM. 1 The purpose of this paper is to articulate some issues in SNG borrowing arising from the peculiarities of the Nigerian situation. To this end, the paper is divided into four parts for ease of analysis. With this introduction, the remaining parts of the paper are as follows: Part II outlines the “models” of control of sub-national borrowing across the developing and emerging market countries. It also highlights Nigeria’s efforts in this regard. Part III outlines the structure of fiscal federalism in Nigeria highlighting Constitutional, legislative and administrative provisions for the sector, revenue allocation, revenue–expenditure gap, while Part IV dwells on the leading issues/challenges in SNG borrowing in Nigeria. II. Models of Control of Sub-national Borrowing It is a truism that inadequate controls and limits on sub-national borrowing and debt explain most of the debt management problems of sub-national governments across developing countries. This section summarizes the experiences of OECD member countries on the various approaches or “models” adopted thus far. The approaches are broadly grouped into four categories, namely, (i) reliance on market discipline whereby Sub-national government (SNG) borrowing activities are mainly monitored and controlled by the market; (ii) cooperative approach to debt control under which controls in the form of fiscal targets and debt ceilings are the results of negotiation processes between central and local governments; (iii) rules-based approach as witnessed by central or upper level governments imposing rules for SNG borrowing activities, and (iv) direct control by the central government over sub-national borrowing. Under this framework, two strands are discernible: first, the SNG is eligible for borrowing with prior approval of central (i.e. upper level) government; and second, SNG is not eligible for borrowing except through on- lending by the central government. The overview of the approaches is: • sole reliance on market discipline for government borrowing is likely to be inappropriate, especially as one or more of the conditions for its effective working are, too often, not realized in any particular country; • wide trend toward devolution of spending and revenue raising responsibilities to sub-national governments seems likely to come into growing conflict with systems of direct or administrative controls by the central government on sub-national borrowing; • rules-based approaches to debt control would appear preferable; in terms of transparency and certainty to administrative controls. Borrowing abroad by sub-national governments should be strictly limited, in accordance not only with the debt servicing capacity of the sub-national jurisdiction involved, but also with macroeconomic (especially monetary and balance of payments) considerations; • these considerations would seem to argue for setting global limits on the debt of individual sub-national jurisdictions on the basis of criteria that mimic market discipline, such as the current and projected levels of debt service in relation to the jurisdiction’s revenues. Nigeria’s experience with control of sub-national borrowing is highlighted in the next section. 2 III. Structure of Fiscal Federalism in Nigeria and Control by the Centre Nigeria is a federation of 36 states and a federal capital territory and 774 local governments. In line with the 1999 Constitution, the states play a significant role in the delivery of economic and social services and in the provision of infrastructure. However, most legislative powers are retained exclusively at the federal level or exercised concurrently with the states. The Constitution provides for the devolution of power and responsibilities for taxation across the tiers of governments. The power to make laws for major taxes and mining revenues including oil and gas revenue is vested in the National Assembly. The two main sources of revenues collected by the federal government are oil and value added tax (VAT). The revenues first accrue to the Federation account before being distributed across the three tiers of government according to a periodically determined formula. Personal income tax, however, is collected and retained by the state governments, and is in many cases the main resource of the states’ internally generated revenue (IGR). As at end 2013 federal transfers to the states accounted for more than 80 percent of the revenue for 32 out of 36 states. (see table 1 below). Whereas the centre controls the bulk of the revenue accruing to states, the state governments have more autonomy in spending. State budgets are formulated and implemented without approval of the federal government, thus with little coordination regarding the macro implications of the states spending on the overall economy of Nigeria. The Constitution vests the National Assembly with the power to make laws with respect to any matter that concerns “borrowing of moneys within or outside Nigeria for the purposes of the Federation or of any State” and “public debt of the Federation”. The main laws that have been enacted by the National Assembly in this area are: (i) the Debt Management Office (Establishment, etc.) Act, 2003, (ii) the Fiscal Responsibility Act, 2007, and (iii) the Investments and Securities Act, 2007 and the Central Bank of Nigeria act 2007. (iv) The National Debt Management Framework (2008 - 2012), which contains the Guidelines for External and Domestic Borrowing by all Tiers of Government. Some dilation on these enactments is in order: • The Debt Management Office Establishment (etc.) Act, 2003, established the Federal Debt Management Office (FDMO), which has among its functions to maintain a reliable database of all loans taken or guaranteed by the federal or state governments or any of their agencies. Other provisions relevant for state governments (section 21) are that all their external borrowings must be guaranteed by the federal government. Also, all banks and financial institutions planning to lend money to state governments or any of their agencies must obtain the prior approval of the Minister of Finance (section 24). • The Fiscal Responsibility Act, 2007, requires the President, within 90 days from the commencement of the Act and subject to approval by the National Assembly, to set overall limits for the amounts of consolidated debt of the federal and state governments. These limits are set by the FDMO as part of the annual budget exercise. • The Investments and Securities Act, 2007, also includes some prudential restrictions on state and local government borrowing. These sub-nationals are allowed to issue its securities only if the total amount of loans outstanding at any particular time, including the proposed loan, does not exceed 50 percent of the actual revenue of the sub-national concerned for the preceding year (section 223). Furthermore, all capital market 3 borrowings must meet a string of criteria listed in part XV of the Act, and finally be approved by the Securities and Exchange Commission (SEC) of Nigeria. • The National Debt Management Framework is an agreement approved by the executive council comprising the federal government and the 36 state governors. It is a document prepared by the Federal Debt Management Office (FDMO) that seeks to assist Nigeria in maintaining its debt portfolio at sustainable levels consistent with economic growth and development, and in line with the development agenda of the government. The Framework focuses more broadly on guidelines for sustainable External, Domestic and Sub-National debt management. It includes a risk management section, designed to ensure prudent risk management and sound debt practices. The guidelines specifically stipulated by the central government for external and domestic borrowing by SNG are as follows: A. External • Approval of overall limits, for the amounts of consolidated debt of the Federal, State and Local Governments, are set by the President on the advice of the Minister of Finance, as specified in the borrowing program for the year. • All external borrowings must either be guaranteed by the Centre or on-lent by the Centre to the state governments and State Governments and their agencies wishing to obtain external loans shall obtain Federal Government's approval-in-principle, from the Federal Ministry of Finance. In addition, the Executive Council of the State wishing to contract external loan must approve the loan proposal which must be followed by a Resolution of the State House of Assembly. • All external borrowing proposals of the Governments and their agencies for the next fiscal year must be submitted not later than 90 days before the end of the current year to the Minister of Finance for incorporation in the public sector external borrowing program for the coming year. However, the proposal should include the following: ◊ The purpose for which the borrowing is intended and its link to the developmental Agenda of the Government; ◊ Cost-benefit analysis showing the economic and social benefits derivable from the intended borrowing; ◊ Cash flow Statements of the MDAs, to ascertain their viability and sustainability; and copies of the State's Executive Council's approval and the Resolution of the State House of Assembly • Governments at all tiers shall only borrow for capital expenditure and human development on Concessional terms. B. Domestic • All capital market borrowings through the issuance of securities must be approved by the Securities and Exchange Commission of Nigeria (SEC); 4 • The total amount of loans outstanding at any particular time including the proposed loan shall not exceed 50% of the actual revenue of the body concerned for the preceding 12 months; • All applications to raise funds from the Capital Market shall among other documents be accompanied by an original copy of an Irrevocable Standing Payment Order (ISPO) by the states; • All domestic bank loans must be approved by the Minister of Finance; • The FDMO is required to keep records of all borrowings and guarantees issued by the state governments; and • All domestic borrowing must obtain approval of the State's Executive Council and Resolution of the State House of Assembly. IV. Challenges in Sub-national Borrowing The challenges facing SNG Borrowing in Nigeria are legion; the major ones include: • Cumbersome process of borrowing: SNG wishing to borrow must go through a number of institutions for prior approval before the circle of borrowing is complete. Such institutions include the Securities and Exchange Commission (SEC), Ministry of Finance (Minister of Finance), Debt Management Office and where borrowing involves commercial banks, the borrowing chain may include the Central Bank of Nigeria. The process is time consuming and hardly cost effective. • A problem has been that the lender of funds in domestic borrowing (especially bond issues) takes overwhelming lead in the preparation of the lending prospectus. For instance, the lender prepares the prospectus, arranges the Issuing House and even fixes the interest rate. As a result, the borrower may be facing more onerous terms of borrowing than is apparent. • There has been the practice of maintaining Sinking Fund arrangements for loan repayments especially for long-term domestic loans. In this regard, there is also the Irrevocable Standing Payment Orders (ISPO) which the states must issue. Thus a situation whereby state in deficit sets aside periodically, funds into a sinking fund reflects bad debt management practice and needs to be addressed. • Contingent Liabilities and Guarantees Issues Many state government access funds from the Federal through several credit schemes, such as Agric Credit Scheme and Small and Medium Enterprises etc. These funds are on-learnt to farmers association and small scale and medium enterprises in the states. While the beneficiaries are expected to pay back the federal government; in reality these liabilities are not recorded as guarantees by states. 5 • Capacity Building Concerns Since year 2007, the Federal DMO has been encouraging the states to set up debt management departments/units in states and to develop capacity to undertake debt management functions in line with sound practice. In this regard, the FDMO developed and provided the states with a template for the establishment of DMDs in the states. Also, FDMO encouraged the states to promulgate public debt management laws (PDML) and fiscal responsibilities laws in order to institutionlise debt management. So far 20 out of 36 states have passed at least one of the two legislations. The FDMO also did a comprehensive debt data reconstruction (DDR) exercise to build up debt management data bases in the 36 states and FCT. Despite all the efforts of FDMO there remains a huge capacity deficit to undertake prompt and effective front, middle and back office functions at the state level. The level of staff development and their experience in SNG financial management is critical to the success of SNG debt management. • Institutional arrangement for repayment of external debt by the states governments have engendered a situation whereby some states have had to pay more debt service than due following long reconciliation periods with the federal government during which exchange rate losses are incurred by the states as repayment is always done in local currency (Naira). Finally, we have attempted to examine certain issues in sub-national borrowing in Nigeria. It is important that policies be directed at addressing the challenges affecting the sub-national borrowing in Nigeria. A critical aspect has to do with capacity. Most states lack the required qualified and experienced personnel to manage their debt profile. 6 REFERENCES Central Bank of Nigeria: (2013) Statistical Bulletin, Abuja Debt Management Office (DMO) website Nigeria’s Debt Profile, www.dmo.gov.ng Ekpo, A.H. and Abaku Englama (2008) “Fiscal Federalism in Nigeria: Issues, Challenges and Agenda for Reform” in Economic Policy Options for a Prosperous Nigeria Collier P., Soludo, C., and C. Pattilo (eds.) Palgrave Macmillan, New York, pp.221-243. Jennie Litvack: (1998) Macroeconomic Impact of Decentralization: Issues in Program Design, The World Bank, Washington, D.C. Otaviano Canuto and Lili Liu: (2010), Economic Premise The World Bank. 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(1999) Guide to Preparing for Corporate Bond Issuance in Nigeria - World Bank (2003), “Managing Sub-National Borrowing and Debt: A Survey of Global Experience”, Being a paper presented at the National Workshop on Sub-National Workshop on Sub-National Domestic Debt Management, organized by Debt Management Office in collaboration with the World Bank, Abuja and held at Sheraton Hotel and Towers, March 17. APPENDIX 8 9 10