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At the end of the Federal Executive Council (FEC) meeting on Wednesday, 9 August, the Minister of Finance, Kemi Adeosun announced that the government would be issuing new dollar debts worth US$3 billion in the nearest future to replace maturing Treasury bill liabilities. Based on the official exchange rate of N305 to the US$, US$3 billion of debt would approximately be worth N915 billion of Treasury bills. So what the government is planning to do is to replace an equivalent portion of its short-term naira debt with longer-term dollar debt.
The last time that the government went to the international markets to borrow, which was March this year, it was able to raise US$500 million at an interest rate of 7.5 percent per annum. The government had earlier in February 2017 raised US$1 billion at an interest rate of 7.875 percent in an issue that was significantly over subscribed by international investors. Both debts are due for repayment in 2032 that is 15 years from today.
Compare this with Treasury bills, which the Federal Government currently issues at an average interest rate of between 18 percent to 22 percent, almost twice the interest rate on its Eurobond. The latest issuing time table for Treasury bills from the Central Bank of Nigeria (CBN) for the third quarter of 2017 shows the government will “roll over” bills worth N1.24 trillion during the period.
“Rolling over” treasury bills simply means that the government is borrowing fresh money to pay off earlier Treasury bill liabilities that are due. So the CBN time table shows that there are N221 billion worth of 91-day treasury bills due within the next three months and the government will just issue another N221 billion of fresh Treasury bills to settle it.
In fact, the interest rates on Treasury bills have become so attractive that investment savvy individuals no longer want to keep their money with the banks but have been requesting that their banks invest their deposits in Treasury bills on their behalf. This makes sense considering that average interest rates on saving deposits is a maximum of five percent, that is if you push very hard but an investment in Treasury bill could give you a rate of 18 percent.
Even though minimum individual investment in Treasury bills is N50 million, banks help aggregate interested investors to take advantage of the higher interest rates.
The banks are also feeding fat on investment in government securities generally. A look at the financials of tier 1 Nigerian banks easily shows that their interest earnings from government securities have become one of the biggest sources of their revenues. In fact, one of the tier 1 banks had noted in an investment note to investors that even if loan growth rate in 2017 does not meet its projections, it would still meet its revenue and profitability targets because of its holdings of government securities.
Not surprisingly, giving the attractive interest rate in Treasury bills, growth in credit to the government has been expanding whereas lending to the private sector has declined. Godwin Emefiele, the CBN governor noted in the last monetary policy meeting communiqué that while net credit to government had expanded by 5.91 percent as at June, credit to the private sector actually declined by 0.02 percent within the same period.
This is a classic case of the crowding out impact of excessive government borrowing as often discussed in economic classes. Who would not want to lend to government at guaranteed interest rates of 18 to 22 percent, than risk lending to the private sector at a high but very risky interest rate of between 28 to 30 percent. Despite the declining credit available to the private sector, there are also evidence that interest rates to the private sector has been rising in the last one year, as banks demand higher interest rates from businesses, high enough to make them leave their current comfort zone of dishing out money to the government at attractive interest rates, earning revenues that they do not have to work for.
Definitely banks are going to be the first victim of Kemi’s new plans if it goes ahead. About N165 billion of annual risk free revenues are at stake if Kemi implements her plan. This plan also means about N915 billion that could be available for lending to the private sector over the period the government pays down its Treasury bills liabilities. This could have a positive impact on interest rates in the domestic market as banks look for the most viable companies to direct these funds to.
On paper, Kemi’s plan looks great. The US$3 billion that would be raised in the international markets would not only come at a lower single digit interest rate and for longer tenure but the US$3 billion raised would also boost dollar liquidity by raising external reserves and strengthening the capacity of the CBN to support the naira. It would also reduce the cost of borrowing to the government and even the private sector as less demand for domestic debts will lead to lower interest rates.
However, there are also significant risks to Kemi’s plan. First, it is doubtful if the CBN will allow N915 billion of maturing Treasury bills be released into the financial system. A key part of CBN exchange rate management strategy so far has been to have a tight grip on liquidity in a bid to keep control over the demand for dollars. The CBN would definitely look for ways to mop up as much of the N915 billion fresh funds that would come into the system with Kemi’s plan as it would fear the impact such inflows would have on demand for the dollar in the domestic market despite the fact that the inflow will be backed by new dollar inflows.
There is also the obvious foreign exchange risk that comes with foreign borrowing. The official exchange rate is still N305, whereas the more market determined investors and exporters’ exchange rate is about N366. This basically means that the exchange rate is really weaker than the government wants to admit. At a weaker naira, the advantage of borrowing at a cheap rate in dollars would be wiped out by the weaker naira. Naira equivalent interest payments could significantly rise if the naira gets weaker in the long run.
Also Kemi’s plan is not an answer to the bigger revenue challenge faced by the government. The biggest challenge faced by government is revenue shortfalls. Admittedly, the government is dealing with this with its various tax initiatives and initiatives to reform the tax system. However, it is not certain how this would translate into higher revenues yet or how soon this will start hitting government treasury.
If anticipated revenues fail to materialise in the next few years, the government could find itself on the hook for significant debt repayments that it many have no capacity of settling. So while Kemi’s plan is great on paper, it also comes with significant risks. Admittedly, short-term advantages of Kemi’s plan outweigh long-term risks. So perhaps it is the best strategy in the short run. After all, as economist say, “in the long run, we are all dead anyway.”
Anthony Osae-Brown
