Adeosuns $3bn Foreign Debt Gambit

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  • Nigeria’s debt service payments are clearly unsustainable, but is committing ‘original sin’ the way to go?

(Sundiata Post) — When a sovereign government needs to borrow to fund its operations, there is an advantage to issuing debt in its own currency.

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This is because if it has trouble repaying bonds when they mature, the treasury can simply print more money.

However, there are limits to this approach. When governments rely on an increased money supply to pay off debt, an approach known as seigniorage, monetary inflation may mean the currency is no longer worth as much.

For example if Nigerian bondholders earn 15 per cent interest on a bond, but the currency’s value is 20 per cent lower as a result of inflation, they have actually lost money in real terms.

With high inflation comes demand for real returns by investors which in turn leads to high interest rates like we have in Nigeria where one year treasury bills yield about 18 per cent and inflation is close to 16 percent.

To get around this problem of expensive domestic debt, countries often engage in ‘original sin’ by issuing debt in a foreign currency.

However, the inability to control the money supply can both trigger and exacerbate financial and economic crises.

It also limits the government’s options to repay in the event of a financial crisis.

Borrowing in a foreign currency also exposes a country to exchange rate risk.

If the local currency drops in value, paying down international debt becomes considerably more expensive. Economists refer to these inherent challenges as “original sin.”

We are breaking down the meaning of original sin because Nigeria’s Finance Minister Kemi Adeosun announced last week that the country plans to refinance $3 billion worth of treasury bills denominated in the local currency with dollar borrowing to lower costs and improve its debt position.

Adeosun said the government planned to refinance maturing naira-denominated short-term treasury bills with dollar borrowing of up to three years’ maturity.

She said it was part of an attempt to restructure the debt portfolio into longer term maturities by borrowing more offshore and less at home, which the minister said would also support private sector access to credit to boost the economy.

Data from the Debt Management office (See figure 1), shows that the FGN has some N3.6 trillion outstanding in Treasury bills as well as N8.1 trillion in FGN bonds.

Servicing these debts have not come cheap with interest rates north of 15 percent per annum for the sovereign.

The DMO data in Figure 2 shows that as at Q1 2017 (January – March) the Federal Government has spent a whooping N449 billion on interest payments alone to service its outstanding debts.

The finance minister also said the debt profile change would have a positive impact on the value of the naira “because it means that $3 billion will be coming into our foreign reserve”.

We are sceptical about any material impact this plan will have on the debt burden, interest rates and economy as a whole.

We think a better action would have involved executing on the already laid out plan to increase FGN revenues through closing tax loopholes and broadening the tax base.

With a tax to GDP ratio of around 6 percent, Nigeria clearly has room to raise the needed funds domestically to retire maturing debts and service existing ones, without exposing itself to the perils of original sin.

These risks came to light in the 1980s and 1990s, when several developing economies (including Nigeria) experienced a weakening of their local currency and had trouble servicing their foreign-denominated debt.

While an argument could be made that the country’s external debt stock of $13.8 billion (as at Q1 2017) is tiny as a percentage of GDP, the worry here is the dubious benefits of such a move touted by the Minister which we feel does not compensate for the increased risks we outlined.

Dollar debt service costs are also not cheap as the FGN paid $127 million to service foreign debts in the first quarter, according to DMO data.

We also think external financing should be linked to more simulative infrastructure projects as opposed to just borrowing to build up the dollar reserves, which is then not optimally/efficiently utilized as a result of the up to 5 market rates for the Naira dollar exchange rate pair.

Mexico’s “tequila crisis” is an example of the dangers of original sin. Money had gushed into Mexico in the early 1990s but when Alan Greenspan, the Federal Reserve chairman, raised interest rates in 1994 the boom came to an abrupt end. By December the government tried to depreciate the peso but the currency crashed by more than 50 per cent and Mexico had to be bailed out by the International Monetary Fund.

With an uncertain oil future and an economy still yet to diversify its FX earnings capacity beyond remittances and oil revenues, this plan to plunge deeper into dollar denominated debt should probably be scrapped! (BusinessDay)

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