Why is government borrowing a problem for Nigerians?
The federal government's borrowing

Last week we published an article on how debt crises happen, focusing primarily on Ghana's current debt composition. We argued that Ghana has been increasing its debt rapidly, and the category of creditors it's been acquiring has made its debt more expensive and unsustainable. This situation explains why Ghana has approached the International Monetary Fund (IMF) for a bailout. Since the late 2000s, Ghana’s debt composition has changed from being composed mainly of multilateral organisations (like the World Bank and IMF) and the Paris club to more commercial loans from the capital market.
 

Key takeaways:

  • Domestic debt in Nigeria and Ghana has been increasing at an alarming rate following the influx of investment into the continent in the early 2000s. Beyond the domestic debt stock, both countries' near-debt crisis is also driven by the quality of creditors. 

  • Nigeria’s debt has been heavily funded by the CBN’s ways and means which

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This shift implies that Ghana's loans are now majorly commercial. Granted, these loans are easier to obtain because they have fewer conditionalities. However, they can be costly—especially when the country is facing severe macroeconomic downturns like Ghana is at the moment. The result, therefore, has been a worsening credit risk and the possibility of a debt default. 

But I admit that the story was incomplete because it focused more on foreign borrowing with barely any discussion about domestic borrowing. This article brings the other side of the story—how domestic borrowing, especially in the capital market, can make a country’s fiscal position precarious. To explain this, we’ll use Nigeria and Ghana as case studies because even though Ghana is seeking a bailout from the IMF, Nigeria’s debt situation is also quite dire.

By the end of this article, we should be very clear about why every country needs to be careful about where it decides to borrow money from.

Let’s dive in.
 

A new world of money

First, a bit of history and context.

In 1979, the world was plagued by a global energy crisis—like the one we’re in today—which led to two decades of economic contractions globally. After countries became stable in the late 90s, the 2000s were ushered in with a heightened increase in commodities demand. It was an excellent decade for African countries, which are largely commodity exporters. During this period, the demand for oil, metals, food and other commonly traded commodities led to record-high prices. Sub-Saharan Africa was growing by more than 5% per year. 

The period was dubbed "Africa Rising". As more attention turned to Africa, investor interest grew. Between 2000 and 2010, Foreign Direct Investment (FDI) into Nigeria tripled. In Ghana, the picture was even more beautiful, as FDI inflows grew by approximately 20x. 

 

 

Those were indeed the good ol' days.

The increased growth in Africa also required that the government spend on key areas like infrastructure and human capital development to sustain the growth. Despite the influx of investment into the continent, the government still needed to borrow, so they went to the market.

As investment increased, so did opportunities for more sophisticated lending into the countries. The ability of a country to pay back foreign loans also became more apparent, increasing their credit ratings and making them more qualified for more foreign loans—especially from the capital market.

African countries began to borrow from capital markets locally and internationally. The increased investment inflows and strict financial sector reforms like the recapitalisation of the banking sector caused the financial sector across key markets in the continent like Nigeria to stabilise. A stable financial market attracts investment.

Companies and individuals could borrow to generate more economic growth, and so could the government. The government didn't have to rely on multilateral organisations and large countries to fund its budget anymore; it could get the money locally. 

The preference for domestic borrowing was driven by how safe it was compared to foreign borrowing. Essentially, governments earned revenue in the same currency they borrowed—reducing the exchange rate risk. So the government splurged.

Returning to our two case studies: Ghana's debt stock increased significantly over that period.
 

 

As you can see from the chart, the Ghanaian government's domestic debt has grown by over 150x in just twenty years. Nigeria's case is very similar, with domestic debt increasing from ₦1 trillion in 2000 to ₦19 trillion last year.  

 


Although increased borrowing was aimed at supplementing budget deficits and growing the economy, both countries have racked up their debts at a rather alarming rate. As government borrowing increased, so did inflation and interest rates, making domestic borrowing more expensive. From 2016, when Nigeria entered into a recession, our debt servicing increased until we practically used all revenue to service debt. This year alone, the government has spent 80% of its revenue servicing its domestic debt! Total debt service is over 120% from January to April 2022. 

 


But this does not fully capture just how bad things are; it only tells us part of the story. As we repeatedly echoed in the previous article on foreign debt, rising debt is not the only issue with both countries. The debt composition, or who they owe money, matters just as much as how much they owe.
 

Silently pilling up 

Before disclosing who these creditors are, here’s a quick primer on the types of domestic creditors a government can have and what it means for them to lend the government money. There are broadly two types of domestic creditors: bank and non-bank. Bank refers to all forms of lending from the central bank and commercial banks. The government either borrows from its bank—the central bank of the country, or commercial banks through its fixed income securities like bonds and treasury bills.

When the government has a budget deficit and needs some money to fund it, the central bank can lend the government money by buying up its securities. In rare cases, however, when the government is going through an economic crunch, there is a limit to how much it can borrow from external sources. In such cases, the central bank can step in to offer some form of funding called "ways and means" financing—like an overdraft to the government. The Central Bank of Nigeria (CBN) lending to the federal government is also a form of expansionary monetary policy. That is, when the monetary authorities are trying to induce economic growth or increase inflation in the economy, they could lend money to the government to carry out some growth-inducing projects or simply fund its budget. The risk is that inflation—as we’re experiencing today, could be detrimental to the economy.

Commercial banks could also lend to the government by buying up the government's securities such as treasury bills and bonds. This is a viable source of income for the banks because these are safe assets with attractive interest rates. Also, because the assets are so safe, the banks rarely have to make provisions on their books for bad debt on this account.

Remember from our article on why banks are taking over discos, our Finance Analyst, Yomi explained that banks sometimes make provisions for bad debt or Tier 2 loans (at the risk of default) which eats into their profit. When lending to the government, there's no reason for the banks to do this because the government will pay back the loans, no matter what.

The safety that government securities provide to the banks causes a "crowding out" effect where banks are unwilling to lend money to the private sector—individuals and organisations because they give most of their loans to the government. From our past analysis of the banking sector, we saw that one of the quickest ways for banks to go under is when their proportion of non-performing loans (NPLs) increases. Therefore, banks avoid this by lending to debtors sure to pay back, and the government is top of that list. So, with most of the bank's loans going to the government, there is very little left for other sectors that require funding to unlock economic growth—even more so during an economic contraction.

Then there's the non-bank lending which is the government borrowing from organisations and individuals—you and me. Because government assets are (meant to be) safer than investing in companies, we could see the crowding out effect with bank lending happening here again. Organisations would instead give money to their government to earn some interest rather than use it to expand.

So far, I’ve explained how growth in Nigeria and Ghana led them to the arms of foreign lenders and how the case wasn’t too different locally. Now let's go into the data to see where the government gets its money locally. Let's start with Nigeria. 

 

The CBN is taking its banker role a little too seriously
 

 

Looking at the composition of the federal government's debt stock, as reported by the CBN, it appears that the federal government's domestic debt is mainly funded by deposit money banks (commercial banks) and the general public. While this is primarily the case, it's essential to look deeper to get the full picture. We must note the debt from the chart above only comprises the debt funded through government securities, excluding Ways and Means financing—one of the major ways the Nigerian government has recently funded its budget.
 

 


The picture gets much clearer when you measure CBN's Ways and Means as a percentage of the total funding through government securities.

The chart above shows that the CBN's loan to the Nigerian government is almost as much as the government willingly advertises through its securities. As the CBN pumps more money into the economy through the government, inflation continues to increase. For a country where inflation has been trending upwards since 2019, further exacerbating the inflation by borrowing from the government at this rate might be the final nail in Nigeria's economic coffin.

What is worse is how the CBN funds the ways and means. It's one thing to pump money into an already inflationary economy; it's another thing to do this at the detriment of the banks and financial sector. We explained before how one of the policies implemented by the CBN in the banking sector is the compulsory implementation of the Loan-Deposit ratio (LDR) at 65%. The CBN mandated that all banks give out 65% of their deposits to the private sector, and when they don't, the CBN penalises them by withdrawing  50% of the shortfall. This money, which is in the CBN's custody, is part of what is lent to the federal government—causing more inflation in the country and low liquidity for banks. 

Another implication of this, it reduces the central bank's independence.

Let's take a detour now to Ghana to see how their domestic debt is faring—given that they're more at risk of default than Nigeria is. 

 

What does Ghana owe?

Earlier, we observed that Ghana's domestic debt stock had increased rapidly over the years. But who does Ghana owe money to?
 


Three main categories of investors buy government bonds in Ghana: the banking sector (made up of the Bank of Ghana—Ghana’s central bank and commercial banks), individuals and foreigners. From the chart above, Ghana’s domestic debt is almost evenly split across these creditors. Our analysis will focus on the commercial banks and foreigners who buy Ghana's domestic bonds.

Remember that banks are willing to invest in government bonds because of the perception that the bonds are safe assets, reducing the banks' need for provisions. But when the government cannot fund its debt obligations, it could, in turn, affect the banks because they may lose the money they have loaned to the government. This will lead to increased Non-performing loans (NPLs), eroding the banks’ profitability. 

As of the end of 2021, 40% of Ghana's commercial bank assets' are made up of sovereign loans—to the Ghanaian government. Although Vetiva capital, a Nigerian-based investment bank, estimates that the Ghanaian government can still meet its interest payments twice over, the exposure to such risks—especially for a country going through a rough fiscal patch, can be bad for the banks' balance sheets. 

In Ghana, the government’s fiscal crunch indirectly impacts the banking sector. One of the reasons why Fitch downgraded UBA Ghana's ratings last year was due to some downstream oil companies that could not pay back their loans due to delays in government payments. So, even if the government has not started to default on its loans to the commercial banks, they are indirectly responsible for the increased NPLs suffered by Ghanaian banks.

Now let's look at foreign investors. As of 2020, foreign investors held about 18% of Ghana's domestic debt. However, the funding from foreign investors made up half of the country's foreign exchange reserves—which is where the problem is. As countries take more contractionary measures to tame inflation, these foreign investors would exit the Ghanaian economy for more attractive and stable investment options in the US, leaving Ghana with a depleted foreign exchange reserve to meet its debt and trade obligations.

One way to retain the existing investors is by raising interest rates following global interest rate hikes, and Ghana has been doing this. So far this year, Ghana has increased its interest rates by 4.5% to 19% (the highest in three years)); this will further increase the yield on the country's domestic debt—meaning that the government would have to pay more interest to its creditors, putting it in an even worse situation. 

As we round off, my earlier comment about countries paying attention to how they rack up debt should resonate. As we have seen with Nigeria and Ghana, the last decade of intense domestic borrowing has been costly and placed both countries in precarious fiscal situations. Granted, domestic loans have advantages because they remove exchange rate risks and don’t come with IMF conditions (on a serious note, we should take their advice sometimes). However, as we have seen, this approach to borrowing is expensive and puts even greater negative pressures on the rest of the economy, including average citizens like you and me.

The challenge now is that both countries (including every other country out there battling a debt crisis) must find a way to get their act together even as the rest of the global economy grapples with significant macroeconomic headwinds. It’s not going to be easy, especially because government spending is needed now—more than ever—to unlock growth in these economies. However, policy changes like fiscal discipline will slowly lead the countries to recovery.

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Gbemisola Alonge

Gbemisola Alonge

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