Of Debt Financing and Economic Recovery

GUEST COLUMNIST

By ABRAHAM E. NWANKWO

There has been a cloud of ambivalence around current discussions on the need to use debt financing to exit Nigeria from economic recession to recovery.  The controversy can be resolved from two broad perspectives: one is the lesson from the historical and ongoing experiences of advanced and well-knowledged economies, in response to the threats of deflation and recession; the other is an examination of the dictates of the peculiarities of the prevailing Nigerian condition.

In response to the Great Recession which started roughly with the collapse of Lehman Brothers in U.S.A. in 2008 and got re-enforced by various local economic and financial crises, the U.S.A., Japan, the Eurozone and the U.K. channeled massive new liquidity into their economies, through, mainly, their central banks.  They conducted unprecedented and unconventional purchases of both sovereign and private sector securities.  They also provided direct lending to the banks and other credit institutions via standing facilities.  The major goals were, and still are, to prop up economic growth and reduce unemployment by boosting aggregate demand.  By June 2016, the advanced economies had spent more than USD 12.3 trillion on quantitative easing.   The U.S. Fed had spent about 3.7 trillion, including USD 2.394 trillion on government securities; after an initial programme of monetary financing of between Yen 60 trillion and Yen 70 trillion per month, the Bank of Japan had since October 2014 committed to a programme of purchasing Yen 80 trillion of government bonds, per month; the European Central Bank started in January 2015 to buy public and private sector financial assets at the rate of Euro 80 billion per month, for eighteen months ending in September 2016.

Given that this type of unconventional monetary financing (Quantitative Easing) has been accepted, more or less universally, as being appropriate for fighting economic downturn, conventional public borrowing by a country such as Nigeria, for the same purpose of pushing back the forces of recession could be considered as being even more normal.

Looking at the issue from within, we have ample body of information to guide thinking, discussion, decision and action.  Long before the structural collapse of oil export prices in mid-2014, it had been established that Nigeria needed investments of about USD 25 billion per annum for 7 to 10 years to cover its huge infrastructure deficit.  An additional structural financing gap has arisen from the drastic drop of oil revenue; the estimate is that oil-related public revenue has dropped by about USD 20 billion per annum compared to the average in the pre-2014 years.  This means that Nigeria’s total investment deficit is not USD25 billion per annum but USD 45 billion per annum.

What does this simple arithmetic tell us? First, it tells us that given the enormous size of the structural financing gap (SFG), we need to tap capital from all available sources.  Therefore, ongoing debates canvassing in favour of one or a limited number of sources and against other sources, are a disservice; they are not helpful.  Activities for exploring and exploiting all sources should commence pari passu, even though their realizations and impacts will follow some natural sequence – short-term, medium-term and long-term.

Second, it tells us that all public revenue sources, including monetization of eligible public assets, when added to private sector equity and debt resources, can contribute only so much of the required total annual investment, and no more.  This maximum contribution cannot be reasonably expected to be more than 50 percent.  Therefore, the balance has to be raised in the form of public debt, preferably with tenors of 15 years and above but not below 10 years.

Should the borrowing be from domestic or external sources?  The relevant background information are as follows: (i) average cost of domestic debt is higher than average cost of external debt by more than 7 percent; (ii) significant domestic borrowing will worsen the existing high debt service-to-revenue ratio, whereas the impact of more external debt on debt service is much thinner; (iii) the country’s Debt Management Strategy (2016-2019) provides for a strategic remix of the total public debt portfolio from the current domestic-to-external ratio of 82:18 to 60:40; (iv) there is a need to avoid crowding out the private sector, so that they can have enough borrowing space to play their lead role in growing the economy, in response to the enabling policy and infrastructure environment provided by government.  In view of the foregoing, the preferred sources of public borrowing over the medium-term is external.

What about the foreign exchange risk associated with foreign currency debt?  The starting point is to note that the country has enormous idle capacity; therefore, a well-programmed and targeted debt capital injection will have high capital-output ratio.  Hence, strong real effect.  The essence of the massive investment plan is that within 5 to 7 years, the country should be moving on a trajectory of sustainable and continuously strengthening economic recovery.  And, from about the Year 8 to Year 10, the economy will start generating adequate public revenue, including forex revenue from the export-oriented diversification programme.   That is why the tenor of the new debts should preferably be 15 years and above so that there will be enough time for a “break-even”.   Local substitution of food and other eligible items over the next 3 to 4 years will save the country about USD 6-10 billion in foreign exchange.  Diversified and expanded export earnings, will grow foreign reserves and generate a growth supporting exchange rate of the Naira. For these reasons, the country will have the capacity to service and repay its external debts.

The channels and sequence of economic recovery and prosperity following massive investment with debt and non-debt capital will be as follows.  Investors (local and foreign) will react positively to a credible and comprehensive recovery investment plan; inflow of external loan proceeds will substantially and immediately impact on forex reserves and moderate the Naira exchange rate; the actual building of infrastructure will stimulate economic activity around construction, generating effective demand for labour and materials, which will trigger a chain of income multipliers; a boost in real sector activity in response to improvements in infrastructure will be the ultimate consequence.  At this stage, the recovery process, which was led mainly by the public sector through massive investment in infrastructure, is taken over by the private sector, which plays the dominant role in producing actual goods and services in their pursuit for profitable business opportunities.

To conclude this simple analysis, it is necessary to emphasize two points: (i)There is the need to guard the economy from committing the “sin-of-avoiding-a-sin” (SAS): The fact that during much of the country’s past, public debt and revenues were not appropriately utilized to build a strong and inclusive economy, cannot justify failure to mobilize debt capital at this time, when the need is compelling, and the governance environment for prudent and productive use is dependable.  We must act bold.

(ii)Nigeria is an upside case, and discerning investors (local and foreign) should know that this is the time to take a profitable position along the recovery path.  Many of them are already acting accordingly.  FDIs and LDIs, imminent Eurobond and other offers in the International Capital Market – Nigeria offers a whole range of profitable investment channels.

Dr. Nwankwo is the Director-General of the Debt Management Office, Nigeria