The Nigeria’s Diaspora Bond And Community in a Complex Economic Environment
Jones O. Edobor, Ph.D
Since the subscription of the recently concluded $300 million Nigerians in Diaspora bond issued by the Nigerian Debt Management Office (DMO) without the participation of Nigerians in Diaspora, many Nigerians in the Diaspora have been calling on the DMO to issue another Diaspora Bond to be exclusively subscribed by Nigerians in Diaspora. These calls appear an indication of a misconception of what a bond is and whether some Nigerians in the Diaspora are not mistaking a bond for an investment fund. This apparent misunderstanding has necessitated shedding some light on what the financial tool “bond” is and when it is applied.
To understand better what a bond is, let us begin by looking at what government budgets are and how they are financed. Actually, a budget is a plan containing all expected revenues/incomes and expenditures (recurrent, capital projects, financing, miscellaneous, etc.), drawn up by the different government ministries and agencies with priorities of the things they intend to do and spend money on; making up the sum what government intends to do and spend money on within a specified period of time, usually a year. A budget contains on the one hand all revenues and the other all planned expenditures – see illustration below. Each budget has a structure with levels that define the budget hierarchy. Budget structures define the framework in which individual budgets are maintained, tracked and monitored, and controlled and appraised/evaluated. Technically speaking, having a budget approved does not guarantee it may be fully implemented. For this to happen, the projected revenue and planned financing targets must be achieved. Budgets are normally not implemented indiscriminately but according to their hierarchy and priority items (recurrent expenditures, financing, etc.).
The illustration above depicts that ideally, revenues only should finance budgets. However, if they do not balance, then there is either a surplus or a deficit.
Government’s budgets are financed through revenues that accrue to government from direct and indirect taxes such as taxes on salaries, on yearly profits of companies, value added taxes (VAT), revenues from User fees, which are fees paid directly to government by individuals or legal entities who consume specific services from government. In this regard, there are certain socially desirable commodities that should be provided publicly, particularly if the private sector can only provide the services discriminately and at a greater social cost than government, for which government collects charges from those who benefit from them. However, full recoveries of costs through charges from direct beneficiaries are only economically desirable, if the goods or services in question are "private goods", having no spillovers for citizens other than the direct beneficiaries. For all publicly provided goods like education, security, roads, some utilities, preventive and curative health services, and anti-poverty programs, etc. where positive spillover benefits suggest that less than full cost recovery from direct beneficiaries is desirable, government may either provide such services free of charge or at a subsidized rate.
Some other avenues for government to raise money are revenues from custom duties and all such fees derived from the auctioning of licenses and leases on government assets, such as airwaves, concessions on mining mineral resources and oil revenues (if available), and outright sales of government physical assets, etc., and from all other revenues from government investments and savings.
Anyway, the sums of all government’s direct and indirect revenues are not always enough to cover what government may intend to spend money on in the budget period. When confronted with a deficit, governments have several options to bridge the gap. This includes continuing to raise taxes and auxiliary fees until the budget balances and/or sell some of its assets, or take loans. The loans can be in form of overdrawing its accounts with commercial banks, taking normal loans, issuing treasury bills, or coupon bonds. The problems with taking loans from commercial banks and issuing Treasury Bills (T-Bills), beyond certain levels are that this can be detrimental to the private sector (crowding out effects), that may need affordable loans to grow their businesses and the economy. Therefore, when certain critical levels have been reached, government may opt not to take loans from commercial banks but from private persons by issuing coupon bonds or take loans from foreign countries.
This paper shall not discuss the technicalities or the procedures of the development of a bond; such as documentation, roles of rating agencies, registration and application with relevant Securities & Exchange Commission (SEC), and choosing agents, marketers and brokers, as well as wealth managers, etc., who may be considered best suited to reach targeted objectives and investors/lenders.
So, what is a Bond?
A bond is a loan (made to a corporate or government entity - municipalities, states or the federal government) in which an investor loans money to the entity which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used to raise money to finance a variety of projects and activities or to simply close the gap between government revenues and expenditures (deficits). The subscribers to bonds are debtholders, or creditors, of the issuer. The bondholders have no say as to how and for what the money is used for, only the issuer determines that.
Why a Bond and how it Works
As already indicated, bonds are usually used to raise money to finance new projects, maintain ongoing operations, or to refinance existing other debts. However, the instrument of a bond could be a first option but it is often applied only when the loan levels with commercial banks have reached certain critical levels. The indebted entity (issuer) issues a bond that contractually contains the following:
Evaluation of a Bond
When considering the riskiness of a bond, amongst the important features that should be looked at closely is the credit quality of the issuer, the price sensitivity to changes in interest rates and the duration of the bond, which are also the principal determinants of a bond's interest rate. If the issuer has a poor credit rating, the risk of default rises and these bonds will tend to trade at a discount. Credit ratings are calculated and issued by credit rating agencies such as Moody, Fitch and Standard & Poor (S&P). Nigeria’s current ratings by these agencies are Moody (B1), S&P (B) and Fitch (B+). The ratings that take several factors and indices into consideration before they are determined are mirrors of the current and short/mid-term economic prospects. It classifies the credit worthiness of the concerned. A couple of years ago Nigeria had triple As.
Well, longer dated bonds also tend to have lower liquidity, hence command a higher interest rate. Because fixed-rate coupon bonds will pay the same percentage of its face value over time, the market price of the bond will fluctuate as that coupon becomes desirable or undesirable depending on prevailing interest rates at a given moment in time. For example if a bond is issued when prevailing interest rates are 6% at ₦1.000 per value with a 6% annual coupon, it will generate ₦60 of cash flows per year to the bondholder. In this case, the bondholder may be indifferent to purchasing the bond or saving the same money at the prevailing interest rate.
Now, if interest rates drop to 5%, the bond will continue paying out at 6%, making it a more attractive option than saving the money in a bank. On the other hand, if interest rates rise to 7%, the 6% coupon is no longer attractive and the bond price will decrease, selling at a discount until its effective rate is 7%.
A bond is considered a discount bond when it has a lower interest rate than the current market rate, and consequently is sold at a lower price. Discount bonds are similar to zero-coupon bonds, which are also sold at a discount, but the difference is that they do not pay interest.
So, what is an Investment Fund?
An investment fund is a supply of capital belonging to numerous investors that could be used to collectively purchase securities or other investment instruments while each investor retains ownership and control of his own shares. An investment fund provides a broad selection of investment opportunities, greater management expertise and lower investment fees than investors might be able to obtain on their own. There is a variation of investment funds that include mutual funds, exchange-traded funds, money market funds and hedge funds. Some common mutual funds include Fixed income funds, Equity funds, Balanced funds, Index funds, Specialty funds, Fund-of-funds and of course Money market funds, .
At the creation of a fund, its defined goals determine its risk, fees and other factors. Individual investors do not make decisions about how a fund's assets are invested. A fund manager oversees the fund and decides which securities or other assets it should hold, in what quantities and when they should be bought and sold. An investment fund can be broad-based, such as an index fund and ETF that invests only in small technology stocks.
The majority of investment fund assets are open-end mutual funds, which allow the issue of new shares as investors add money to the pool, and retire shares as investors redeem. These funds are typically priced just once at the end of a trading day.
Closed-end funds are managed investment funds that issue a fixed number of shares, and trade on an exchange. While a net asset value (NAV) for the fund is calculated, the fund trades based on investor supply and demand. Therefore, a closed-end fund may trade at a premium or a discount to its NAV.
What is a Treasury Bill - T-Bill?
A Treasury bill (T-Bill) is a short-term debt obligation issued by a government with a maturity of less than one year. T-bills have various maturities and are issued at a discount from par. T-Bills investors do not receive regular payments as with a coupon bond, but one time interest rate. T-bills can have maturities of just a few days and up to a maximum of 52 weeks, but common maturities are one month, three months or six months. The longer the maturity dates, the higher the interest rate that the T-Bill will pay to the investor. The difference between the purchase price and par value is interest. For example, an investor purchases at par value N1,000 T-Bill for N950. When this T-Bill matures, the investor is paid N1, 000, thereby making N50 on the investment.
Performance of Nigeria’s recent Budgets
A brief analysis of Nigeria’s recent budgets show that in 2015, the volume of Nigeria’s budget was around ₦4.4 trillion with projected total revenue of ₦3.359 trillion. This amounted to a planned deficit of ₦1.041 trillion (23,66%). In 2016, the volume of the budget was increased to around ₦6 trillion, with projected yearly revenue of about ₦3.78 trillion. There was a planned deficit of ₦2.22 trillion (37%). The 2017 budget was further expanded to a volume of about ₦7 trillion, with expected revenues of only about ₦4 trillion – with a deficit of about ₦3 trillion (42,86%).
As can be seen in the graphic below, the revenues from 2015 to 2017 have more or less been stagnant between ₦3.6 trillion and ₦4 trillion, yet expenditures are exploding.
Figures are in Trillion Naira
The increases in the budgets are being solely financed with increased borrowings, instead of making efforts at structural reforms.
As the performance of Nigeria’s budget is solely dependent on crude oil price and its production levels, there is no room for underperformance or distortions of any kind (Niger Delta or elsewhere). In addition, missing the projected GDP growth level used as basis for the calculation of the budget can lead to missing the budget targets.
According to the Debt Management Office (DMO), as of March 2017, Nigeria had further incurred ₦7.1 trillion debts in the last two years. Bearing in mind that the planned deficit for 2015 was ₦1.041 trillion and for 2016 was ₦2.22 trillion - a total of ₦3.261, one wonders, where has the delta of ₦3.839 trillion come? A possible explanation for this more than doubling of the planned deficit for the two years in focus suggest that there is either a serious budget indiscipline going on that have led to this huge over spending of ₦3.839 trillion or the planned revenues were missed by ₦3.839 trillion. Should the latter be the case, this would mean that the actual revenues for both years combined amounted to only ₦3.3 trillion - a miss by 54%. Either way, these are indications that Nigeria is in far deeper troubles than are being admitted. To worsen matters, there are serious indications that the targeted ₦4 trillion revenue in the 2017 budget shall be missed badly, which shall further increase the growing debts and exacerbate Nigeria’s economic woes in the coming years. These and other indicators are pointing to a country that is far from coming out of its economic crisis, and its currency exchange rate turbulences, may further escalate.
Furthermore, according to the DMO, at the end of March 2017, the domestic debt of the FGN stood at $39,077 billion and the domestic debt of states at around $10 billion, while the external debt stock of the federal and States governments were around $14 billion. In 2011, the ratio of the stock of the external debt to total debt stock stood at 13.64%. Around June of 2016, the ratio had risen to 18.33% and has continued to rise since then. Nigeria’s debt profile stood at almost $63 billion and growing. More worrying is the rising external debt of the federal and state governments that rose from $9.46 billion to $13.81 billion in just two years, representing an increase of $4.35 billion or 45.98 percent
When evaluating the ability of a country to service its external debt, its external debt-export ratio is significant. In 2011, the external debt stock/export ratio stood at 8.40% and by mid-June 2016, it had risen to over 23%. These figures may not yet be alarming when compared with some other countries, particularly when compared to the optimal target of 40% set in the DMO medium term Debt Management strategy for 2016-2019. The problem with this strategy and Nigeria is that its main forex earning is through the export of crude oil that is increasingly coming under pressure. Moreover, given accelerating climate change and international treaties, many industrialized economies are developing policies to reduce their consumption of fossil energy, which is leading to accelerated promotion of e-cars and renewable energy sources. Some of these countries have already proclaimed their intentions to ban fossil energy powered vehicles between 2025 and 2050. Given this threat and other factors, there are strong indications that peak oil (production, demand and consumption) appear to have been passed, so that demand for crude oil is likely to decline in the future. Nigeria is advised to take these threats seriously, truly diversify its economy and invest in electricity generations now, instead of consuming nearly all its revenues on overheads.
In any case, for a serious qualitative comparative analysis to take place, the export structure of the other countries in focus, whether or not they too run a mono commodity export economy with a price of their major commodity being determined abroad, coupled with a volatile currency.
Essentially, what should give particular cause for worrying is the fact that Nigeria was there before. In 1970, Nigeria had less than US$1 billion in debt and many Nigerians and policy makers considered Nigeria under borrowed, with similar kinds of arguments, referring to international prudent levels. By 2000, the debt had risen to about US$28.27 billion and by the end of 2004 to about US$35.94 billion. Most of the debts then were accumulations of arrears, interest and penalties with a principal balance of only 7% and principal arrears of 40% of the debt volume. The rest were interest and penalties because Nigeria was unable to service the debts when due. That debt crisis barely more than a decade ago also started just as now, with a massive external borrowing and setting fictitious optimal targets not based on data, to offset the collapse in oil prices of the 1980s. In the end, Nigeria had to apply for and began begging for debt relief.
Admittedly, it could be argued that Nigeria’s economy was smaller in the 80s; fact is the debt volume was also smaller than now. In fact, the debt ratio to export revenue was better then. Debts in foreign currencies have a way of swelling, when confronted with a volatile (mono) export commodity and currency. The problems of the past, as now, are the reluctance to carry out a structural reform to reduce the recurrent expenditures. This is further complicated by the overestimation or too optimistic projections of the country’s performance/productivity and the underestimation of the dynamics of the country’s volatile source of foreign incomes to service its foreign debts.
Those who propagate that Nigeria is under borrowed, appear ignorant of the errors of the 80s through the 90s and all through to 2004. Nigeria runs the risk of being taken down the same path and this should be avoided or prevented.
Finally, the concept of a bond does not make it an instrument that a third party could design or even demand for, as some Nigerians in the Diaspora seems agitating. It is the issuer of a bond, who identifies its needs, determines what kind of bonds and sets the terms, taking prevailing market conditions into consideration. It is the issuer that files in an application with the relevant SEC for approval and who must meet their conditions.
Lastly, each time the government issues a bond, the burden on future budgets and generations increases. While it is patriotic for Nigerians to support their government by purchasing Nigeria’s bonds, they have cause to worry over that their DMO is increasingly having difficulties to issue investment grade bonds. The Nigerians in the Diaspora should be relentless in speaking truth to government, by insisting that external debts must not be allowed to continue to swell at its current growth rate, as this portends danger that could once again get out of control and jeopardize development prospects in the future. So, instead of calling for or debating Diaspora bonds or the like, Nigerians in the Diaspora should rather concentrate on influencing the government to reform to reduce its overhead (recurrent expenditures) to reduce its deficits and thereby its needs for external financing.