Politics of national debt sustainability ratios -By Jekwu Ozoemene

Filed under: Political Issues |

Jekwu Ozoemene

 

On Wednesday morning, I had an interesting chat with my elder brother, Uche Ozoemene, on our national debt sustainability, and for the first time thought to put my position on paper.

Anytime governments want to justify why they can and should borrow more, they go to the country’s Debt to GDP Ratio. This is especially so for the Government of Nigeria.

An ongoing debate within the economic policy community is the relevance of this ratio to Nigeria’s particular revenue generation versus debt and debt service situation.

First off, my position has always been that regardless of the size of a government’s debt portfolio, the key issue is whether they can generate sufficient revenue to service and repay that debt.

Another concept we need to appreciate is that more often than not, governments never really fully repay their sovereign debt. They simply do what we refer to in banking as “rollovers” or “extensions”, as prosperity and economic growth may ultimately make what initially appeared to be huge borrowings increasingly insignificant (for instance, the UK has debt exceeding 100 per cent of GDP in 81 of the last 170 years and has never had cause to default).

So, what then is important as regards to the quantum of sovereign debt that a country can sustain?

The cost of debt service. I repeat, the cost of servicing the debt.

You see, it is sly (actually clever by half) for our macro-economists and politicians to always run to a low Debt to GDP ratio to justify wanton and unsustainable debt.

Why? Because Gross Domestic Product is the aggregate value of all goods produced in a country in a year and comparing it against the country’s debt is in essence to say, because the country earns XYZ from all the goods it produced in a year (since GDP can also be thought of as national income), it can repay XYZ debt on the strength of these earnings.

Do you now see the fallacy of this ratio when applied to Nigeria’s situation?

The Government of Nigeria does not have access to all the national income, only the share it collects in taxes! The GDP figures we quote reflect activity across the whole spectrum of the national economy, both the public and private sectors however .

Government has to pay its debt from tax receipts and other government income, not from the income of the economy as a whole!

To put this in further perspective, in 2013, compared to a GDP of US$510bn, tax revenue from all levels of government (federal, state, local) was about 7.8 per cent of the GDP and this is based on about N4.8tn (about US$30bn) collected by the Federal Inland Revenue Service, N833.4bn (about US$5.2bn) by the Nigeria Customs Service, and about N648bn (US$4bn) by the various states and local councils.

More interestingly, if we isolate our national tax revenue from our oil revenue, then Nigeria’s Tax to GDP ratio for the oil sector will be circa 27 per cent, while if you do the same for the non-oil sectors, you will get circa 4.6 per cent, the lowest in the whole wide world!

Let me break this down further. While the oil and gas sector contributes just 10 per cent to our GDP, it accounts for 27 per cent of our tax revenue, 40 per cent of our government’s total revenue and over 95 per cent of our total export earnings.

Do you now understand why our much touted low Debt to GDP ratio makes absolutely no sense in the face of our current national realities?

People are also quick to reference the Eurozone countries as well as the US and Japan’s high Debt to GDP ratios as justification for further borrowing by Nigeria.

Again, this position is because we ignore the fact that a country with a high tax compliance rate can afford more debt than those with low compliance rates. Thus, a debt service to government revenue ratio reveals the true burden of a country’s debt on the government’s finances. The debt to GDP ratio comparison simply ignores this crucial point!

This is for those who still run to the debt to GDP ratios of the Eurozone countries, the US, and Japan – At the end of the first quarter of 2017, the government debt to GDP ratio in the Euro Area stood at 89.5 per cent.

Very high, right?

But debt service /interest payments as a percentage of the GDP/tax revenue for most of these countries are very low. Take Italy which has one of the highest 2016 Debt to GDP ratios in the Eurozone at 132.6 per cent (down from circa 150 per cent) but has an interest burden versus government revenue ratio of about five per cent.

Japan had a national debt of over 220 per cent of GDP in 2013, yet net debt interest payments was about 1.4 per cent of GDP for the period. The UK and the US net interest payments did not exceed five per cent. In the US for instance, the US Federal tax revenue in 2012 was US$2.45tn, 11 times higher than the US$220bn in net interest payments on the debt and about seven times higher than the US$360bn in total interest payments.

For our comparator economy, South Africa, the country had a debt to GDP ratio of 50.10 per cent but debt service to government revenue of 10.23 per cent in 2015.

So, back home to our Nigeria, just look at our debt service as a percentage of government revenue table below (note that the 2017 figure is an estimate) to appreciate why some analysts have palpitations over our current debt profile and our hunger to borrow even more.

Year Debt Service as a percentage of Government Revenue

2003: 34.86 per cent

2004: 28.72 per cent

2005: 22.41 per cent

2006: 12.87 per cent

2007: 9.16 per cent

2008: 11.94 per cent

2009: 9.52 per cent

2010: 13.46 per cent

2011: 14.84 per cent

2012: 18.72 per cent

2013: 20.539 per cent

2014: 29 per cent

2015: 28.1 per cent

2016: 66 per cent

2017: 80 per cent

You see?

Therein lies the problem! If we spent 66 per cent of our 2016 revenue servicing interest on our loans and in 2017 have since spent circa 80 per cent of our revenue servicing interest, how on earth do we intend to pay salaries and how can we fund our capital projects?

If we refinance some of the domestic component of this debt into lower interest foreign debt as is currently being proposed, how do we manage the even bigger challenge of the exchange rate exposure?

How do we factor in the potential Fed rate hike in December 2017 (70 per cent probability) and 2018 (60 per cent probability)?

Let’s discuss, devoid of politics and sophistry.

Dr Ozoemene, a financial services specialist, is based in Lagos

 

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