Quantitative Easing

Why debt restructuring is not an option for Nigeria – Akpata

Egie Akpata is the chairman of Skymark Partners Limited, a company based in Lagos. He worked at BMO Financial Group in Toronto, Deutsche Bank AG in New York, United Capital PLC and UCML Capital Ltd where he was a director. Egie has completed transactions in the debt and equity markets, as well as mergers and acquisitions, worth more than 3 trillion naira over the past 14 years. He is an active player in local capital markets and a regular contributor to CNBC Africa. In this interview, he examines the implications of recent developments surrounding Nigeria’s debt market, among others. Extract.

Jhe Eurobond market was shaken this week when the finance minister said Nigeria wanted to restructure its local and external debt. How likely is Nigeria to end up restructuring its debts?

I believe the Debt Management Office (DMO) subsequently issued a circular on its website making it very clear that Nigeria has no intention of waiving any of its debt obligations. This point was reinforced during the investors meeting held in Washington DC on October 14, 2022 by the Minister of Finance, the Governor of the Central Bank (CBN), the DG Debt Management Office (DMO) and the DG Budget Office.

I believe that investors in FGN Naira Bonds and USD Eurobonds can rest assured that the coupon and principal of these instruments will be paid at maturity.

Can Nigeria really afford its current debt profile?

The concept of affordability for a sovereign state is whether interest and principal payments can be made when due. The short answer is yes, Nigeria can afford its current debt profile as it has the means to meet all interest and principal payments as they come due.

But the very high debt service-to-revenue ratio suggests that Nigeria cannot afford these debts and may need IMF assistance or restructuring.

I think it is important to look at the details of these specific debts to understand why Nigeria does not need to go the IMF or restructuring route unlike what happens to some African countries like Ghana and Zambia.

To begin with, it is important to separate foreign and local debts. The majority of Nigeria’s debt is in naira with external debt of $40 billion including $15.6 billion in Eurobonds. Monthly interest charges on Eurobonds are $100 million, a fraction of the cost of oil subsidies.

The next Eurobond maturity is $500 million in July 2023 and there is no 2024 maturity. So in the grand scheme of things, Eurobonds aren’t a big deal in terms interest or principal payments.

The other external debts are bilateral or multilateral loans with very low interest rates, long moratoriums and very long repayment periods. Data from the DMO shows that $140 million was spent on servicing bilateral and multilateral debt in the second quarter of 2022. This is less than $50 million per month, which is not huge for Nigeria.

The reality with naira debt is that new debt is constantly being issued to pay off old debt. This means that the stock of naira debt continues to grow. However, as long as the market has confidence in the whole system, investors will continue to buy newly issued naira bonds. The government can also raise taxes and devalue the naira to increase the naira it gets on foreign exchange earnings.

As a last resort, the CBN can print money to meet naira debt payments. So there really is no need to consider going the very destructive route of naira debt restructuring.

What are the implications of a country restructuring its local debt? Why are some African countries willing to go this route if it is a bad option?

Countries considering restructuring their local sovereign debt are likely to have few options because of the limitations of their local debt markets or make it a condition imposed by foreign debt holders.

Restructuring of local sovereign bonds will generally involve a reduction in coupon, an extension in duration and potentially also a discount on principal. All this implies a reduction in the value of these instruments of up to 20% or more.

Now suppose the Nigerian government decides to restructure its N15tr bonds into naira, resulting in a 20% loss in market value. It’s N3tr loss of value. Pension funds hold N8.7tr of these bonds. Do we want retirees to lose N1.7tr? Banks hold about N6tr of these bonds. A loss in value of N1.2tr is enough not only to wipe out all bank profits for two years, but also to put some banks in trouble.

Of course, if the government has decided to restructure its bonds, private issuers are likely to ask for the same conditions. After all, they paid a premium to the sovereign when issuing their bonds because of their credit risk. If the supposedly risk-free issuer essentially defaults and restructures, why wouldn’t companies do the same?

As you can see, the fallout from local currency debt restructuring is so widespread, its costs so high, its impact on the stability of the financial system so great that the simple alternatives of issuing new debt to repay old debts, higher taxes, devaluation and printing money are much better options.

The Eurobond market for African sovereigns appears to be in turmoil, with nearly all bond issues trading at deep discounts. Why is it? Is Nigeria definitively excluded from this market?

Global bond markets are currently experiencing high volatility, rising yields and falling bond prices. The reason for this is that most central banks around the world are raising interest rates to fight record inflation.

Bonds typically pay a fixed coupon, so when market interest rates rise, the value of those bonds declines so that the yield on those instruments remains in line with current market realities. Unfortunately, when rates rise at this record pace, all bonds, not just African Eurobonds, will lose value.

In addition, the creditworthiness of some African issuers is now in question as their governments seek IMF assistance. Yields above 20% suggest that the market does not expect current coupon and principal repayment terms to be met.

For example, Ghana’s Eurobond 2027 is trading at a yield of 45%, but Nigeria’s Eurobond 2027 is trading at a yield of 14%. This huge difference is because the market expects Nigeria to make coupon and principal payments on time. The same cannot be said for Ghana whose obligation will probably be restructured.

The markets are not inefficient enough for an investor to realistically realize the 45% return the bond appears to be yielding based on current prices.

Once the US Federal Reserve stops raising interest rates, the market will stabilize and it will be possible for countries like Nigeria to issue Eurobonds. However, these new issues will carry significantly higher interest rates than previous issues.

The days of very low interest rates are well behind us and anyone borrowing new funds should expect to pay a significantly higher interest rate than in the past.

It looks like the N22tr “ways and means” borrowings will be securitized and added to local government debt. How did it become so important and how exactly will it be securitized?

Since the global financial crisis of 2008-2009, central banks around the world have expanded their balance sheets through quantitative easing. This largely involved buying bonds to depress secondary market yields.

It also had the effect of making central banks the main holders of government debt and effectively lending indirectly to the government. The 2020 COVID crisis has led to a new round of quantitative easing. For example, the Bank of Japan owns 50% of all outstanding Japanese government bonds.

The US Federal Reserve’s balance sheet has shrunk from $880 billion in 2008 to $8.8 billion today, primarily due to its holdings of US government bonds and some corporate/mortgage-backed bonds .

Rather than buying bonds in the secondary market or at primary auctions, the CBN provided loans directly to the federal government. This was probably to reduce interest charges, as “ways and means” loans are very likely to cost much less than bonds issued on the open market.

The government, through DMO, will likely exchange this CBN debt for standard issue, long-term FGN naira bonds whose coupon is likely to be lower than the market. Ultimately, CBN will end up being the largest holder of FGN bonds at N22tr compared to N15.1tr outstanding today. A bit like the Fed or the American BoJ, which are the biggest holders of their sovereign bonds.

Some of these “ways and means obligations” will likely end up on bank balance sheets instead of repayments or cash reserve ratio rebalancing.

The current budget deficit of the FGN is so large that it cannot be financed by the monthly DMO bond auction of around 250 billion naira per month without driving up interest rates very significantly. The difference seems to be in “ways and means”, which could explain why it is increasing by around 500 billion naira per month.

Looking at the proposed deficit of N11tr in the 2023 budget, it is very likely that the “ways and means” loans from the CBN to the FGN could increase faster than the current N500b approximately per month.

Volatility in UK financial markets has increased with the introduction of the new Prime Minister’s mini-budget. The newly appointed Chancellor lost his job and most new initiatives were cancelled. What can Nigeria learn from these events?

I think the main lesson here is the importance of good communication with the markets. Financial markets are very rational and don’t like surprises. Governments must be proactive in recognizing the likely reaction of markets to their policies and political actions which have financial costs.