20 July 2018 ( Lagos ) : In their H1 18 strategy report, analysts had estimated fiscal deficit over 2018 to print at N2.9 trillion – from their revenue expectation of N4.4 trillion and expenditure of N7.3 trillion – which basically formed their domestic borrowing expectation of N1.7 trillion over 2018. Coming into 2018, actual fiscal deficit in the first two months of 2018 printed at N510 billion (split into N288.9 billion in January and N221.7 billion in February) due to higher government outlay which exceeded FG receipts over the same period. 

Precisely, FG’s receipts of N561.7 billion over the first two months stemmed from higher oil prices and crude production while expenditure over the same period printed at N1.1 trillion. In terms of domestic borrowing over the period, FG net issued N122.7 billion and N109.6 billion in January and February respectively which combined sums up to N232 billion – 45.5% of actual fiscal deficit – implying that FG must have sourced funding from alternative sources to meet the balance of N278 billion. Perusing through the financial statement of the Apex bank revealed an increase in CBN claims on the federal government to the tune of N715 billion over 2M 18 wherein analysts believe the FG must have drawn down on to fund the shortfall between fiscal deficit and domestic borrowing.

Over 2018, analysts expect higher crude oil prices and production to bolster oil receipts and, by extension, FG retained revenue. With a budget implementation of 75%, they now expect fiscal deficit to print at N1.78 billion over the year. In terms of financing, on the sale & privatization of government assets where FG expects N311 billion, they forecast receipt of 50% of the expected proceeds. On foreign borrowing, they expect the FG to issue $2.8 billion (N850 billion) in Eurobonds over the second half of the year. 

With regard the balance of N775 billion which should ordinarily be financed through domestic borrowing, they assume 50% part funding by the CBN which suggests that the government could possibly net issue ~N388 billion over 2018 under analyst's base scenario.

In this report, analysts focus on developments in the fiscal space over H1 2018. They also delineate their view on the feasibility of FG’s 2018 projections and implications for government borrowing farther out.

Budget outlay revised to match higher revenue

After six months of face-off, the legislative arm finally passed the 2018 budget in May with the President assenting the appropriation bill in June 2018. Expectedly, the approved bill came with adjustments. First-off, relative to proposed receipts, aggregate revenue was up N559 billion to N7.17 trillion, following an upward revision to oil revenue estimate (N546 billion to N2.99 trillion) reflecting an upward revision in crude oil price assumption to $51/bbl. (prior: $45/bbl.), while keeping other oil variables unchanged. 

The adjustment to crude oil prices was in line with current realities, as crude oil prices averaged $71/bbl. over H1 18 (+25%). On non-oil revenue, receipts from Company Income Tax (CIT) was revised lower to N658 billion (- N136 billion) while under ‘other revenue’, a new revenue source – FAAC2 levies – was introduced with planned receipts of N146 billion over 2018. Overall, approved aggregate non-oil revenue printed at N4.17 trillion, unchanged from what was proposed.

Largely reflecting the increase to FG revenue, aggregate expenditure was revised upward by N508 billion to N9.12 trillion with much of the increase allocated to capital expenditure (+N445 billion to N2.88 trillion), accounting for 31.5% of total FG expenditure (2017: N2.17 trillion). Also, statutory transfers increased N73 billion to N530 billion with the increase most likely allocated to NDDC and UBEC3. 

Overall, with the foregoing showing higher reviews to revenue than expenditure, fiscal deficit printed at N1.95 trillion, lower than N2.01 trillion earlier proposed. To finance the deficit, the government plans to generate N311 billion – split into N306 billion from privatization of government assets, and N5 billion from sale of other government property. The balance of N1.64 trillion would be financed by borrowings, split into domestic (N793 billion) and foreign (N849 billion) borrowings.

Higher oil prices underpin improved FG receipts

Over the first two months of 2018, the federal government fiscal deficit printed at N510 billion (split into N288.9 billion in January and N221.7 billion in February) due to higher government outlay which exceeded FG receipts over the same period. Starting off with receipts, FG collected N561.7 billion, representing a decline of 45.2% YoY due to the bloated base of the same period in 2017 from one-off receipts4. 

Excluding the one-time revenue translates to a 61.8% YoY increase in actual receipts. While the breakdown of 2M 18 revenue into oil and non-oil receipts wasn’t provided, analyst's estimated value of oil receipts suggests that the sub-component was the key driver of receipts. According to their estimate, FG’s share of oil receipts printed at N323.9 billion – 58% of total receipts, supported by higher crude oil price and production. 

Elsewhere, non-oil receipts of N237.8 billion (+3.4% YoY) was supported by higher tax collection following improved economic activities and widening of the tax base5. Having said the above, analysts highlight that FG’s actual receipts in 2M 18 was 53% short of budgeted revenue (N1.19 trillion) over the two-month period, largely due to non-oil receipts which had a shortfall of 65.8%.

On expenditure, outflow over the review period printed at N1.1 trillion with recurrent expenditure (N830 billion) accounting for 77% of total spend while the balance was disbursed to meet capital expenditure (N242.2 billion) – which, in analyst's view, was utilized on 2017 capital projects considering that 2018 capital spend commenced after the assent of the 2018 bill. 

Relative to pro-rated 2M 18 budget, actual recurrent expenditure suggests that FG achieved 90% of its recurrent budget, reflecting its obligation to meet personnel, overhead and debt service spend, as well as the fact that spending on recurrent starts from the beginning of the fiscal year irrespective of when the budget is passed. Accordingly, budget implementation in the two-month period printed at 70.5% (vs. 89.6% in 2M 17).

History seems to be repeating itself

Despite fiscal deficit of N510 billion, FG net issued N122.7 billion and N109.6 billion in January and February respectively which combined sums up to N232 billion, 45.5% of deficit. This therefore suggests that FG sourced funding from alternative sources to meet the balance of N278 billion (54.6% of fiscal deficit), considering that the proceeds from the $2.5 billion Eurobond in February 2018 were earmarked to meet maturing Treasury Bills and thus, do not think it was used to finance the fiscal deficit. 

Perusing through the financial statement of the Apex bank revealed a resumption of funding by the CBN to FG. Interestingly, analysts saw an increase in CBN’s claims on FG from Jan 2018, with MoM increase of N318.8 billion and N396.5 billion in the first two months of 2018, suggesting CBN helped plug the FG deficit.

Momentary respite but headache persists

Over the first four months of 2018, FAAC allocation to state governments expanded 42% YoY to N698.7 billion, reflecting higher oil receipts and increased VAT allocation (+17% YoY). Although, the sturdy growth suggests an improved revenue for states, analysts note that on an annualized basis, actual allocation to states accounted for only 23% of cumulative state government budget for 2018 (vs. 22% in the prior year). 

The dismal receipt-budget picture as well as most states inability to generate sufficient internally generated revenue has left the federating units in a dire condition of constantly failing to meet their obligations including the payment of workers’ salaries.

FG finances in better shape on higher oil prices

Over the rest of 2018, analysts expect FG’s receipts to remain robust with much of the support coming from the oil segment. On oil, they expect oil prices to remain stable at an average of $72.5/bbl. over H2 18 – which is significantly higher than the budget oil price benchmark of $51/bbl. The foregoing alongside their expectation of 2.0mbpd oil output (budget: 2.3mbpd) and exchange rate of N305/$, translates to oil receipts of N2.9 trillion, at par with the budget.

On non-oil receipts, analysts believe that revenue from this segment will grossly underperform budget due to ambitious targets set by the FG. Specifically, analysts are pessimistic on proposed revenue of N710 billion from the restructuring of JV oil assets and N512 billion from recoveries with the former highly unlikely given the absence of moves by the FG with regard commencement of the process towards the reduction of its stake in JV assets. On other non- oil receipts, analysts have varied expectation. 

Analysts are positive on improved custom receipts due the recent upsurge in excise duty rates on alcohol & tobacco7 and FG’s improved ability to collect custom taxes. Overall, they have raised their non-oil estimate by 10% to N2.2 trillion. Combined with oil receipts, they estimate federally collected revenue to print at N5.08 trillion for 2018 (32% lower than budget projections). Assuming 75% budget implementation (100% recurrent & 40% Capex – Jun to Dec 18), they expect fiscal deficit to print at N1.78 trillion.

CBN backdoor financing guides to muted local borrowing over 2018

Regarding funding sources, as stated earlier, FG plans to raise N311 billion from the privatization and sale of some non-oil assets. However, considering the bureaucracy and political drags, analysts anticipate 50% of the non-oil asset sale proceeds under their base case scenario in 2018. FG also plans to seek external funding of $2.8 billion via Eurobonds (N850 billion) over the second half of 2018 which, in their view, would be successful considering that FG’s Eurobond sale of $2.5 billion earlier in the year was oversubscribed with a bid-cover size of 1.4x. The balance of N775 billion, using their estimated fiscal deficit, should ordinarily be financed through domestic borrowing. 

However, analysts believe part of the deficit would be financed by the CBN considering the increase in CBN’s claims on FG over Q1 18 to the tune of N715 billion, after five months of repayment on the part of FG. Also, in recent times, government’s keen drive to reduce its debt burden and debt service cost explains its aversion towards increasing its supply of paper. Assuming 50% part funding suggests that the government could possibly net issue ~N388 billion over 2018 under their base scenario. 

Additionally, analysts played out different scenarios in the table below to forecast the potential size of domestic paper issue using their estimated fiscal deficit (N1.78 trillion) for 2018. They estimate that to finance the budget, the net debt issue could range between N311 billion and N737 billion with the range sizably lower than 2017 net issuance of N1.27 trillion. In sum, their scenario analysis guides to muted domestic borrowings in 2018.

Reporting for EasyKobo on Friday, 20 July 2018 in Lagos, Nigeria

Source: ARM Securities Limited

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