In majority of emerging markets, the use of capital markets for investment financing still has a long way to go in order to enhance the availabilty of long term funding, says Oluseun Olatidoye, the Head of Debt Capital Markets at FBNQuest Merchant Bank Ltd.
According to him, most of these countries, including Nigeria, would rather go for fixed income instruments. “This is almost natural since they offer a better fit for the large chunk of investors given attractive yields, consistent cash flow, and less susceptibility to volatilities, unlike equities,” he aded.
However, Olatidoye cautioned that project bonds, Sukuks, and other infrastructure-based fixed income products may be unappealing to foreign interest due to foreign exchange policies, liquidity, and tenor.
At workshop of the Capital Market Correspondents of Nigeria (CAMCAN) in Lagos recently, Olatidoye gave his reasons and also proffered ways in which Nigeria could fund instrastructure through the capital market.
It is a stylized fact that infrastructural advancement positively correlates with the economic growth and development of an economy. It forms the bedrock of economic prosperity through institutional productivity and overall human wellbeing, which is the outcome of efficient power, transport, healthcare, education, housing, and ICT systems.
For Nigeria, the elusiveness of infrastructure isn’t just the problem, but reliable financing remains an unsolved puzzle. It is even more worrisome given the bourgeoning deficits courtesy of increasing decadence in the existing infrastructure, poor funding, and corruption.
The orthodox financing source for Nigeria’s infrastructure has been through fiscal channels. The efficacy of this hasn’t only been questioned, but its reliability. Major revenue sources for the Federal Government are taxes and oil proceeds, and in the days of yore when the economy grew at an average of 6 per cent annually, oil money and Inland Revenue were still insufficient to bridge the infrastructure gap.
Although the recent move to tax the economy to prosperity remains largely contentious, the nascent comments that oil prices might have reached its peak adds another concern. According to the National Integrated Infrastructure Master Plan (NIIMP), $3trillion would be required to fund the infrastructure gap in 30 years (this estimate may have become inaccurate since it was before the 2016 devaluation). Meanwhile, Mckinsey reportedly puts the estimate at $31billion (NGN9.5trillion) annually for a decade. Hence, taking the same funding approach will still fail to bridge the deficit.
The state of Nigeria’s infrastructure isn’t just that of disequilibrium (as per supply failing to meet demand), but also the case of a waning quality. Many Nigerians can attest to the infrastructural decadence and how it has stymied capital inflow, economic performance and made living excruciating (Nigeria ranks 152 out of 157 in the 2018 World Bank Human Capital Index).
On the average, Nigeria spends about 3.6 per cent of GDP between 2007 and 2017 on public infrastructure compared with 4.8 per cent in South Africa and 4.7 per cent in India and when considered on a per capita basis, Nigeria’s public capital is less than half of the Sub-Sahara average. The increasing demand for infrastructure in Nigeria is largely tied to her rising population, and more specifically the teeming urbanization (50 per cent of Nigerians live in urban areas).
It is estimated that the current population would have ballooned to about 330million people in the next 21 years, making Nigeria the fourth most populous country by 2040, behind India, China, and the US. Other things being equal, one would expect that there would only be more pressure on the existing facilities, and the government’s financing capacity will even be more challenged. In the 2019 edition of the Global Competitiveness Index, Nigeria ranked 130 out of 141 countries in terms of the state of infrastructure, and 116th in overall global competitiveness. Highlighting the deficit individually, Nigeria’s power generation capacity is about a third of its installed capacity of 12,522MW. Notably, 86 of Nigerian companies use generators. Households aren’t exempted either.
Healthwise, there are about 15 beds per 1000 Nigerians, and 30 primary healthcare centres per 100,000 Nigerians. Budgetary allocation to the health sector is meagre and below the World Health Organization’s recommendation. The wanton exodus of Nigerian doctors furthers the vacuum, and participation of private players have also failed to close up.
Only 16 per cent of Nigerian roads are paved, and it was recently estimated by the Minister of Works and Housing that about N300billion will be required to fund the gap in (federal) road infrastructure, but barely 10 per cent of that is allocated in annual budgets. Nigeria’s housing deficit has been put at 17million and grows by 20 per cent yearly. The demand for affordable housing remains on the rise and there is a dearth of existing interventions to support closing the gap. Recall that about 100 million Nigerians live in the cities, the rising demand for an abode naturally motivates a rise in prices from the supply side, even for the most indecent set of homes where 80 per cent of the urban population actual reside.
In a survey by Association of Chartered Certified Accountants (ACCA), lack of finance or funding ranked as the second barrier (behind lack of political leadership) to meeting infrastructure needs, this brings to fore the need for a workable funding plan. In Nigeria, we have seen the case of sole funding by the government, funding by DFIs, PPP, and a tap into the capital market by both government and corporates.
Historically, commercial banks have been the first point of call for government and private institutions when it comes to infusing private capital into infrastructural development. More recently, banks have been bitten once and are now twice shy, hence a retreat from such endeavour given the tie up of depositor’s monies which have gone bad. For instance, up to 35 per cent of banks’ Non-Performing Loans are from energy (power and oil and gas) projects. Arguably, the shut doors against many of such projects considered illiquid and unpromising by the banks, in addition to a mounting fiscal constraint have made it imperative to shift attention to the capital market which has become an emerging approach to infrastructure financing in Nigeria. One of such attempt is the N100billion inaugural FGN Sukuk where we (FBNQuest Merchant Bank) were the Co-lead Financial Adviser for the transaction. Notably, asides the Sukuk and the green bond by the Federal Government, states remain laid back in approaching the capital market for infrastructural financing (except for Osun state with its N11.4billion Sukuk in 2013).
It is rather the case of plain bond issue tied to IGR as against project-specific cash flow. Subnationals that have issued bonds in the Capital Markets to fund infrastructure include Lagos State who is at the fore front of developing a yield curve for the state, Oyo State, Osun State, Ekiti State, Ondo State, Zamfara State, Bauchi State, Niger State, Ebonyi State just to mention a few. On the private end, issuances are also largely muted, save for the N8.5billion NSP Green Bond issue this year. However, the hitherto subdued choice for a capital market alternative is a combination of the market being undeveloped or unready for infrastructure financing and mere neglect by borrowers as a result of their disposition to a relatively faster funding process.
Achieving a more active domestic capital market for infrastructural projects requires further development in the areas of general education of stakeholders, operating structures, legal framework, and issues around liquidity.
Obtaining financing through either equity or debt arrangements further proves doable in the case of Nigeria, when thenarrative in other emerging climes (Brazil, Peru, Kenya, South Africa, and GCC countries) are considered, although, in the majority of emerging markets, the use of capital markets for investment financing still has a long way to go to help countries enhance the availability of long term funding The style of discussion so far tends towards the fixed income side of the market. This is almost natural since they offer a better fit for the large chunk of investors given attractive yields, consistent cash flow, and less susceptibility to volatilities, unlike equities. However, this doesn’t preclude the relevance or existence of financing that partly or fully incorporate equity structures (such as the Nigeria Infrastructure Debt Fund, also listed on the NSE).
Unarguably, the potential of the capital market in addressing Nigeria’s infrastructural needs is determined by the size of the domestic investor base, mainly pension funds, and to a much lesser extent insurance companies and sovereign wealth funds. Pension fund assets added up to N79billion within the first nine months of the year, and currently at N9.5trillion as of September. Investments in infrastructure-related products have been encouraging likewise. While the trends in government Sukuk investments have tapered, there has been notable growth in government and Corporate Green bonds, Infrastructure Bonds and Infrastructure Funds Regulatory limits for pension assets in infrastructure-based products range between a maximum of 25 per cent and 35 per cent for government and corporate issues (depending on rating) and a maximum of 20 per cent forinfrastructure funds (Fund IV Retiree Fund is excluded from infrastructure funds). That translates to a minimum of NGN1.9trillion and a cap of N3.3trillion (based on the September total fund size). Although capital from the insurance sector is another buy-side option, it lags considerably behind the pension funds, a quick reason being the low consumption of insurance among Nigerians (approximately 0.31 per cent of Nigerians).
For pension funds that form the bulk of the buy-side, the Retirement Savings Accounts (RSAs) account for as much as 80 per cent of the entire pension assets. This underscores the importance of capital preservation to this set of investors, notwithstanding the benefit of risk diversification that infrastructure/project bonds offer.
Hence, it is expected that higher preferences will be towards highly profitable projects that can sufficiently fund its leverage, without the intervention of an ISPO or credit guarantor.
On the retail side of the market, it is largely unarguable that capacity is more limited in the case of Nigeria. Retail investor size sums to circa 3millionxvii and to have meaningful participation would require a great deal of education of this investor category. Besides, the mobilization of retail funds is more likely through mutual fund schemes.
Foreign capital is a great deal in the domestic debt capital market. Meanwhile, it is pertinent to note that project bonds, Sukuks, and other infrastructure-based fixed income products may be unappealing to foreign interest for a couple of reasons. Top of such concerns includes foreign exchange policies, liquidity, and tenor (money market has been the major destination for FPIs). However, asides luring investors with reasonable yields, mitigating structures need to be in place to address risk factors, and this is largely reliant on a significant degree of macroeconomic policy stability and direction to capture offshore investors in long term domestic projects.
Accepting the Invitation: What needs to be in place?
In an ACCA survey previously cited, the dearth of political leadership ranked the number one impediment to infrastructural funding. This factor is largely representative of Nigeria. A strong spirit of transformation must be displayed through reforms in the legal, regulatory and economic systems to capture high investor confidence. To successfully tap into the capital market for infrastructural financing, the existence of sound macroeconomic and policy frameworks are pre-conditions, hence, freedom must be given market forces to take its course. As much as the government has its role, political interference must be limited. This insures investors against any form of political risk, and most importantly corruption which has the potential of crippling the entire endeavour. Foreign exchange volatility if not addressed in the ‘most market’ approach could deter the interest of foreign counterparties. Depending on the structure of the bond, projects could be of a nature that exposes the financers to devaluation risks, which will whittle down the dollar value of local currency cash flow from such projects. Hence, may fail to service the debt (especially if denominated in the dollar). Moreover, investors will be wary of rating characteristics of the issue. As it is often the case for government-sponsored issuances where the state’s creditworthiness influences the rating of its issue or SPV. This will offer the highest form of safety and confidence for investors. We should be reminded that PENCOM requires a minimum of an ‘A’ rating from two rating agencies for infrastructure funds. Ultimately, if infrastructure funds are the preferred options for issuers, the ingenuity of financial advisers would be put to test in coming up with structures that protect investors from currency fears (assuming the status quo remains) and also meeting the rating criteria.
Regulators have the principal onus to educate the investing public and other capital market participants. This forms the starting point of extracting the most benefit from an efficient capital market. Also, adequate market infrastructure should be in place to promote transparency (for instance, developing a whistleblowing policy), and address potential cogs from the issuance process to trading, settlement or rollovers. As an incentive, the overall cost related to pre-issuance, issuance and post-issuance activities can be should be revised downwards. Specifically, a favourable tax regime should be instituted for infrastructural investments.
We believe that the Capital Markets represents a very good platform for raising funding for infrastructure development going by some landmark transactions in recent years. We have funded over portions of 26 roads across the six geopolitical zones in the country with the sum of N200billion on the FGN Sukuk I and II, we have raised N11.4billion for the development of primary, middle and secondary schools facilities in Osun State, we have funded the development of affordable housing on the Mixta Real Estate plc Bond Issues and we have developed a number of roads, bridges, health facilities using the opportunity presented by the Capital Markets.
We understand that there are challenges ranging from the inability of the buy-side to embrace specialised products, appropriate pricing of the instruments, expensive guarantee products, cost of transactions etc. we understand that it remains a veritable instrument for funding our huge infrastructural deficit if harnessed properly.