In about the next five years, Nigeria’s economy will have substantially moved to a position of diversified exports and public revenue, maximum domestic satisfaction of aggregate demand and self-sustainability. Under that condition, the appropriate public debt management strategy, with particular reference to the relative weights of the domestic and external components of the public debt portfolio, will be quite different from what it is today. Implicit in this assertion is that the country’s debt strategy is being evolved along a development curve, which reflects the prevailing condition and the envisioned direction of the economy. The historical realities of the Nigerian economy have dictated four stages of public debt management strategy. But before outlining the four stages, it would be apposite to touch on the hypothesis of “original sin” in the economics of public debt management.
The original sin hypothesis, first propounded by Barry Eichengreen and Richardo Hausmann in 1999, and together with Ugo Panizza in 2002, describes a situation whereby most countries are unable to borrow abroad in their domestic currencies. It implicitly has two aspects, international and domestic. The international aspect is concerned that domestic currency cannot be used to borrow abroad, arguably leading to currency mismatch, which causes macroeconomic and financial system instability. The domestic aspect is concerned that many countries do not have developed domestic bond markets where they can borrow long-term at fixed interest rates in local currency. An extension of the domestic aspect is that by developing a strong, local currency domestic bond market, a country will be able to attract investments in debt securities, without exposing itself to foreign currency liabilities, thereby arming itself with a viable alternative to foreign currency borrowing. The original sin hypothesis is useful for understanding the evolution path of Nigeria’s public debt management strategy.
In the early 2000s, Nigeria took a deliberate decision to develop a reliable domestic bond market as an alternative source of long-term borrowing by government and the private sector. This was sequel to the country’s experience with unsustainable external debt and crisis that developed before the Debt Management Office (DMO) was established in October 2000, and the eventual exit from the odious Paris and London Club debts in 2005 and 2006.
Following this, the market made rapid and entrenched progress: bonds of up to 20 years; avoidance of monetary financing of fiscal deficits; high participation of non-bank public; a vibrant secondary market; success of corporate issues, about 23 issuances amounting to over N570 billion between 2010 and 2016. Accordingly, Nigeria succeeded in redeeming itself from the domestic aspect of the original sin.
The achievements of domestic debt market development have been realised at a substantial cost, which has been accepted in exchange for the overriding macro-social benefits of debt market sovereignty. It is natural that at the early stage of operation of the market there would be freer room for mobilisation of funds. Beyond this stage, rigidities, constraints and scarcities, arising from shallow savings culture, unimpressive development of sub-sectors of the financial market, high-cost economic environment, would begin to manifest, indicating the need to push out the possibility curve. These forces have manifested as upward pressure on the yield on the domestic debt. Yet committed to the strategic objective, the country persisted on relying on domestic borrowing for a considerable number of years, despite relatively higher cost of domestic borrowing. This is the second stage in the debt management strategy and represents where the country was located from about 2014 into 2016.
Beyond financing established infrastructure needs, there is need to ensure that aggregate expenditure is of such quantum and composition to enable exit from recession. The challenges identified above will be largely addressed by medium-term macroeconomic and structural changes, which will result from the country’s economic recovery and growth plan. But this plan itself has to be appropriately and timely funded.
The strategy in the third stage is necessarily derived from the realistic funding structure for the required investment. The first line is to encourage and incentive the private sector to undertake as much as possible of the investment, including through public-private partnership. Even when the private sector has made their maximum contribution, if we take into account the nature of targeted investments and the condition of the economy, it is reasonable to expect that the government will be responsible for at least 50 percent of the total requirement. The preference would be for the public sector contribution to be in the form of non-debt capital. However, because of the enormous size of the overall investment, it is obvious that a substantial portion of the public sector investment will be funded from debts – if the government is to fully provide its expected contribution.
The decisive turnaround should be sufficiently achieved between the next 5 and 7 years. Until then, there should be a tactical shift towards external borrowing, so that the total public debt portfolio mix changes to accommodate a higher share of external debt, significantly above the current share of 19 percent. But this portfolio twist would be only a tactical manoeuvre aimed at fixing infrastructure and overcoming transitional constraints, prior to returning to the long-term position of domestic debt dominance because a strong economy will generate adequate savings for investment by both the public and private sectors.
It is important to note that this is the most dangerous and difficult stage of the debt management strategy progression. If the economy does not succeed in converting the external borrowings to domestic productive capacity and self-sustaining economic growth, with substantial diversified-export component, the resulting economic and social disruption will be unbearable. On the other hand, if the country shies away from taking the bold but calculated and explicitly-programmed step, it would be sure of sliding downwards. Success based on a bold and detailed plan is the only viable option.
In the fourth and final stage, public borrowing will reverse the leaning established in the third stage: foreign currency borrowing could be completely or substantially avoided, on a sustainable basis. There are two major sources of policy confidence for such a strategy. The first is that the emergence of the Nigerian economy as a highly developed one will include as a component a high rate and size of domestic savings and financial sector development, which will provide adequately and affordably for long-term borrowing by both the public and private sector. The second is that the national currency will have become strong and predictably stable. As a result, foreign investors will be satisfied to buy local currency denominated debts, whether they are issued in the domestic market or in the international market. At that stage, Nigeria will even be in a position to issue naira-denominated Eurobond.
It is important to emphasise that the essence of the advanced strategy is not that the country will not need or desire external holdings of its debt, rather, the essence is that external investors in the country’s debt instruments will do so in the form of local currency obligation. That means that even with foreign investor participation, the country will not be exposed to foreign exchange risk. Another point worth emphasising is that even under this regime, the country is likely to choose to maintain foreign currency loan exposure of the multilaterals, such as the World Bank and the African Development Bank. But such will constitute a paltry percentage of the total public debt, whilst carrying relatively soft terms.
• Dr. Nwankwo is the Director-General of the Debt Management Office, Nigeria