November 28, 2019

Hard work ahead for beleaguered state governments

In aggregate terms, the public finances of the state governments (including the FCT) are in a mess. Internally generated revenue (IGR) has settled on a plateau, at least according to the CBN data; the states are therefore dependent upon the monthly payout from the federation account, and in good measure the fluctuations in oil revenue; capital spending is inadequate in the context of development needs; the debt burden of N3.85trn and $4.23bn at end-2018 is sizeable, even unserviceable in some cases, despite five separate FGN programmes of debt relief in 2015 and 2016; and enhanced regulatory supervision has belatedly reduced states’ access to new financing.

While IGR has been stuck in a range between N740bn and N770bn over the past three years, total revenue for states increased from N2.47trn in 2016 to N3.73trn last year due to an improvement in the oil price and, to a lesser extent, production. (We will avoid the territory of the level of NNPC payments into the federation account.) States would have welcomed the higher payout of course but just 34 per cent of their revenue in 2018 could be considered independent (i.e. IGR or their share of the VAT pool).

States’ aggregate spending in 2018 was 73 per cent recurrent and 27 per cent capital. The capital allocation came close to the FGN’s minimum budget target of 30 per cent yet it’s insufficient developmentally, as any observer on the ground can see.

Insufficient IGR, insufficient capital spending and excessive indebtedness mark states’ finances. Their aggregate domestic debt soared from N1.66trn to N2.50trn in 2015, when the burden of Lagos state actually diminished: the annual increases have since slowed to plus or minus N500bn due to the combination of debt relief and tighter FGN control over their borrowing.

For a minority of states, domestic debt is about twice annual IGR although the multiple can rise to 20 and beyond for others. All external, and much domestic, debt service is deducted from the monthly payouts. If we take the most indebted state, Lagos, and the distribution this June from May revenue in the federation account, we find a gross allocation of N4.81bn, which became N1.88bn after debt service and rose back up to N10.49bn on the back largely of its share of VAT.

In the case of Enugu, which is moderately indebted and not an oil producer, the comparable figures were N3.61bn, N3.33bn and N4.73bn. Lagos, therefore, had a far higher bill for debt service but also, by virtue of its size and relative wealth, access to a much larger share of the VAT pool.

We cite aggregate data because we will draw some conclusions about the workings of the federal system. In passing we note the acute differences between states. Lagos achieved an IGR-to-total revenue ratio of above 60 per cent in 2018 for the fourth year in succession, while Rivers and Kwara finished second and third according to the CBN data. Bayelsa finished bottom of the table with a ratio of just 3.9 percent. In this case, the revenue from the 13 percent derivation formula may have acted as a disincentive to boost IGR.

States have been active in promoting investment to create jobs and increase household consumption. Some have allocated land to new ventures. This is easiest when they have established electronic land registers, which have become sources of stable flows of IGR. To give a few examples of new investment plans: transport and a modular refinery with Chinese backers, plantations and an industrial park in Edo; a dairy business in Ekiti; rice mills and sesame processing in Jigawa, along with hopes of granting long leases over grazing land; and talks on cooperation in development between Lagos and Kano states.

These are isolated examples but we see that a state has more or less potential to raise IGR in consequence of the size of its workforce and of its “investibility”. This reality has fuelled discussion of more radical solutions to overhaul battered state government finances. Not so long ago, the FGN could have authorized a drawdown of the excess crude account but the impact today would be negligible since at the balance at the last count was just $240m.

One solution would be to adjust the formulae governing the distribution of funds in the federation account and the VAT pool between the three tiers in favour of the states. The impact in naira terms would be sizeable, particularly if the FGN does raise the standard rate of VAT. Such an adjustment would surely come with a transfer of additional responsibilities from the FGN to the states, however.

We would be wary of such a move for fiscal reasons. Without an improvement in management skills and financial control, the additional resources could be spent on bureaucracy and vanity projects, for which there is undeniably precedent. If the decentralisation brought worse finances, the FGN, not least as the guarantor of states’ external debt, would have to pick up the bill in the last resort. We hear an argument that the FGN does not have a glorious record in fiscal management. We acknowledge it but the FGN is at least subject to some regulatory and judicial supervision. Hard work and transparency offer the safer, if boring, escape from the mess of state government finances.

 

Gregory Kronsten

Head, Macroeconomic & Fixed Income Research

FBNQuest