March 26, 2018

A warning from the IMF on borrowing for productive investment

Rex Tillerson, the then US secretary of state, made some punchy criticisms of Chinese lending policy in Addis on 08 March. This was his first, and last official trip to Africa. Without offering any examples, he opined that a sovereign borrower in difficulties with its loans from China can “lose control of its own infrastructure or its own resources through default”. For good measure, he added that Chinese investments “do not bring significant job creation locally”.

We have seen some historic loan drafts between China and governments but will not be tempted into this highly sensitive territory. We can comment, however, on financing costs on the basis of the quarterly data releases from Nigeria’s Debt Management Office.

Our simple calculations are based upon the stock of external debt mid-2017 and the total debt service for the year including principal repayments and service fees. The average cost for the year was 3.1 per cent, and that for Eurobonds predictably the most expensive at 5.0 per cent. The ratio for China was 3.7 per cent, for the World Bank’s International Development Agency (IDA, its soft loan window) and the African Development Fund 2.0 per cent, and for the African Development Bank 1.3 per cent. These are reasonable estimates we stress, and do not allow for the timing within the year of disbursements and repayments. There were no principal payments on Eurobonds in 2017 for example but US$87m paid to the IDA.

The overall cost for Nigeria is rising because it has tapped international capital markets three times in less than 18 months, and is likely to return to them. The FGN’s thinking is that it has to invest heavily in the infrastructure if it is to replace the rent-seeking economy with a model based on production, that its own resources for the task are clearly inadequate and that it must therefore borrow. Its external development partners such as the IDA and Exim Bank of China have risen to this challenge yet the FBN wants additional financing for the infrastructure. There is another reason for the Eurobond issuance, which is to reduce overall debt servicing costs, and these partners do not have a remit to support the FGN’s successful policy of debt externalization.

We have no quarrel therefore with the thinking. With some local variations, this is how the East Asian countries transformed their economies, and made the leap from low income to middle income status. Heavy spending on the infrastructure helps to attract direct investment. Nigeria’s investment ratio of 17 per cent of GDP in 2017 is at least ten percentage points too low to achieve the desired transformation of the economy.

The external debt stock has further to rise because the gaps in the infrastructure remain huge. To support this point, we can all pull figures from the local media and official projections. To take just two: the federal transportation ministry is said to be negotiating a loan of about US$15bn for the Port Harcourt-Maiduguri rail project, and policymakers have identified a funding gap of US$10bn per year for five years for the power sector. We urge patience therefore for the rebuilding of the infrastructure. We also add the caveat that due to political culture or for whatever other reason (and we will deliberately avoid this hornet’s nest), the government is encountering more resistance from vested interests to its plans for transformation than its East Asian counterparts did in the 1980s and 1990s.

Driven probably by the normalization of US monetary policy, the financial press and think-tanks have become preoccupied with the mounting external debt burdens of developing countries, both emerging and frontier. So a paper recently published by the Jubilee Debt Campaign noted that their debt payments increased by 60 per cent in the three years to 2017. Tellingly, IMF research shows that the median ratio for public debt/GDP in low income countries has risen from 34 per cent in 2013 to 47 per cent in 2017. It also observed that in many cases the fiscal deficit widened and investment declined.

As with all data and warnings for groups of countries, we have to drill down further. In Nigeria’s case, the debt stock is manageable, at between 25 and 30 per cent of GDP in the worst scenario. Jubilee’s warning does apply however, which underpins the FGN’s agenda of debt externalization. The IMF’s warning is highly significant, too. The debt stock is set to increase across creditor categories (multilateral, China, other bilateral and commercial). The debt servicing bill should ease if the FGN successfully pursues its current strategy.

As for what could go wrong, the oil price could crash again and the offshore portfolio community could exit en masse, triggering fresh pressure on the exchange rate and the balance of payments. Neither is our current expectation. The executive in the years ahead has to stick to its script: borrow because it has no choice if it is to pursue the stated agenda but spend productively. Failing which, it becomes another statistic for the Fund’s combination of wider deficits and lower investment.

Gregory Kronsten
Head, Macroeconomic & Fixed Income Research

FBNQuest