Why the $1 billion Eurobond sale should be shelved

As far as deficit-budget financing is concerned, the federal government has been relying chiefly on domestic borrowing since the country was rescued from the stranglehold of the Paris and London Clubs in 2005. Data from the Debt Management Office show that as at June 2016, domestic debt made up over 80% of the country’s total debt stock. The huge cost of servicing internal debt and the need to free some borrowing space for the private sector has necessitated a rebalancing of the debt portfolio in favour of cheaper external loans, but there are risks. In the suite of foreign debt, Eurobonds (which are commercial borrowings by governments usually denominated in US dollars) are costly and carry considerable risks.

It is against this backdrop that the plan by the federal government to issue $1billion Eurobonds in the first quarter of 2017, as announced by the Minister of Finance, gives cause for concern. According to newspaper reports, the government has already appointed Citigroup, Standard Chartered Bank and Stanbic IBTC Bank to manage the $1 billion Eurobond sale. The warning of Joseph Stiglitz, a renowned Economist, resonates with not a few Sub Saharan African countries already caught in the Eurobond web: ‘borrowing money from international financial markets is a strategy with enormous downside risks, and only limited upside potential – except for the banks, which take their fees up front’.

It will be recalled that Nigeria launched into the Eurobond market when a10-year $500 million Eurobond was issued in January 2011. This was followed by another sale amounting to $1 billion in 2013 bringing the total outstanding commercial debt to $1.5billion. Eurobonds carry significantly higher borrowing costs than concessional debts from multilateral institutions. A 2015 World Bank study found that whereas multilateral concessional loans to Sub Saharan African countries carried an average interest rate of 1.6% and a maturity of 28.7 years, the financing from international sovereign bonds come at an average floating coupon price of 6.2% with an 11.2-year maturity period. Data obtained from the DMO website show that although these commercial loans make up only 13% of Nigeria’s external debt, they accounted for about 28% of the cost of servicing foreign loans in 2015. The bullet repayment structure of the bonds (which means that a lump sum principal payment will be made on maturity) poses significant repayment risks as the country is expected to repay $500 million in 2021 and another $500 million barely two years later. Nigeria may experience difficulty in repaying or refinancing the face value at maturity if there are adverse changes in international market conditions in view of the country’s heavy reliance on crude oil exports.

Furthermore, the depreciation of the naira relative to the US dollar following the decline in crude oil revenue implies an increase in the cost of servicing the Eurobonds. This means government will have to spend increasingly more in naira terms by way of interest payments on the Eurobonds in the event that the naira continues to decline in value. Indeed, the seriousness of currency risks cannot be overstressed, not least because of its negative effect on government’s fiscal balances.

As with other financing instruments, timing is critical for a successful Eurobond issuance. Nigeria’s first Eurobond issue in 2011 was small in size, at just $500 million. It was primarily meant to establish a benchmark-bond that would enable Nigerian companies borrow at competitive rates from international credit markets. The country also needed to test its credit worthiness in international capital markets and so that successful outing was indicative of the level of confidence foreign investors had in Nigeria. The second issuance was made at a time when the country had fairly strong macroeconomic fundamentals with positive GDP growth rate and relatively healthy international reserves buoyed by high crude oil prices. So, foreign investors’ sentiment was positive especially on the back of favourable ratings from Standard and Poors and other Rating Services. Low interest rates in the United States and other developed countries on account of quantitative easing equally contributed to the success of the 2013 Eurobond issuance comprising a 5-year $500 million bond and another 10-year $500 million bond. Due to the favourable market conditions at the time, their yields at issue (5.375% and 6.625% respectively), were lower than the debut bonds which were sold in January 2011.

Today, the narrative has changed for the worse. Macroeconomic fundamentals have deteriorated following plummeting crude oil revenue. The economy witnessed negative GDP growth rates for three consecutive quarters last year with headline inflation a little shy of 20% in December 2016. The IMF had estimated the economy shrank by 1.7 per cent in 2016. The country recorded massive drop in foreign investment with the National Bureau of Statistics confirming a plunge in capital importation to just about $1.8 billion in the third quarter of 2016. Although, from a solvency perspective, public debt to GDP ratio remains below the policy-dependent debt burden thresholds according to DMO’s debt sustainability analysis, Nigeria’s debt service to revenue ratio at over 30 per cent poses a serious threat to the country’s fiscal stability.

Indeed, concerns about the country’s vulnerability to crude oil price and the weakening macroeconomic fundamentals will certainly make the Eurobond issuance very costly for Nigeria. Although oil prices are expected to stabilise above $50 per barrel following OPEC’s decision to cut output, the threat of militant attacks on oil facilities remain a dark cloud in the firmament. By the same token, developments in the global environment remain a major factor: Brexit is still mired in legal issues while the uncertainty thrown up by the election of Trump as President of the United States is yet to settle. Trump’s expansionary fiscal policies are feared to lead to a spike in interest rates in the US and a stronger dollar which has the potential of complicating macroeconomic management for Nigeria.

Only recently, Fitch Ratings Ltd, one of the world’s leading Rating Services, downgraded the outlook on Nigeria’s long-term debt “to negative from stable” citing “tight foreign exchange liquidity and low oil production’’. According to the Rating Agency, while public debt remains low at 17 percent of GDP, the decline in government revenue “poses a risk to debt sustainability”. The downgrade by Fitch of the country’s sovereign credit rating will most likely raise the cost of the $1 billion sovereign bonds at the international debt market since investors will demand higher risk premiums as compensation for increased risk.

If investors are ‘lining up to buy $1 billion bonds that Nigeria is expected to issue in the coming months despite the poor state of the economy’ as reported by Reuters, it is because these rational investors, cashing in on the country’s current economic woes, expect the bonds to be sold cheap (at a high yield) and sufficiently whet their high-risk appetite. The yield on Nigeria’s $500 million international sovereign bond due in July 2023 was 6.631 per cent as at January 25, 2017 according to Bloomberg. It is a no brainer that yields are bound to trend upwards as foreign investors price in the risk of the credit downgrade by Fitch.

Agreed, Eurobonds can prove a veritable means of diversifying funding sources as they come with few conditions attached and allow governments to channel funds into areas they see as priorities, but this is only when the proceeds are well applied. Can anyone point to any viable project which was completed with the 5-year $500 million Eurobond issued in 2013 with principal repayment expected to kick-in just next year? Even if we assume the story will be different this time around, the fact remains that given the present state of the economy it would be suicidal to approach the international capital market for very costly funds. The relatively high interest rate of 10.75% paid by Ghana for its October 2015 Eurobond amid widening fiscal deficit is a lesson on when not to issue international sovereign bonds. So, rather than approach the international capital market from a very weak position, the country should focus attention on meeting the conditions for accessing concessional loans from multilateral institutions such as the World Bank and the African Development Bank which include having in place a clear economic road map.

In view of the enormous downside risks, borrowing through the Eurobonds window make timing of the issue an important consideration. With the Nigerian economy still in the woods, accessing the international capital market at this time for funds will be counterproductive. The government should therefore work first to stabilize the macroeconomic environment. Till this happens, the plan to issue $1 billion Eurobonds should be shelved.
Uche Uwaleke, a Fellow of ICAN and Chartered Stockbroker, is an Associate Professor of Finance and Head of Banking & Finance department at Nasarawa State University Keffi