Government bonds in Nigeria : The debt sustainability dilemma in the light of the COVID-19 pandemic

Welcome to the new normal!
Worldwide, countries have experienced the impact of COVID-19 in varying degrees, politically, economically and socially;; thus, the odds of sliding into economic downturn for most developed and developing countries is on the rise.

For an Emerging Market like Nigeria that has barely recovered from the 2016 economic recession, the odds are not just higher, this pandemic may just be the catalyst to propel it into another brutal and painful recession.

Like most oil dependent economies already saddled with dwindling oil revenues as a result of the slowdown in global economic activity, additional debt incurred on COVID-19 relief most probably debt service to revenue ratios compared with pre-pandemic levels.

Urgent and aggressive policy action is therefore required to be taken at averting the potential debt crisis that may arise as a fallout of Covid-19 pandemic.

The Global Economic Impact
The tumultuous effect of the pandemic in Nigeria is over dependence on oil for its export dependence on oil revenues, that the 2020 budget was prepared on the assumption of a relatively stable market and increased global oil demand, with oil price and oil output benchmarked respectively at $57 per barrel with productions levels set at 2.18 million barrels per day.

The drastic decline in global economic activities due to the pandemic has crude oil revenues, which accounts for one-third of the public revenue in 2020.

With uncertainty in oil prices during the global lockdown and resultant impact of supply and demand shocks on non-oil revenues, the Nigerian Government is now compelled to rely on additional debt to finance its fiscal deficit which was revised to N5.2 trillion in April 2020.

As of March 2020, the Senate put Nigeria’s total debt profile at N33 trillion. Figures emerging from the Debt Management Office (DMO) indicate that as of December 2019, the Federal Government’s domestic debt stood at N14.2 trillion, while external debt was $27,676.14 or circa N10 trillion. The DMO has stated in addition that between January and December 2019, the Federal Government paid N480.4 billion on servicing external debts alone. Given the decline in net private capital flows as a result of the pandemic, the International Monetary Fund (IMF) approved financial assistance in the sum of SDR 2,454.5 million (US$ 3.4 billion, 100 percent of quota) under the Rapid Financing Instrument (RFI) to meet urgent balance of payment needs. An additional $3.5 billion is also expected from other multilateral lenders.

According to the Medium-Term Expenditure Framework and Fiscal Strategy (MTEF/FSP) report recently released by the Federal Ministry of Finance, Budget and National Planning, Nigeria incurred a total sum of N943.12 billion in debt service in Q1 of 2020 whilst the Federal Government retained revenue was put at N950.56 billion. This is estimated to be 99% during the period. Whereas, according to the Joint World Bank-IMF Debt Sustainability Framework for Low-Income Countries to revenue threshold should not exceed 23%1. As a consequence, subnationals that rely heavily on the Federal struggle to cover their overheads and meet their existing debt obligations.
The onset of the COVID 19 pandemic has thus led to a revenue expectations and a downward revision of the 2020 fiscal budget. Furthermore, the antecedent effect of the pandemic will include a deficit in fiscal funding, debt sustainability issues, capital flows and revenue pressures.

Government and Corporate Bonds: Debt Sustainability
A Bond is a debt security in which the authorized issuer owes the holders a debt and depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. A Corporate Bond is a bond issued by a corporation to raise money for capital and operating cash flow purposes. Any bond not issued by a government body is a corporate bond.

These debt instruments are actively used in Nigeria for funding by the federal government, subnationals and corporates to raise capital to finance infrastructure projects and plug fiscal deficits.

Federal Government Bonds are currently the largest component of the Nigerian domestic bond market representing about 87% of the market whilst Subnational and Corporate Bonds represent about 13% of the market which incidentally accounts for the illiquid Subnational bonds market.

Sovereign and Subnational Bonds
On 30 March, the Debt Management DMO press statement to inform the general public that the Federal Government Savings Bond offer for the month of April was suspended.

The DMO further stated that arrangements had been made to ensure that all coupon payments and redemptions of FGN securities are made as and when due to investors designated accounts. Nevertheless, on 7th April, 2020, it was announced that President Buhari had approved the suspension of the payment of interest on debts owed by state governments in order to reduce their debt burden. According to the Minister of Finance, Budget and National Planning, a moratorium would be granted on the Federal Government and CBN-funded loans in order to create fiscal space for the states, given the projected shortfalls in FAAC allocations. According to the DMO, as soon as monthly average FAAC receipts fell below a specific threshold, interest and capital payments by states would be suspended till monthly average FAAC receipts exceeded the threshold.

Notwithstanding the assurances of the federal government, there is the looming apprehension that the economic fallout of the pandemic may very well trigger Subnational and Sovereign Bond defaults in the very near future.

In the case of States and Federal Government agencies, S. 256 of the Investment and Securities Act, 2007 provides that:
upon a default by a body to meet its obligations under a bond issuance, and after the expiration of six months therefrom, the trustees of the bond shall present the copy of the irrevocable letter of authority/guarantee for repayment issued by the Accountant General of the State/Federal Government to the Accountant General of the Federation to deduct at source from the statutory allocation due to the issuer, for the purpose of redeeming any outstanding obligations.

Given the uncertainties around revenue generation, a pending fiscal deficit and monthly allocations to state governments, the likelihood of a default in state and federal government bonds is imminent. The Irrevocable Standing Payment Order issued by the Accountant General of the State/the Federal Government is therefore of no consequence where the revenue generation is insufficient to meet the debt obligations. Nigeria is therefore seeking Venturesafrica.com/covid-19-pandemic-puts- african-government-in-a-debt-dilemma to raise $6.9 billion in the form of concessional funding through external borrowing from the World Bank, the International Monetary Fund and the African Development Bank in a bid to support the implementation of the 2020 budget. It is important to note that $10.86 billion or 39% of external debt as of April 7, 2020

In the absence of a specific legal default, commercial terms and arrangements are often undertaken with bondholders in order to restructure the debt obligations. The COVID-19 pandemic crisis makes a default on sovereign debt more likely than not and it is on account of this prospect2 that talks with multilateral lenders to suspend debt repayments for this year. Where this is unsuccessful and a default is declared by the bondholders, Nigeria may face the same debt crisis experienced by Greece in 2015, when it almost declared bankrupt because it International Monetary Fund when it was due. The debacle left Greece on the brink of collapse.

In the event of a default by the Federal Government on its Eurobonds, bondholders will either have to give up future profits or enter into decades-long litigation that is costly and undesirable. The key Bonds terms relating to enforcement and renegotiation matters that will have to be critically examined in order to address the extent by which the Nigerian government can seek a suspension of interest payments and restructure the debt are:-

Enforcement
The Argentine debt crisis of 2011 and its aftermath depicts the major shift in the legal framework of international sovereign debt markets. Prior to the Argentine crisis, defaulting governments were protected by the principle of sovereign immunity and the absence of a supranational legal authority to enforce payment. However, following the default in Argentina, a suit was filed by dozens of hedge funds in New York against the Argentine government. 15 years later, these holdout creditors obtained a favorable court ruling that compelled the government to pay over $10 billion as settlement. In other words, the veil of sovereign immunity has been pierced and cannot be relied upon to prevent enforcement by the courts.

Furthermore, debtors frequently waive sovereign immunity in the commercial documents governing the bonds. Thus, creditors will be able to obtain foreign judgements against them. While this means that creditors can institute a lawsuit, it does not mean that creditors can collect on their debts.

Renegotiation Clauses
In the event of a default, the creditors can as a group increase their collective welfare by giving the sovereign a partial relief. The contract terms that facilitate the ability of creditors to grant sovereign partial relief in dire times are referred to as Collective Action Clauses (CACs) and classified below3. The CACs permit bondholders to modify the terms of the bond through collective action:

i) Non-payment modification
This provision governs the modification of non-payment term. i.e terms other than principal, interest, and time of payment. Typically, some fraction of bondholders between 50 and 75 percent can vote to alter the terms and bind all of the bondholders to the revised terms.

ii) Paymentmodification.
This clause governs the modification of payment terms but it tends to vary based on whether the bonds are governed by New York or English law. Since the early 2000s, bonds issued under New Y ork law allow that the payment terms can be modified by a vote of 75% of the bonds. In bonds under English law, there is frequently a requirement that there be physical meeting of the holders. Typically, 50% is the quorum for the first meeting and 75% of those holders have to vote for there to be a binding modification of the payment terms.

iii) Aggregation
The typical modification clause operates within a single bond issue. Aggregation provisions operate issuances. The typical aggregation clause requires that a minimum percentage, typically 66.7% of the bonds of a particular issuance agree to a proposed modification of payment terms. The aggregation clause also requires agreement among the bondholders aggregated across all of the issuances of the sovereign (typically, at the 85% level in terms of monetary value of all issuances). If both conditions are met then the restructuring agreement becomes mandatory for all bondholders.
It is also important to note that then are inscribed in the 1969 Vienna Convention on the Law of Treaties as well as in several national legislation, mainly regarding contracts. These legal principles also form part of international common law and are therefore applicable to all debtors and creditors without it being necessary to prove their consent to be bound by them or the illegality of the debt.

The United Nations International Law Commission defines force majeure as follows:
The is the situation that arises when unforeseen circumstances beyond the control of the person or persons concerned absolutely prevent them from respecting their international obligation, by virtue of the principle that one cannot do the impossible

The Preparatory Committee of the Conference for Codification (The Hague, 1930) accepts the applicability of the force majeure argument to the debt, because, according to the Committee, a modifies total or partial service [of the debt], unless it is forced to do so by

International jurisprudence explicitly recognizes this argument, which legitimizes a suspension of debt repayment to both private and public creditors such as States, the IMF and the World Bank.