Mohammed AbubakarDirector, Debt Management Department

Ministry Of Finance, Sokoto StateNigeria

Presentation at World Bank DMF Stakeholder's Forum 2015Asian Development bank Headquarters, Manila, Philippines

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Background of sub-national entities in Nigeria

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Regulatory Framework for Sub-National Borrowing

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Issues of Fiscal Federalism in Nigeria

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Problems States encounter in relating to Debt Management

Conclusion and Way Forward

Outline of Presentation

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Nigeria is Federal Nation inWest Africa with 36 Statesand Federal CapitalTerritory, and 774 localgovernments,

Population is about 175million

Aggregate GDP stood atN21,041,701.10 million atbasic price at First Quarter2015

The Constitution providesfor the devolution of powerand responsibilities fortaxation across the tiers ofgovernments. .

Background of Nigeria

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• The Constitution provides for the devolution of power and responsibilities for taxationacross the tiers of governments. However, there is mismatch between states’ increasedresponsibilities and the available funds to finance them.

• The two main sources of revenues collected by the federal government are oil and valueadded tax (VAT). The revenues first accrue to the Federation account before beingdistributed across the three tiers of government according to a periodically determinedformula. The current revenue allocation formula is as follows:

• Federal Government = 52%, • States = 26.72%, and • Local Governments = 20.60%

• Personal income tax, however, is collected and retained by the state governments, and is in many cases the main resource of the states’ internally generated revenue (IGR).

• The centre controls the bulk of the revenue accruing to states, the state governmentshave more autonomy in spending. State budgets are formulated and implementedwithout approval of the federal government, thus with little coordination regarding themacro implications of the states spending on the overall economy of Nigeria.

Background of Nigeria

Regulatory Framework for Sub-National Borrowing is guided by the following laws and agreements.

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The 1999 Constitution vests the National Assembly with the power to make laws with respectto any matter that concerns Domestic and External loans for the purposes of the Federation orof any State

The Debt Management Office Establishment (etc.) Act, 2003, gave powers to the FederalDMO (FDMO)to among to maintain a reliable database of all loans taken or guaranteed by thefederal or state governments or any of their agencies and also to provided that all banks andfinancial institutions planning to lend money to state governments or any of their agenciesmust obtain the prior approval of the Minister of Finance ,

the Investments and Securities Act, 2007 gave guideline and requirements for domestic borrowingthrough bonds.

The Fiscal Responsibility Act, 2007, requires the President subject to approval by the NationalAssembly, to set overall limits for the amounts of consolidated debt of the federal and stategovernments. These limits are set by the FDMO as part of the annual budget exercise.

The Investments and Securities Act, 2007, also includes some prudential restrictions on stateand local government borrowing. These sub-nationals are allowed to issue its securities only ifthe total amount of loans outstanding at any particular time, including the proposed loan,does not exceed 50 percent of the actual revenue of the sub-national concerned for thepreceding year.

The federal and the 36 state governments and FCT approved a National Debt ManagementFramework agreement which provided additional guidelines for external and domesticborrowing

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Control of State External Borrowings

Any Government in the Federation, or its agencies and parastatals can only obtain external loansthrough the Federal Government.

States governments agencies must provide evidence that they have not over-borrowed externally.In this regard, State Governments must demonstrate that the ratio of their projected external debtservice plus all other deduction obligations for the next twelve months (inclusive of the new loanunder consideration) to their total Federation Accounts Allocation over the preceding twelve monthswill not exceed 40%

No external loan will be approved without evidence that appropriate cost- benefit analysis andfeasibility studies have been carried out and prioritisation as well as due process procedures havebeen followed

All external borrowing proposals of the Federal, State and Local Governments and theiragencies/parastatals for the next fiscal year should be submitted not later than 180 days precedingthat year to the Minister of Finance

All external loans must be supported by Federal Government guarantee before final approval. In thecase of a State Government wishing to contract external borrowing, the State Executive Councilmust approve the loan proposal, and this will be followed by a resolution of the State House ofAssembly.

Every State shall execute a Subsidiary Loan Agreement with the Federal Government which mayinclude an Irrevocable Standing Payment Order (ISPO) that allows the Office of the AccountantGeneral of the Federation (OAGF) to deduct monthly, money from the State’s gross allocation to payback the loan contracted to the lending institution

Central government absolutely controls the sub-national external borrowings

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Control of Domestic State Borrowings

• Any borrowing by a Sub-national shall be the obligation solely of that particular Sub-national unless explicitly guaranteed by the sovereign;

• All Sub-national borrowings shall be subject to public disclosure and periodic updates to any originaldisclosure and the disclosure of material facts shall be the affirmative duty and specifically assignedfunction of appointed officials, lenders and lenders’ representatives, issuing houses, underwritersand other market participants;

• Sub-nationals shall devise or put in place a collateral arrangement such as a sinking fund to hedgeagainst potential default to protect investors; and,

• All Sub-nationals shall be subject to the rulings of a court of competent jurisdiction in the event of aviolation or default in part or whole of the agreement governing any loan obligation of the sub-national.

Domestic On-lending from the Central Government:

The central government can on-lend funds to the Sub-nationals. However, all the projects and programs financed under this modality will be properly monitored by

the Federal Government, through the DMO, in collaboration with MoF, to avoid fiscaland other imbalances.

DMO would undertake a project assessment prior to processing the on-lending loanrequest to assess, 1) credit risk , 2) legal risk, market risk and operational risk whichcould be due to inadequate internal control systems, human error, management failure.

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Control of Domestic State Borrowings

Borrowings from the Capital Market is control by investments and Securities Act (ISA) 2007 :

The provisions of the Act include the following:

The total amount of loans outstanding at any particular time including the proposedloan shall not exceed 50% of the actual revenue of the body concerned for thepreceding 12 months;

Any internal loan to be raised from the Capital Market must conform to therequirements of ISA and as may from time to time be directed by the Securities andExchange Commission (SEC);

Before any application is made for contracting a loan from the Capital Market, such abody making the application must obtain the Approved Resolution of the State Houseof Assembly and the State Executive Council in the case of States and LocalGovernments; and,

All applications to raise funds from the Capital Market shall, amongst otherdocuments, be accompanied by an original copy of an Irrevocable Letter of Authoritygiving the Accountant General of the Federation the authority to deduct at sourcefrom the statutory allocation due to the body, in the event of default by the body inmeeting its payment obligations under the terms of the loan and the relevant TrustDeed.

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Control of Domestic State Borrowings

Borrowings from the Commercial Banks

All banks and financial institutions requiring to lend money to the Federal, State andLocal Governments or any of their agencies, shall obtain the prior approval of theMinister of Finance” in accordance with Section 24 of the DMO Act, 2003, and theFiscal Responsibility Act, and shall state the purpose of borrowing and the tenor. Themonthly debt service ratio of a sub-national, which includes the commercial bankloan being contemplated, should not exceed 40% of its monthly FederationAllocation of the preceding 12 months

All commercial banks lending to a sub-national must make a provision (currently 50%)on all such loans in line with the Prudential Guidelines of the CBN.

Sub-nationals are expected to immediately, upon contracting a commercial bankloan, furnish the federal DMO with details of the loan.

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Public Debt Profile of Nigeria

Dec.11 Dec.12 Dec.13 Dec.14

TotalPublicDebtofFederalGovernment(millionUSD)

39028.14051 46112.05599 51728.20688 53,493.40

TotalPublicDebtofStates(millionUSD)

10,122.09 12,345.98 12,781.66 14,232.88

0

10000

20000

30000

40000

50000

60000

millionUSD

PublicDebtofNigeria

79%

21%

TotalPublicDebtofNigeriaasatendDecember2014

FedGovt

80%

20%

TotalPublicDebtofNigeriaasatendDec-13

FedGovt

States

79%

21%

TotalPublicDebtofNigeriaasatDec.2012

FedGovt

States

79%

21%

TotalPublicDebtofNigeriaasatEndDec.2011

FedGovt

States

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Challenges in Sub-national Borrowing in Nigeria

• Cumbersome process of borrowing: SNG wishing to borrow must go through a number of institutions for prior approval before the circle of borrowing is complete. Such institutions include the Securities and Exchange Commission (SEC), Ministry of Finance (Minister of Finance), Debt Management Office and where borrowing involves commercial banks the borrowing chain may include the Central Bank of Nigeria. The process is time consuming and hardly cost effective.

• A problem has been that the lender of funds in domestic borrowing (especially bond issue) takes overwhelming lead in the preparation of the lending prospectus. For instance, the lender prepares the prospectus, arranges the Issuing House and even fixes the interest rate. As a result, the borrower may be facing more onerous terms of borrowing than is apparent.

• There has been the practice of maintaining Sinking Fund arrangement for loan repayment especially long-term domestic loan. In this regard, there is also the Irrevocable Standing Payment Orders (ISPO) which the states must issue. Thus a situation whereby state in deficit sets aside periodically, funds into a sinking fund reflects bad debt management practice and needs to be addressed.

• Lack of debt recording system• Contingent Liabilities and Guarantees Issues• Many state government access funds from the Federal through several credit scheme, such as

Agric Credit Scheme and Small and Medium Enterprises etc. These funds are on-learnt to farmers association and small scale and medium enterprises in the states. While the beneficiaries are expected to pay back the federal government; in reality these liabilities are not recorded as guarantees by states.

• Lack of capacity for debt negotiation and analysis

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Issues of Fiscal Federalism in Nigeria

• Federal transfers to the states accounted for more than 80 percent of the revenue for 32 out of 36 states.

• State internal revenue sources are:1. Pay as You Earn2. Direct Assessment3. Taxes on landed properties, Roads e.t.c

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Issues of Fiscal Federalism in NigeriaFew states generate IGR

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Those with high capacity to generate IGR and can borrow

(low risk in borrowing)

Those with medium capacity to generate IGR (Medium risk in borrowing)

Those that rely heavily on federal allocation (high risk in borrowing)

Akwa IbomDeltaEdoKanoLagosRivers

Cross RiverKadunaOgunOyo

BornoEkitiYobeZamfara

Issue of Fiscal Federalism in NigeriaStates can be classified into 3 categories

Other Problems States encounter

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1. High level of contingent liabilities at the Sub-national level.2.Lack of Adequate capacity building programmes and intervention from thefederal DMO is not enough, WAIFEM is the only body that supports the Sub-national in this regard.3. High level of staff turn over due to political reasons.4. Lack of Adequate manpower.

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It will be recalled that the central government exercises full control/restrictions onexternal borrowing but less restrictions from borrowing domestically, the Sub-nationalsare therefore forced to borrow from unconsetional windows.However, the central government need to open up and borrow on behalf of the Stateand on lend at a consetional rate, this will change the ratio from 20-80 to about 60-40for external borrowing between the Sub-nationals and the Federal Government, in thisRegard, it will be correct to affirm that the Sub-nationals have been crowded out by theFederal Government.

Regarding capacity building, it was noted that DEMPA mission was conducted in four(4) out of a total of thirty six (36) states in Nigeria. Therefore, there is need to covermore state in order to identify the training needs of the Sub- Nationals.Finally, the frame work for that management strategy, is not fully in place as onlyadhoc system is in use in most of the Sub-National management offices.

Conclusion and Way Forward

End of Presentation

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