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Rate of excess crude run-down threatens Nigeria’s credit worthiness

By Babajide Komolafe
The rate at which the excess crude oil savings is been spent by the government threatens  the nation’s creditworthiness and the cost of borrowing in the international market, warns Razia Khan, Standard Chartered Economist.

“Earlier reforms in Nigeria had helped to establish the country’s reputation for a substantial saving of its oil windfall, boosting its external creditworthiness. The 2010 Budget, with the magnitude of increased spending that is envisaged, will go some way towards undoing that reputation.”, she stated in a report on Friday.

In the report titled, Nigeria – 2010 Budget – A massive increase in spending , the Head of Macroeconomics and Regional Head Research, Africa, Standard Chartered Bank, expressed concerns over the huge increase in budgetary spending and the underlying assumptions of the budget.

The report stated,  “With elections due before April 2011, some increase in spending was always probable. But spending has been ramped up massively, rising almost 50% from the amount initially tabled under the 2009 budget.

According to the head of the Senate budget committee, the purpose of the budget is to ‘stimulate the economy out of the recent global economic crisis, through targeted fiscal interventions’. Capital expenditure alone is set to rise around 81%, but Nigeria’s track record on fiscal intervention is not encouraging. Nor is its reputation for the quality and efficiency of development spending. Spending at the Federal level has increased substantially since the transition to civilian rule in 1999, but with Nigeria’s infrastructure deficit still significant, critics argue that there is little to show for it. Moreover, despite the increase in development spending, recurrent expenditure will still dominate the overall budget

“Projections used to support the 2010 budget are also a source of concern. Budget assumptions of an inflation rate of 11.2% and a growth rate of 5.47% are not in themselves problematic, and in any case, only a small share of the country’s revenue is dependent on nominal growth assumptions. It is oil that has always mattered.

From this perspective, the budget assumption of a benchmark oil price of USD 67/barrel (up significantly from previous years) and an oil output assumption of 2.35mn barrels per day, make for an uncomfortable combination.

With a high benchmark price of oil factored into the budget, the rate of oil windfall saving will decline from already-weak levels. The output assumption is also ambitious in the context of OPEC production curbs and Nigeria’s vulnerability to any renewed escalation of militant activity in the Delta. Crucially, revenue assumptions will be susceptible to any new downturn in the global economy. There is little conservatism in forecasts, and little in the way of a built-in buffer to protect against any downside risks.

“The oil price and output assumptions combined leave little room for slippage. But a renewed global economic downturn, more stringent OPEC quota reductions, or an escalation of militant activity in the Delta – although not core scenarios for the moment – might all threaten revenue in some way.

Second, revenue assumptions from the planned oil-licensing round may prove overly ambitious. Not only does considerable uncertainty still surround the passage of Nigeria’s Petroleum Industry Bill,  but a greater level of clarity over unfolding political developments is likely to be sought by inv
estors in Nigeria. In particular, investors will be wary of any likelihood that the award of oil licences might be subject to subsequent legal challenges.

“Third, while Nigeria’s domestic bond market has rallied substantially on the back of improved liquidity provision, at current valuations, market participants will be wary of any reversal in yields. A number of factors have contributed to the current situation. The global economic crisis and the selloff on the Nigerian stock exchange (its capitalisation dominated by financials), triggered a safe-haven flight into the domestic bond market.

The CBN financed its intervention in the domestic banking sector by creating an asset on its balance sheet, and followed this up with the provision of accommodative monetary policy, but banks have yet to resume lending in a more meaningful way. Rising oil output has led to increasing statutory disbursements – or FAAC allocations – to the three tiers of government in Nigeria, boosting liquidity. Not least, more frequent disbursements from Nigeria’s excess crude account in recent weeks have also played a key role in boosting liquidity.

“Now, potentially greater levels of government spending must be factored in to the equation as well. But how much more can the market rally? 20 year yields in Nigeria recently touched a low of 7% before correcting moderately. For now, there are few alternative outlets for the liquidity release. But given how stretched bond market valuations appear, this could change rapidly. It is not just greater levels of spending that should be factored in – given the risks to the revenue assumptions outlined in the 2010 budget, greater levels of domestic borrowing are also probable, and with this, the potential for a correction in domestic borrowing costs.

“Extent of excess crude run-down is a concern: The cost of foreign borrowing and assessments of Nigeria’s creditworthiness will also need to be watched. While the run-down of Nigeria’s excess crude reserves may have been justifiable in response to the worst of the global crisis when oil output and prices were down, and narrow money growth negative, recent disbursements from the excess crude account (ECA) – with higher oil output and prices and greater FAAC allocations – are more difficult to justify. Nigeria has seen a significant dissaving of its crude windfall in recent months. Despite more favourable external conditions, and increased oil output, Nigerian Foreign exchange  reserves have not registered the gains that might have been anticipated.


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