By Babajide Komolafe
Public debt has become a major challenge for most governments around the world. In the developed countries concerns over public debt is forcing governments to cut spending and adopt austerity measures. In Nigeria the opposite is the case.

The thinking in government is  that the country is far from the threat of public debt crisis hence budget is designed to maintain the nation’s high level of spending.  But should the nation experience a 35 per cent fall in revenue as it did in 2009, how would the federal government and the other two tiers of government sustain the huge spending pattern reinforced by the 2011 appropriation bill.

In 2009, the nation’s revenue fell by 38.4 per cent to N4.844 trillion, courtesy of persistent fall in the price of crude oil, the nation’s major source of revenue, between 2008 and 2009. From a peak of $147.27 per barrel in July 2008, crude oil prices fell rapidly and generally to $50 per barrel by the end of the year.

As a result, the average price of Nigeria’s Bonny Light crude oil, which rose from $66.46 per barrel in 2006 to $101.15 per barrel in 2008, crashed to $62.1 per barrel in 2009.

Concomitantly, the nation’s total revenue from oil and gas fell by 51 per cent to N3.191 trillion from N6.53 trillion in the previous year.

To maintain the same high level of fiscal spending, which was prompted by the phenomenal increase in crude oil prices between 2006 and 2008, the three tiers of government drew from the excess crude oil revenue savings and resorted to borrowing.

As a result, the excess crude oil savings dropped from $20.34 billion in 2008 to $6.54 billion in 2009. Which means the three tiers of government shared $13.4 billion from the excess crude account in one year.

When multiplied by the average exchange rate of N149.5 per dollar for that year, this translates to N2.587 trillion.

Also total public debt rose to N3.8 trillion from N2.8 trillion in 2008, implying borrowing of N1 trillion in 2009 most of which came from the domestic debt market. That year the federal government’s domestic debt rose by 39 per cent to N3.228 trillion.

Thus the three tiers of government had to augment for the sharp decline in crude oil prices with N3 trillion sourced from the excess crude savings and domestic borrowing.

However crude oil price have not only recovered but is experiencing another phenomenal increase and now well above $100 dollar per barrel, thanks to the unrest in the Middle East.  And like in the past, the increase in crude oil prices is stimulating increased propensity to spend by the three tiers of government.

Thus,  influenced by a mindset that the boom in crude oil prices would persist, the National Assembly jerked up the crude oil price benchmark for the 2011 budget to $75 per barrel and also total budget expenditure to N4.971 trillion, N745 billion higher that the N4.226 trillion proposed by the President. It is pertinent to note that the approved budget has an inbuilt deficit to be financed largely by domestic borrowing.

The  implications of the approved budget is that there is no provision for a sudden sharp and persistent fall in crude oil price which can cause expected revenue from oil sales to fall by as much as 51 per cent as experienced in 2009. It is obvious that nobody in government expects such to happen.

But one of the crude realities and lessons of the past is that decline in crude oil prices are usually sudden, rapid and persistent, occurring when least expected.

This is because they are usually triggered by unforeseen economic developments like the subprime mortgage crisis that triggered the global economic meltdown of 2008.

Countries that have grasped this reality have learnt to always prepare for such shocks by not allowing their fiscal expenditure to be influence by boom in crude oil prices.  This is because should crude oil prices experience the seasonal sharp, sudden fall, the government would have to resort to increased borrowing either externally or domestically.

This could lead to debt crises, if the nation’s debt burden is already high or requires significant share of the budget for servicing.

As it is, there appears to be limited options for the three tiers of government should crude oil prices take a sudden and long deep. In 2009, there was $20.34 billion of excess crude savings. Presently, there is just about $6.9 billion in this account. The implication is that much of the sudden fall in revenue will come from borrowing, mostly domestic borrowing through issuance of FGN Bonds and treasury bills.

But the level of the nation’s public debt is already precarious. Due to the increase in public debt to augment the decline in revenue in 2009, the Debt sustainability index, which is measured by debt to GDP ratio worsened to 15.4 per cent from 11.6 per cent, while total debt to revenue ratio deteriorated to 144.3 per cent from 88 per cent. Similarly total debt service to revenue ratio rose to 20.5 per cent from 10.5 per cent.

These imply that the nation would require the revenue of almost one and half years to pay off its debt, and 20 per cent of revenue went into debt servicing.

Although the Debt Management Office (DMO) has severally assured that the level of the nation’s public debt is well below crisis level, those with foresight have raised alarm about the rate at which it is growing especially at a time of boom.

Their worry is that should there be a sudden decline in crude oil prices like in  between 2008 and 2009, the public debt will not only rise , it would balloon with severe implications and impact on the economy.  This concern was aptly expressed by the Central Bank of Nigeria at the end of its Monetary Policy Committee  (MPC) in March. “The Committee recalled that in the past few MPC meetings, it had stressed the need for fiscal retrenchment and drawn attention to the unsustainability of the rising trend of domestic debt”, it stated.

Foreign investors and the international community are also worried said Razia Khan who is the Head of Research for Africa, Standard Chartered “There is need to check government borrowing   now because of its potential risk to the financial markets and the sustainability of the amount of money required to service the debt”, she said.

The likely scenario prompting these concerns is quite frightening. The CBN and economic experts imagine a situation whereby there is sustained rapid decline in oil revenue by 40 to 60 per cent for two or three consecutive years. With little or no excess crude savings to fall back on, the level of borrowing required to maintain the current level of government spending would trigger a sharp rise in public debt such that about N1 trillion or more might be required for debt servicing.

And as government increasingly depend on borrowing to finance the budget the debt servicing might become messier.

Presently more than half of government borrowing comes from banks, who lent to government money that should have been loaned to businesses and individuals. Thus increased government borrowing mean increased reduction in loan to businesses and individuals, reduced investment and consumption spending, which weakens aggregate demand and gross domestic growth.

But the greatest danger is to the financial sector, particularly the banks that purchased most of government debt instruments.

Banks hold  about half of FGN Bonds, which constitute about 64 per cent of total public debt. The bonds are traded in the secondary market where the prices and yield fluctuate as dictated by the market realities Investigation reveal that presently about 80 per cent of FGN Bonds are illiquid. These were bonds purchased by banks in the secondary market in 2009, when prices were high.

But the prices of the bonds have fallen significantly so the banks cannot find buyers to buy at the price they want to sell to recover their investment.  Thus they have to either hold the bonds to maturity or sell at lower price, which is less likely. But the banks still carry these bonds at face value in their balance sheets. To carry them at current market value would cause their balance sheet to fall very significantly.

Increased government borrowing would however aggravate the precarious situation. As government borrows more to maintain spending level, the CBN would increase interest rates to curb inflation, and this would cause bonds’  yields to rise and their prices to fall, causing further dent on banks’ balance sheet. Somewhere along the line, things would definitely fall apart, and banks would have to reflect the market value of the bonds in their books and provide for the loses.

Depending on how the apex bank chooses to manage the situation, the result could be another banking crisis with severe impact on other parts of the economy, all because government cant curb its spending pattern. Off course this is a scenario which may never happen. But because it can happen, it is better to adopt the motto of the Boys Scout-Be Prepared.