How Nigeria Incurred Huge Debts

culled from THISDAY,  March 13, 2005

This section considers the prospects for achieving external debt sustainability in Nigeria against a background of 20 years of arrears accumulation, debt restructuring, and rescheduling.  In recent years, Nigeria has limited its cash debt-service payments to levels comparable to or somewhat lower than those of developing country oil exporters, sub-Saharan countries and African Heavily Indebted Poor Countries (HIPCs), while discriminating among its creditors and continually accruing new arrears.  As a result, most international financing sources are closed to Nigeria, and debt-service payments have not significantly reduced the level of debt.
Two illustrative rescheduling scenarios are presented, neither of which is meant to suggest or prejudge a particular outcome for any future debt-restructuring agreement that Nigeria may enter into with its external creditors.  The scenarios are based on achievement of ambitious growth rates, which would require implementation of a wide range of appropriate macroeconomic, structural, and governance measures over an extended period, and somewhat higher cash debt-service payments than made in recent years.  Preferred creditors (multilaterals) hold a relatively small share of Nigeria’s debt, and most of the remaining debt is eligible for Paris Club-type rescheduling.  The analysis concludes that a single concessional flow rescheduling would only provide stopgap debt relief.  A concessional stock-of-debt operation could provide a comprehensive solution to Nigeria’s long-standing debt problems in a good policy environment.

The Origin and Development of External Debt in Nigeria

The origins of Nigeria’s external debt problems date back to policies pursued during the 1970s oil boom, that led to extreme vulnerability to downturns in the oil price.  Successive governments emphasized heavy investment in public works, primarily aimed at building import-substituting industries.  Public investment was financed by oil export earnings, some domestic financing, and relatively modest external borrowing, primarily from multilateral and bilateral sources.  The exchange rate was fixed to contain external inflationary pressures.  Over time, the real effective exchange rate appreciated substantially as demand pressures raised prices of nontradable goods.  The appreciated exchange rate biased domestic investment in favour of projects that were capital intensive and relied heavily on imported inputs, while agriculture suffered as the rate of return to farmers fell.
In an environment of poor governance, dwindling external finance, and infrastructure deficiencies, a majority of the projects financed by public borrowing during the late 1970s and 1980s have failed.  A study carried out by the Federal Ministry of Finance in 1996 of commercial external loans from bilateral and commercial creditors (amounting to about 70 percent of external debt outstanding in 1996) has documented in detail problems encountered by externally financed projects.  Typically, loans were incurred by state governments with federal guarantees, and the lender obtained insurance from an official export credit agency.  Many of the projects have not been completed, owing to cost overruns or lack of finance, as external lending was progressively reduced during the 1980s. 

Of those projects completed, many are inoperative owing to a lack of power or other missing links in the manufacturing sector.  Completed physical and social infrastructure has typically been neglected through nonexistent or inadequate maintenance. In some cases, imported goods financed by loans could not be located. No significant project that was completed and documented by the official study appears to have generated foreign exchange-denominated sales.  The authorities have taken note of past deficiencies in project management and now apply a due process test to many federal-financed capital projects.  However, much remains to be done at the state level of government.

Most of Nigeria’s external debt was contracted in the 1980s.  Oil export receipts declined by over 50 percent between 1980 and 1982 (from US$24.9 billion to US$11.9 billion) and then by half again in 1986 (to US$6.4  billion) on account of lower world prices and smaller export volumes.  The majority of Nigeria’s external public debt was accumulated in the 1980-86 period, during the civilian Shagari and military Babangida administrations, when the debt stock (including late interest) increased five-fold from US$5 billion to US$25 billion.  Over this period, the debt service-to-exports ratio increased from 6 percent to 72 percent, and the ratio of external debt to goods exports increased from 17 percent to 320 percent (Figure VII-1).
From 1982 on, restrictions on access to foreign exchange led to the accumulation of arrears and the successive rescheduling and restructuring of trade credits and commercial bank debt.  A policy of prioritizing payments of medium- and long-term credits, including through the centralized allocation of foreign exchange, led to the accumulation of arrears on short-term trade credits, particularly in 1982 - 83 and 1986.  The Federal Government offered promissory notes issued by the Central Bank of Nigeria (CBN) and guaranteed by the Federal Government for eligible uninsured trade credits in 1983.  The promissory notes were restructured in 1988, with a face value of US$4.9 billion.  Insured claims were assumed by the Federal Government as debts to Paris Club creditors.  Debts to London Club banks were restructured in successive agreements reached in 1984, 1987, 1989, and 1992.  The final agreement in 1992 involved a debt-reduction operation in which the Nigerian authorities bought back US$3.4 billion commercial debt at a 60 percent discount (i.e. eliminating US$2.0 billion and paying off US$1.4 billion), exchanged an additional US$2.0 billion at par for collateralized par bonds maturing in 2020 (also known as Brady bonds), paid US$0.4 billion in arrears, and paid US$0.2 billion for principal collateral. 

Overall, the debt-reduction operation reduced London Club bank debt from US$5.8 billion to US$2.0 billion, including payments by Nigeria of US$2.2 billion, and reduced significantly Nigeria’s total debt stock.
Nigeria also agreed to several nonconcessional reschedulings with Paris Club creditors, beginning in 1986.  Reschedulings took place in 1986, 1989, and 1991 during Stand-By Arrangements with the Fund, rescheduling in total US$14 billion of arrears and eligible medium-and long-term debts.  In the context of continued weak oil prices and the authorities’ payment priorities, reschedulings were followed by renewed arrears accumulation, and the overall debt stock continued to rise as late/penalty interest was added to the debt stock.

From 1992, Nigeria’s external debt stock stabilized as debt-service payments were broadly equivalent to total interest due.  The authorities limited actual debt-service payments to a ratio of net oil revenues.  As a result, arrears increased sharply in years when oil revenues declined, such as 1994-95.  The authorities limited actual debt-service payments to a ratio of net oil revenues.  As a result, arrears increased sharply in years when oil revenues declined, such as 1994-95.  The authorities also sought to remain current on debt service due to the largest commercial creditors (par bonds and promissory notes) and to multilateral creditors (principally the World Bank and the African Development Bank Group) and did not pay official bilateral creditors.  This prioritisation led to a gradual increase in the share of bilateral debt in total external debt to almost 80 per cent by 2002, almost entirely on commercial terms nonetheless debt indicators on balance have improved over the past decade as the average oil price - and, in parallel, government revenue and GDP - rose from its low level in the second half of the 1980s.
In light of its continued debt-servicing difficulties Nigeria’s access to new credits has remained extremely limited over the past decade.  Access to bilateral credits was cut off, and lending from commercial creditors has been minor, very sporadic, and at market interest rates.  Beginning in 1993-94, the African Development Bank and the World Bank lent to Nigeria on concessional terms, with total disbursements of about US$850 million over the period to 2001 (about 3 per cent of total debt outstanding at end-2002.

Following democratic elections in 1999, the Obasanjo administration sought to normalize relations with creditors. Following approval of a Stand-By Arrangement in July 2000, Nigeria reached agreement with the Paris Club in December 2000 on a fourth nonconcessional rescheduling of almost the entire stock of Paris Club debt outstanding.
Arrears of US$21.3 billion - representing over 90 percent of the total debt to the Paris Club - and maturities falling due in the period August 2000 - July 2001 of US$0.3 billion were rescheduled.  Bilateral agreements have been completed with only three of the fifteen Paris Club creditors, in respect of about 13 percent of the debt rescheduled, but discussions are advanced with several other large creditors.  Two agreements fix interest rates for the remainder of the loans, thereby lessening the likely volatility of future debt-service obligations.  Table VII-1 shows the impact of the rescheduling on debt-service payments due.

Through end -2002 Nigeria has been accumulating new arrears on external debt-service payments.  These total approximately US$2.3 billion, principally to the Paris Club on pre- and post-cutoff-date obligations and to non-Paris Club bilateral creditors.  In part, debt-servicing difficulties have been attributed to the Supreme Court ruling of April 2002 that external debts should be charged upon and payable out of the revenue and assets of the part of the government that incurred the indebtedness, and not the Federation Account.  With this judgment, the traditional practice of servicing external debts as a first-line charge on the Federation Account (before revenues are shared across federal, state, and local governments) was declared unconstitutional.  External debt-service payments should now devolve to the individual levels of government that contracted the debts.  It is provisionally estimated that the state governments would be responsible for 24 percent of debt service falling due, with the remaining 76 percent the responsibility of the Federal Government.  In August, agreement was reached with state governments to allocate resources from the Federation account for selected external debt-service payments.  However, discussions on the modalities of servicing the debt in compliance with the Supreme Court ruling, particularly in respect of Paris Club obligations, are ongoing.
Nigeria’s ratio of debt service paid to exports have been generally lower than comparator groups in recent years in part owing to debt relief under the 2000 rescheduling.  Debt service paid in relation to exports is lower in Nigeria than Sub-Saharan Africa (average) and for developing country fuel exporters, reflecting Nigeria’s debt rescheduling in 2000-01 and arrears accumulation in 1999 and, most likely, in 2002 (Table VII.2).  Debt service due before rescheduling is generally higher for Nigeria than for both these groups.  Debt service paid by Nigeria has also been lower than payments made by African HIPCs in 1999 - 2002, with the exception of 2001.

Prospects for Future Debt Sustainability

This section assesses Nigeria’s external debt situation at the end of 2002 and evaluates its sustainability over the medium to long term.  The scenario presented are subject to a number of critical assumptions concerning, inter alia, the evolution of oil prices, the willingness of creditors to restructure debts, and the stance of fiscal policy.  The scenarios are, therefore, only illustrative in nature and are not intended to suggest or prejudge a particular outcome for any future debt-restructuring agreement that Nigeria may enter into with its external creditors.

Nigeria’s medium-term balance of payments outlook, in the absence of further debt rescheduling, remains difficult.  The short-term challenge is to reverse the large decline in external reserves experienced in 2002, in a context of gradually declining oil prices and oil export volume growth constraints (Organisation of Petroleum Exporting Countries (OPEC) quota and sluggish global demand).
A baseline balance of payments projection before rescheduling is shown in Table VII-3.  Strong fiscal adjustment and no real exchange rate appreciation are the key instruments to achieve the needed import restraint over coming years.
The policies underpinning the macroeconomic framework are projected to improve the macroeconomic indicators over the medium term.  Specifically, GDP growth is projected to accelerate to around 5 percent by 2007 as a result of a sustained implementation of appropriate macroeconomic policies, accelerated structural reform, and vigorous actions to improve governance.  The current account deficit will be capped in the range of 31/2-4 percent of GDP.  Gross reserves are projected to rebuild from 41/2 months of import coverage at end -2002 to about six months’ coverage over the medium term.  Notwithstanding significant projected increases in non-debt-creating private capital flows and a gradual increase of concessional lending from multilateral agencies, financing gaps will arise on the order of US$1 billion per year over the period 2003-07 and thereafter.