Africa Weekly Review: State government debt issuance in Nigeria; Eskom and the South African government

Nigeria: A new sub-asset class is born

The more conservative portfolio investor will recall the many years when Nigeria was in arrears to its official external creditors (although not to the London Club) and will wince at the prospect of naira bonds being issued by state governments. Not only has one state (Lagos) announced plans for a launch this year but S&P said on August 14 that it will establish a national scale of credit ratings for Nigeria.

Detailed analysis by Economic Associates, a prominent Lagos-based consultancy, shows on a state-by-state basis the proportion of the total budget that is met from internally generated revenue (IGR). Using 2006 figures, Lagos unsurprisingly heads the list at 64 per cent, followed by Kaduna in the north at 23 per cent. However most states’ proportion of IGR was in single digits, meaning that they secured more than 90 per cent of their revenue from the federation account..

This group even included some oil-producing states such as Delta and Akwa Ibom. These states do not have a huge incentive to generate their own revenue since according to the formula for distribution from the federation account they receive 13 per cent of the total pool under the derivation principle (as oil producers) as well as their share as individual states. They may well believe that the percentage they receive under the derivation principle will be increased as President Umaru Yar’Adua seeks to bring to an end the unrest and disruption of oil exports in the Niger Delta. It should be added that several of these state governments score particularly poorly in terms of governance.

Lagos first off the block

Four of the five largest states in output terms in 2006 were oil producers (see the chart below). The exception was Lagos which has plans to raise NGN75 billion (US$630 million) this year in the first tranche of a maiden bond issue. Governor Fashola, elected last year for the first time and thought to harbour hopes of a second term, has great ambitions for the infrastructure of the state. It borrowed US$200 million in 2007 from the World Bank for slum clearance and its capital spending plans cover transport, waste clearance and low-income housing.

Chart 1:Gross state product 2006 (share of GDP)

We expect the Lagos issue to be well-received by investors, given the paucity of naira-denominated paper in the fixed-income market. Lagos is the obvious candidate to be the first state to issue bonds. Its governor is ambitious (without being reckless), its 2008 budget is sound, and it is the only state which sources more of its revenue from its own taxes than from the federation account. The greatest selling point of the Lagos issue is that Nigerian growth during this commodities boom (unlike earlier versions) is stronger in non-oil sectors than in the oil economy, and that Lagos state is home to many rapidly expanding companies in financial services, communications, real estate and construction. There is a case on this basis for Lagos state to be similarly rated to the sovereign

A challenge for ratings methodology

For the 35 other states of the federation, the S&P ratings exercise will be revealing. The Debt Management Office (DMO) in Abuja is anxious that state governments set up similar bodies and pass fiscal responsibility laws. The DMO is aware of the sensitivities of the states but eager to provide them with training and assist with recruitment. The sovereign is rated by both S&P and Fitch at BB- for long-term foreign currency obligations, and BB for the local currency equivalent. The rating of a state overwhelmingly dependent on the federation account for its revenue stream becomes a call on the regular distributions and on one-off payments out of the Excess Crude Account. Any judgement must also take into account the perennial pressure for changes in the prevailing formula.

As a footnote, it is worth noting that the regular distributions are made net of deductions for the states’ debt service obligations to external creditors (multilateral institutions such as the World Bank group and the African Development Bank). In some cases, the deductions are sizeable: in 2007 they represented 10 per cent of the gross allocation to Cross River and 9 per cent to Oyo.

South Africa: Eskom downgrade and the Treasury’s increasing dilemma (continued)

The savage downgrade of Eskom by Moody’s on August 11 made good headlines. The foreign and local currency ratings were cut by three and four notches respectively, both to Baa2. However, Moody’s traditionally has had the highest ratings for Eskom of the three main agencies. Its new foreign-currency rating is the equivalent of BBB on the S&P scale: S&P has Eskom one notch higher, at BBB+, but on negative watch; and it is likely to downgrade the company.

The downgrade was driven in part by the agency’s concerns about the relationship between the government and state-owned Eskom. At the same time, it increases the pressure on the government to increase its support for the company. We noted in our Weekly Review dated 8 August that this was a painful dilemma for the National Treasury.

Apparent funding gap

Eskom’s five year investment programme (excluding nuclear components) has been costed at ZAR343 billion, of which the Treasury is lending ZAR60 billion over three years, with the company planning to borrow a further ZAR150 billion. A well-placed market analyst in Johannesburg calculates, on the basis of the increase in tariff approved by the regulator in June, that a funding gap of between ZAR40 billion and ZAR60 billion remains.

All-important price review

Commentators have this week dwelt upon a Treasury statement dated 18 July which noted, inter alia, that it would consider providing guarantees so that Eskom could “access funding not otherwise available”. This has prompted press speculation that the Treasury might guarantee loans to Eskom from multilaterals such as the World Bank and the African Development Bank.

In our view this would be a last resort because the Treasury does not like providing guarantees and has viewed a prominent role for multilaterals in development finance as being more appropriate to low-income countries than to South Africa. That said, we would expect the Treasury to guarantee loans to Eskom if it saw a funding gap on a scale to jeopardise the company’s investment-grade status and its five-year investment programme (and refamiliarise South Africans with power outages). Eskom, possible private-sector investors in power plants, the market, the ratings agencies and the Treasury will all be waiting for the regulator’s review of the Multi-Year Price Determinant, which is expected as early as next month.

As a footnote, the monetary policy committee (MPC) met yesterday and left its policy (repo) rate unchanged at 12.0 per cent. We noted on 8 August that the central forecast for inflation cited after the previous MPC meeting in June did not assume any tariff increases from Eskom. The latest forecast incorporates the tariff rise and the imminent rebasing/reweighting of the CPI basket, and sees inflation peaking at 13 per cent, compared with 12 per cent in the June statement, before returning to the target range in 2010.

Recent research reports:

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South African mining: Opportunities in a changing regulatory environment
Government negotiations are not one-sided

Ivory Coast: Electoral risk ahead
A strong economic rebound would likely follow a successful election outcome

With best regards,

Gregory Kronsten
Director, Africa Research
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