Proposed $30bn Loan: Avoiding the Eurobond Curse

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Uche Uwaleke examines the pros and cons of federal government’s resort for external borrowings

The federal government’s plan of seeking foreign loans to ramp up development expenditure in the face of huge infrastructure deficit and declining international reserves appear justified in the light of the findings of a study by Foster and Pushak, cited in the 2016 IMF article IV Consultation report on Nigeria, to the effect that the country requires capital spending of about US$14 billion a year for over a decade to close identified infrastructure gaps. This is as good as committing all the federally collected revenue each year to capital projects with no provision for recurrent expenditure! Against the backdrop of this stark reality and the increasing cost of servicing domestic debt, the resort to external borrowing stands to reason. At least, it is a better option than increasing the rate of Value Added Tax or selling government stakes in critical National Assets.

Be that as it may, the sources of the foreign loans should be of vital consideration given the fact that the country’s debt crisis prior to 2005 was more from external than domestic debts. Section 41 (1a) of the Fiscal Responsibility Act 2007 provides that ‘’government at all tiers shall only borrow for capital expenditure and human development, provided that, such borrowing shall be on concessional terms with low interest rate and with a reasonable long amortization period ’’ while Section 41(2) provides that ‘’notwithstanding the provisions of subsection 1(a) and subject to the approval of the National Assembly, the Federal Government may borrow from the capital market’’. While the National Assembly awaits details of the proposal to procure foreign loans by the federal government, the breakdown of the US$29.96 billion facility which is already in the public domain shows ‘’proposed projects and programmes loan of US$11.274billion, Special National Infrastructure projects US$10.686billion, Eurobonds of US$4.5billion and Federal Government budget support of US$3.5billion“.

It is the Eurobond component that stirs some concern due to its non-concessional nature. By definition, Eurobonds are international bonds issued outside the country in whose currency its value is stated. They represent a means of diversifying sources of development finance. Unlike concessional loans which are often tied to a particular project and procurement source, Eurobonds issuances come with few conditions attached, allowing governments more control over where they channel the funds. This discretionary feature can be abused by corrupt governments thereby turning the loans to a curse instead of a cure. Also, Eurobonds, like most debt instruments, attract transaction costs which reduce the final amount the issuer collects and unlike multilateral and bilateral loan agreements which are often on concessional terms, Eurobonds carry significantly higher borrowing costs especially when issued by a mono-product country like Nigeria that is highly susceptible to external shocks. In view of the enormous downside risks, borrowing through the Eurobonds window make timing of the issue an important consideration. With the economy still in the woods, accessing the international capital market at this time will be costly for Nigeria and result in what has been dubbed the ‘’Eurobond curse’’ in finance literature. This curse arises from the increasing burden on the issuer of servicing a debt procured on unfavourable terms (at a very high cost) in a desperate attempt to overcome economic challenges.

It is a fact that the country’s ratio of external debt service to government revenue is low compared to indicative thresholds or even that of peer countries but this narrative is bound to change if a US$4.5 billion Eurobond component is added to the external debt stock between now and 2018. According to data obtained from the Debt Management Office website, Nigeria’s external debt stock as at 30th June 2016 of about $11.26 billion comprises US$7.99 billion from Multilateral sources (representing 70.96 per cent), US$1.77 billion Bilateral (or 15.72 per cent) and US$1.50 billion Eurobonds which translates to 13.32 per cent. In spite of the low size of Eurobonds relative to the other two sources, the cost of actual external debt service payments in the first quarter of 2016 was highest for Eurobonds which took up 38.8 per cent with Multilateral and Bilateral sources accounting for 36.7 per cent and 24.5 per cent respectively. To further underscore this point, as at October 31 2016, the closing prices and yields of Nigeria’s 10-year Eurobond (2013-2023) were US$97.146 and 6.912 per cent respectively. It is instructive to note that the yield of this US$500 million Eurobond at issue was 6.625 per cent and given the inverse relationship between bond prices and yields, the increasing yield and lower price is a reflection of the waning investor confidence in Nigeria.

In January 2011 when Nigeria issued a US$500 million debut Eurobond which was aimed in part to establish a benchmark yield curve in the global market, and in 2013 when another US$1 billion bonds were raised from the international capital market, the country was not in a recession -little wonder these issues were oversubscribed. Today, market conditions are far from favourable.

A study on African Eurobonds conducted by Deutsche Bank in November 2015 observed as follows: ‘’while the challenging economic backdrop has not prevented new issuance, it has resulted in higher yields. Those countries that did issue in 2015 had to offer significantly higher yields than previously. For Zambia and Ivory Coast, primary market yields increased by 70 bp and 100 bp respectively, and for Ghana, even by 260 bp to 10.75% in relation to the last issues in 2014. Angola, the only debut issuer in 2015, had to offer a yield of 9.5%. Yields increased also on secondary markets, with the increase being highest for commodity exporters with weakening fiscal and/or external fundamentals such as Zambia, Gabon, Ghana and Nigeria’’. In Oct 2015, the ‘Pulse Newsletter’’, a Ghana based publication, reported that Ghana was abandoning the issuance of US$1.5 billion Eurobond after a failed roadshow in Europe which saw only few investors signifying interest in buying the bonds at exorbitant interests rates of 11 percent much higher than the coupon rates of 8 per cent and 8.5 per cent for the country’s last two billion dollar- bond issues.

Clearly, the present market conditions are not conducive and so the proposed US$4.5 billion Eurobonds issuance over the next three years will involve significantly high costs given the economic challenges facing the country which will take some time to overcome. The IMF expects Nigeria’s GDP to contract by 1.7 per cent in 2016 and slowly recover in 2017, growing by 0.6 per cent. In the event of lower-than-expected GDP growth and weakening domestic currency, the country will have a huge challenge servicing the Eurobonds. Again, interest rates in US may go up post President Obama era. It will be recalled that Donald Trump, the Republican presidential candidate, at the first presidential debate in September had accused the Federal Reserve Chairwoman Janet Yellen, of “doing political things” by keeping interest rates low. When interest rates in the US eventually rise, the burden of servicing new Eurobonds will become worse.

According to the Debt Sustainability analysis report by the DMO, the maximum amount that Nigeria can borrow for the fiscal year 2017 is US$22.08 billion with new external borrowing accounting for US$16.56 billion. The other components of the proposed loan excluding the Eurobonds amount to over US$25 billion. If the government is positive about obtaining concessional loans from multilateral sources such as the World Bank and the African Development Bank as well as from Bilateral sources like the EXIM Bank of China and the Japan International Cooperation Agency, then every effort should be made to fast track access to these cheap funding sources and shelve for now the idea of obtaining commercial credits in order to escape the Eurobond curse already afflicting many sub-Saharan African countries.

– Uwaleke, is an Associate Professor and Head, Banking & Finance department Nasarawa State University Keffi, Nasarawa State