The move by the federal government to prevent further blemish to its credit rating by securitising and restructuring some long dated existing financial obligations of approximately N2.7 trillion is expected to strengthen banking system liquidity.
The Financial Derivatives Company Limited (FDC) stated this in its Economic Bulletin for July titled: â€˜Rising public sector debt, a ticking time bombâ€™, obtained on Tuesday.
The Nigerian banking system has been vulnerable to commodity price and currency volatility shocks. However, one of the weaknesses of the sector has been the high default rate of debtors.
According to the report, non-performing loans in the banking system are now believed to be approximately 16 per cent of total risk assets.
Last year, Fitch Ratings reduced the Support Rating Floors of 10 Nigerian banks to â€œNo Floorâ€ on the backdrop of rising foreign debt and lack of institutions to cushion these banks in the event further shocks to the system. Major contributors to the asset quality problem of the sector are government contractors as well as some government employees.
The banks now shun more loan requests by government and public sector contractors. In the past two rounds of bank distress, government delinquency was a major catalyst of bank failure.
Crucially, many of the loans obtained by contractors affected by federal government loan default had been written off as non-performing loans by these banks leading to many rating agencies questioning the strength of the banking system in withstanding further shocks.
Also, most of the banks also sustained significant losses to their share values and as such increased liquidity is to facilitate a tapering in the speculation of a banking crisis, the report stated.
According to the report, Nigeria has a reputation of chronic indebtedness and financial delinquency dating as far back as the 1970s, when Nigerian debt was ruled as sub-standard by the London Club of Bankers.
It cited the case of the cement armada whereby defaulting on confirmed irrevocable Letters of Credit was the first time the government of Nigeria became a documented defaulter in the international arena.
Furthermore, it stated that the accumulation of arrears on trade finance then, resulted in a rescheduling of trade and payable debts in the 1980s.
Also, the cumulative effect of the piecemeal and unstructured approach to debt servicing (accounts for 66% of recurrent income) resulted in a choking debt trap. In the end, Nigeriaâ€™s accumulated external debt reached a level of $36 billion (HIPC â€“ Heavily Indebted Poor Countries). A combination of deft negotiation and a payment of $18 billion comprehensive debt forgiveness were achieved in 2005.
On the domestic front, the report stressed that the delays and default in payment for bona fide transactions such as the JV cash calls have strained the financial reputation of the federal government.
To this end, the report described the securitisation of debt through promissory notes as a step taken by the government to address debt to â€˜helpless creditorsâ€™ of the government such as FGN contractors and suppliers, pension and salary arrears and state governments.
“Many multinational contractors blacklisted Nigeria because of its tarnished payments record. The others who had no choice had to inflate the contracts to reflect the additional default risks. The hedge against delays or possible defaults resulted in project cost inflation at the expense of the tax payers.
“To put the proposed securitisation of N2.7 trillion in context, it is roughly $8.9 billion and 29.3 per cent of gross external reserves and 12.3 per cent of money supply. The impact of this proposed debt scheme transcends through key variables such as interest rates, exchange rates, asset quality and monetary stability,” it added.
Nonetheless, the report held the view that exchange rate was likely to be negatively impacted from this debt scheme.
In fact, it assumed that many “contractors who cash out their notes will go straight to the forex market.”
“Increased demand of that magnitude with little or no corresponding supply on the part of the CBN could undermine past interventions by the apex bank and force the value of the naira down. Therefore CBN policy in the FX market will have to be intensified in order to offset anticipated exchange rate losses,” it added.
“Apart from the catalytic impact of the securitisation on growth and its stimulus effect on the recovery from recession, the timing of the programme has raised eyebrows. Some analysts fear that the scheme could be abused for political purposes. In the past, the judicial process had been abused to create fictitious debts that had no genuine transactions. “As we slowly go into the electoral cycle, it is feared that political favour could be extended to friends and supporters to fund political campaigns. With both leading political parties in dire need of funding, sceptics fear that the temptation of fiscal abuse is high.
“The federal government needs to exercise discipline in the execution of this proposed debt scheme. The crux of the current issue about default and delay in payment dates back to the culture of allowing arrears to build up in the first place.
“Brokerage abuse and unethical practices between banks and government, lead to the culture of using funds set aside for settling contractors and suppliers to trade for extra profit. Therefore, to break the cycle of bad governance and negligence, which has brought the nation to this point, ethical execution from screening contractors to issuing the notes and payment at maturity, is required,” it advised.