Fifteen out of the 36 states of the federation have issued N595.3billion (about $1.6billion) in bonds from the domestic capital market in the last seven years.
Leading the states is Lagos, which issued about N312 billion worth of bond instruments in four years. Lagos, the most vibrant of all the states in Nigeria in internal revenue generation, accounted for more than half the total issuance in the debt market in the review period.
According to a recent report on Nigerian States and their Credit Worthiness by Moody’s Investors Service, “The number of states tapping the domestic capital market tripled in this period.”
Meanwhile, as of 2017, Lagos is the most heavily indebted of all the states with the largest external debt of $1.5 billion and the largest domestic debt stock at N363 billion (about $1 billion). Delta State, one of the oil- rich states, which enjoys extra revenue from derivation besides the general monthly federal allocation from the central purse came behind Lagos with N50billion debt from a state bond that was issued in 2011. Osun, one of the poorest states in the federation in terms of revenue generation and least earner from the federal purse, borrowed N41.4billion from the debt market in 2012 and 2013 respectively.
The state issued N30billion worth of bond in 2012 and later visited the capital market for N11.4billion in 2013. Though Lagos is the most indebted state in the federation as of 2017, Osun state is more burdened with debt compared to any other state in the country considering its lean revenue sources. Plateau, a non-oil producing state in the North-central space of the federation ranked fourth on the domestic debt table with N28.2billion, which it borrowed in 2015.
Other states on the debt list of the local capital market include Ondo, N27billion; Ekiti and Gombe raised N25billion a piece from the bond market in two tranches respectively. Niger raised N21billion in two tranches while Benue’s N18billion was raised both in 2011 and 2015 respectively. Among the top 10 leading debtors in the bond market is Bauchi with N15billion in 2014.
According to Moody’s Investors Services unit, the debt of Lagos state does not weigh on its revenue, as deductions are made from Lagos’ statutory allocations for external debt service and domestic debt service for which there is IPSO contract. In 2017, these deductions reduced Lagos’ total gross allocation by more than 80 percent. However, Lagos’ ability to raise internally generated revenue (IGR), combined with a larger value added tax (VAT) allocation, means that the state is not as reliant on Federation Account allocations as its peers.
Furthermore, although Lagos is the most heavily indebted state in Nigeria, its debt-to-revenue ratio is low relative to Nigerian state peers that rely primarily on statutory revenue.
“A key differentiator for Nigerian states is their ability to generate IGR, which is made up of income tax, property taxes and other levies the state may choose to impose. IGR, like VAT, is relatively stable and has proved to be resilient when the oil price dropped sharply. As such, those states that are able to raise significant IGR have more predictable revenue and greater fiscal flexibility”, says Moody’s.
Meanwhile, the states with the highest levels of IGR are Lagos, Ogun and Rivers. Of these, Lagos was by far the top performer in 2017, with an IGR level more than three times higher than Rivers, the second-best performing state. All three states benefit from being located in wealthier and more urbanised parts of the country.
Pay-as-you-earn (PAYE) income taxes make up the largest portion of IGR, accounting for about two-thirds of the total amount. As PAYE is levied on salaried employees, states which have more rural economies are at a disadvantage in raising revenue in this way, whereas the reverse is true for those states with larger urban populations working in the formal economy.
“States, which have taken advantage of the fiscal flexibility in this institutional framework, and are successful in raising IGR, also benefit from an increased borrowing capacity’, Moody’s noted.
For states that are primarily reliant on their statutory allocation (as revenue received from the Federation Account is sometimes known), this volatility can affect the ability of states to service debt, as was the case during the last oil price shock when several states required assistance from the federal government. The two other main components of state revenue- the VAT allocation and own-source revenue, known as IGR (internally generated revenue), are a much smaller proportion of the all states’ total revenue, but they are generally more stable.
VAT revenue, like the Federation Account revenue, is collected centrally. The states receive 50 per cent of all VAT collected, and this allocation has been growing slowly, but steadily, over the last 10 years.
The Investment and Securities Act of 2007, which was enacted at a time when the Nigerian government was “resetting” public debt sustainability, provides the legal basis for state bond issuances.
The guidance provided makes clear that the debt remains an obligation of the borrowing state alone, and that there is no guarantee by the federal government unless explicitly stated.
However, the legislation outlines a repayment structure for state bonds, requiring the establishment of a sinking fund to repay the debt.
In applying for permission to issue on the capital markets, states must submit an Irrevocable Standing Payment Order (ISPO), giving the Accountant General of the Federation the authority to deduct at the source of statutory allocation in event of insufficient funds in this sinking fund. In practice, debt service deductions are made regularly from statutory allocations, as can be seen in revenue flows published by the Federation Account Allocation Committee.
This is a credit supportive feature of the Nigerian institutional framework for regional and local governments (RLGs), which although not as powerful as a sovereign guarantee, establishes debt service as a priority claim in future cash flow.