State government finances mostly below water
Since July 2015 the FGN has delivered six separate programmes to ease the pressure on state government finances. It moved in response to the slide in oil prices one year earlier, which highlighted the dependence of most states on their monthly payout from the Federation Account Allocation Committee (FAAC) and their failure to develop taxable local economies. The FGN also recognised that money in circulation and spending power would be boosted if the states were able to resume full payment of their employees’ salaries and pensions.
The impact of the FGN’s debt relief has been limited. BudgIT, the independent fiscal research body, estimated that in June this year 20 of the 36 states were still in arrears of some description on their payments. We have turned therefore to the 2017 edition of its State of States report in search of an explanation. We welcome the report for its pulling together of data from selected sources, although not the CBN, and for the snapshots on each state with suggestions on where they might be able to help generate investment, which should eventually create internally generated revenue (IGR) for their use.
These BudgIT reports are best known for the fiscal sustainability index. Because these are useful indices, unlike several in circulation, state governors sit up and take notice at the placing of their states. A low position in the league table should prompt them to complain to BudgIT and, if possible, rebut the findings.
For this column, our interest in the report lies in states’ debt obligations. The debt mountain of Lagos State looks huge in isolation: N735bn at end-2016, consisting of N312bn naira-denominated and N423bn in fx debt. The mountain looks less daunting when we study its constituent parts. The fx debt is more than six times that of any other state but is all due to multilateral and bilateral agencies at below-market rates. We should add that all external debt of states is guaranteed by the FGN and therefore subject to greater scrutiny, we suggest, than that of loans from commercial banks.
We should also allow for the fact that Lagos State has borrowed N215bn domestically in the form of bonds. This issuance has to be approved by the Debt Management Office and the Securities and Exchange Commission, so our point about scrutiny above again applies. Lagos is the only state government to issue bonds that the offshore portfolio investor would consider buying. Further, external ratings agencies have Lagos State on a par with the FGN and it will soon have access to the 13 per cent derivation formula as an oil-producing state.
The debt service on such bonds is deducted from the monthly statutory allocation by the FAAC in the form of irrevocable standing order payments. The BudgIT report shows that the net allocation to Lagos averaged N490m in January-July 2017. This would be alarming were it not for the fact that the state collected an average of N25bn per month in IGR last year. In contrast, the report also shows that the average net allocation to Osun State was negative to the tune of N180m in the same seven-month period. In this case IGR in 2016 averaged just N700m.
The FGN could ease the fiscal pressures on states and help to clear their arrears if it agreed to an increase in the 5 per cent standard rate of VAT. A doubling of the rate would still leave Nigeria below the level set by the Economic Community of West African States, of which Nigeria is a member. VAT payments into the federation account amounted to N87bn in August (distributed in September) and the states’ aggregate share (net) totaled N42bn. It appears, however, that a rise in the standard rate is one of the red policy lines drawn by the presidency. The commentary in the 2018-2020 Medium Term Expenditure Framework stresses that the focus for VAT collection remains coverage and compliance but says that a change to the rate is a possibility in the medium term, which we take to mean after the elections.
The deep flaw in Nigerian federalism is that only a handful of states are close to enjoying fiscal autonomy. This was not always the case. Under the purest form of federalism, the states receive all revenues and transfer to the central government what they (the states) consider necessary to meet shared obligations such as defense and foreign policy. Given Nigeria’s post-independence history, this would be hard to sell.
India has a diluted form of federalism where corporation tax is paid to the central government and the states levy indirect taxes. As elsewhere, there are discrepancies in wealth and economic development across states but they all have viable and taxable economies. Nigeria has more states than India (29 plus seven union territories) but one sixth of the population. Many are not viable fiscal units for the foreseeable future. We can blame the distortion created by the discovery of oil and we can hope that further state creation is off the agenda. Looking ahead, we have to recognize the long haul ahead for the majority sitting in the lower reaches of the BudgIT sustainability index.
Head, Macroeconomic & Fixed Income Research
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