A second look at Nigeria’s debt swap strategy

by | March 5, 2018 1:21 am

The Federal Government’s US$2.5 billion Eurobond offer closed on 23 February. It was highly successful with investors placing an order book totalling US$11.5 billion and the federal government restricting its acceptance to the US$2.5 billion it had gone to the market to raise. The US$2.5 billion commercial debt is broken down into two portions. The first part is made up of US$1.25 billion debt repayable in 12 years and attracting interest rate of 7.143 percent per annum. The second part is also US$1.25 billion but repayable in 20 years and attracting an annual interest rate of 7.696 percent.

Unlike the previous Eurobonds raised by the federal government, the Debt Management Office (DMO) is quick to point out that this bond is different. It is not really an additional debt in the true sense of the word. It is more of a debt swap where the DMO is borrowing from the international capital markets at a cheaper rate to pay down on more expensive domestic debts.

So, the US$2.5 billion new Eurobond issue will go into the repayment of an equal amount of maturing treasury bill obligations which could amount to about N763 billion based on the official exchange rate of N305 to a dollar. This is not the first time the DMO is doing this type of debt swap on behalf of the federal government.

Towards the end of 2017, the DMO had reserved about US$500 million of the US$3 billion it raised from a Eurobond issue in November 2017 to pay down maturing treasury bill operations. This resulted in the DMO redeeming a total of N198 billion in treasury bills that matured in December 2017. The usual practice before then was to allow these treasury bills roll over, which meant taking on a new domestic debt to repay the maturing debts, sometimes at higher cost.

The DMO has offered two very strong reasons why it is engaged in this new debt management strategy of replacing domestic commercial debts with foreign commercial debts. The first reason has to do with the short term nature of the government’s treasury bill obligations. Treasury bills have tenures ranging from an average of three months to one year.

This means that the government is forced to refinance them at short term intervals. This is not the case with the Eurobond debts. The Eurobonds that are being used to replace the treasury bills have tenure of 10 years to 30 years. The government would therefore not be concerned about refinancing it in the short term. This eliminates any short term interest rate risks and creates a level of certainty about government financing.

The other reason advanced by the DMO in replacing domestic debt obligations with foreign debt obligations has to do with cost. The average yields or interest rates on the 364-day treasury bill was as high as 22.91 percent in most parts of 2017 before declining to about 16.15 percent towards the end of last year. Average yields or interest rates on government treasury bills remain about 15 percent which is almost twice the yields on the Eurobond issues. Eurobonds are therefore cheaper and the government wants to take more of it to replace the costlier short term domestic debts. Kemi Adeosun, the Minister of Finance has actually stated earlier this year that the swap could save the government as much as N64 billion in interest payments per annum.

There are also secondary reasons for the government’s debt management strategy. It is hoping that by reducing its demand for domestic debts, more money will be left over for corporates and even individuals to borrow from the banks. Many banks have been feeding fat on the high interest rates the government was offering on its debt securities, sometimes accounting for as much as 30 percent of some bank’s earnings.

Even individuals had gotten wise and have been asking their bankers to put their money in treasury bills to enjoy the bumper risk free returns from the government. With the government reducing its borrowing, banks will now be forced to look for real businesses to loan money, which would have a positive impact on productivity in the economy.

There are also the more technical reasons of the government wanting to raise the foreign component of its total debt portfolio from around 22 percent to 40 percent in a bid to achieve what it called a 60 to 40 percent ‘optimal debt mix’. At this level, the government is hoping its debt service burden would be manageable. The DMO has also set the target of ensuring that not more than 25 percent of the total debt portfolio are short term, leaving the balance of 75 percent as mainly long term debts.

While the DMO strategy is great on paper, it is also coming with significant risks. The first obvious one is the foreign exchange risk. The interest rates on Eurobonds are paid in dollars, which is why they are very attractive to foreign investors who bear no significant risk in holding them. The dollar liability of interest payments puts a higher burden on the Central Bank of Nigeria (CBN) to maintain naira stability not only in the short run but also in the long run as any depreciation in the currency will translate into higher borrowing costs for the government.

But the challenge for the CBN is that long term naira stability is not completely within its control. With the economy highly dependent on export earnings from crude oil sales, international oil prices and stability in the oil producing region of the Niger Delta has more impact on long term naira stability than the CBN.

For now, the government would enjoy lower interest rates on its overall debt portfolio but that could change quickly if oil prices crash and export earnings drop which forces the CBN to weaken the currency. Sadly, the risk of this scenario happening is high which questions the pursuit of this debt management strategy in the first place.

Would it have paid us more if we had borrowed US$3 billion to rebuild our railway infrastructure than just replace debts? At least, a railway could have repaid the debt over the 30-year period.  This is a question that would haunt us if the risk of a weaker currency wipes out the short term gains of the current debt swap strategy in the long run.


Anthony Osae-Brown