Kaduna State Risk Profile Vulnerable, Revenue Weaker, Says Fitch
Fitch has considered Kaduna risk profile vulnerable while the international rating agency assesses the state risk profile as weaker, according to a new report. The state is heavily burdened by borrowing which has continued to impact its budget as debt services hinder budget performance.
In the report, Fitch said that Kaduna’s fast-growing population of over 8 million residents and the traditionally strong primary sector contribute to weak socio-economic standards. It added that a large informal economy hinders private sector development, which ultimately affects the internal revenue generation (IGR) tax base.
Given the pressure to cede VAT collection to the state, some analysts told MarketForces Africa that Kaduna would be impacted, but also added that it has the capability to uptrend industrial activities that would raise VAT earnings.
“Dominant agricultural and service sectors drive the economy, although Kaduna’s development plan focuses on the state’s rich mineral resources by attracting foreign investors to key industrial projects”, Fitch said in the report.
The ratings agency affirmed Kaduna State’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B’ with a stable outlook while its National Rating was affirmed at ‘A+ (nga)’.
The ‘B’ IDR reflects Kaduna’s own payment capacity, while debt-service support from the central government through deductions from the statutory allocation is factored into the debt framework, the report said.
It said the ratings reflect that Kaduna’s revenue structure remains dependent on oil transfers despite increasing internally generated revenues (IGR). Its assessment factored in the state’s growing debt to fund necessary capital expenditure for the development of basic infrastructure and social services.
Kaduna’s issuer default ratings are aligned with the Nigerian sovereign’s and no other rating factor applies to the ratings, it said.
Meanwhile, Fitch assesses Kaduna’s Standalone Credit Profile (SCP) at ‘b’, reflecting the combination of a ‘Vulnerable’ risk profile and debt sustainability metrics in the ‘bb’ category under its rating case.
Kaduna’s risk profile vulnerability combines five factors assessed by Fitch as ‘Weaker’ including revenue robustness and adjustability, expenditure sustainability, liabilities and liquidity robustness and Flexibility.
The state expenditure adjustability was at midrange, according to the report while Fitch noted that the assessment reflects its view of a very high risk relative to international peers.
It said the issuer’s ability to cover debt service with the operating balance may weaken unexpectedly over the forecast horizon of 2021-2025 due to lower revenue, higher expenditure, or an unexpected rise in liabilities or debt or debt-service requirement.
Revenue Robustness: ‘Weaker’
In its assessment of the state’s income generation, Fitch views Kaduna’s N112 billion operating revenue as dependent on allocations of oil revenue transferred monthly from the Federal Accounts Allocation Committee (FAAC).
This represents about half of operating revenue on average, albeit declining, from 57% in 2018 to around 40% in 2020, the ratings added.
It also noted that 2020 FAAC allocations suffered from the sharp decline in oil, prices, which has been partly offset by the national government with draw-downs from cumulated reserves, mitigating Kaduna’s transfer decline at -9%.
The report noted that Value added tax is collected by the central government and allocated to the states through the FAAC, remained stable at around 16% of the state’s operating revenue.
“Kaduna is making major improvements in its IGR collection mechanism”, Fitch said.
IGR grew by over 50% in 2019 from the figure reported in 2018, but the pandemic slowed Kaduna’s efforts to boost IGR in 2020, which grew by a modest 1%. It was noted that Kaduna allowed for some tax incentives during the pandemic, including grace periods and minimal tax discounts.
Fitch then said even under a scenario of a stressed economy, it expects Kaduna to resume the positive trend of IGR and envisages tax revenue growth of 10% on average in 2021-2025, partly offset by sluggish oil-related revenue.
Revenue Adjustability: ‘Weaker’
According to the report, Kaduna’s revenue potential depends on the state’s ability to expand its tax bases, in terms of broadening the pool of taxpayers and enforcing tax compliance.
The main fiscal revenues are pay-as-you-earn taxes, for which Kaduna cannot set the tax rate, and land charges, for which Kaduna is implementing measures to expand the tax base.
The ability to enlarge the pay-as-you-earn tax base is limited by the population’s low level of income, with over 50% living below the poverty line.
Expenditure Sustainability: ‘Weaker’
Again, the ratings see expenditure suitability as weaker, having been cushioned with borrowings amidst fiscal slippage.
“Kaduna’s varied set of responsibilities ranges from education (25%), healthcare (15%), economic development (over 15%), energy and environment (around 8%).
“Past expenditure dynamics show a good record of cost control, with operating revenue and expenditure growing at the same pace on average in the last 10 years, around 7%-8%”.
Fitch reveals the expectation that the spending will outpace revenue growth in the medium term, in a rating scenario of a prolonged economic downturn.
“The operating margin will remain positive, but we expect it to halve to around 15% from the last 10-years average of above 30%, in a post-pandemic scenario of more support coming from the state for the economy and healthcare”, it added.
However, the report noted that capital spending has a key role for Kaduna in its efforts to transition the local economy to a more developed stage and to grow the local tax base.
Expenditure Adjustability: ‘Midrange’
There are no mandatory balanced budget rules defined by the central government for states, which are required to keep their deficits at 3% of national GDP.
Fitch said Kaduna’s cost structure is moderately flexible, as an average of 40% of expenditure is capital expenditure, which is largely financed by the operating balance and can be delayed in case of need, as was the case during the last recession in 2015-2016.
“During 2020, Kaduna’s operating costs declined sharply after a 50% cut in overheads as a consequence of the fiscal tightening implemented by Kaduna’s government to cope with the pandemic, counterbalancing the salary growth that followed the minimum wage increase implemented by the national government back in 2019.
“We expect operating expenses, and in particular overheads, to catch up from 2021 onwards”.
Fitch considers that expenditure reduction is moderately affordable, given the high potential to increase the existing level of healthcare and infrastructure services, while enhancements in the procurement process could improve expenditure allocation.
Liabilities & Liquidity Robustness: ‘Weaker’
On the liability and the state’s liquidity position, Fitch said the national framework for debt is evolving and borrowing limits are quite wide.
It added that there are no restrictions on debt maturities, interest rates or currency exposure. Over 90% of Kaduna’s debt is served from deductions from the statutory allocation, including loans with local banks for salary bailouts, while the remaining part is made up of intergovernmental loans.
At end of 2020, 80% of Kaduna’s N262 billion adjusted debt, when including pensions and contractors’ arrears, was in foreign currency. The ratings noted that the sharp increase in debt came after the disbursement of a US$350 million loan from the World Bank.
“The historical average cost of debt is below 1% for multilateral foreign debt, while domestic debt carries interest rates around 10%. Kaduna’s debt amortisation profile is smooth with long maturities and sustainable debt service below 1x the operating balance”, it explained.
On liabilities and liquidity flexibility which the report considers as Weaker, Fitch deems Kaduna’s liquidity as weak as the state has no committed liquidity lines. It cited that domestic banks rated in the ‘B’ category tend to extend credit lines either with short maturities or with Federal Government of Nigeria (FGN) backup through direct deductions from the FAAC for longer maturities.
“Fitch prudentially considers cash as restricted for payables”.
It said emergency liquidity may also come directly from the federal government, as was the case in 2015-2016, with the Budget Support Facility helping states tackle pressures due to liquidity shortfalls, supporting payment of salaries and pensions.
On the state’s debt sustainability, in its rating scenario of a prolonged economic downturn, Fitch expects Kaduna’s debt-to-operating balance (payback) ratio to sharply increase above 20x (2020: 5.4x) incorporating the effects of an economic downturn.
Fitch expects some volatility in the payback ratio in 2021-2022 due to fluctuating oil-related transfers from the Federal Government and operating spending catching up after the sharp decline in 2020 during the pandemic.
It said fiscal debt burden measured by net adjusted debt/operating revenue – could move to above 300%, while the operating balance would cover Kaduna’s actual debt service by 1x.
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Kaduna State Risk Profile Vulnerable, Revenue Weaker, Says Fitch
