Lagos Foreign Debt Burden Rises Sharply Over FX Reform
Amidst sustained borrowings, Lagos State debt stock has been projected to worsen in 2023 as a result of the devaluation of the naira in June. Lagos continues to lead the pack among top sub-national borrowers even with its huge internally generated revenue.
Data obtained from the Debt Management Office (DMO) showed that the Lagos government’s domestic borrowings settled at N812.383 billion in the first quarter of the year.
However, the state government has $1.250 billion in foreign currency exposure to multilateral lenders ($1.149 billion) and a bilateral arrangement of $101.5 million as of December 2022.
All the 36 states and federal capital territory combined foreign currency exposures settled at $4.456 billion in 2022. Lagos state accounted for 28% of the total exposures to multilateral, bilateral, and other foreign creditors, the DMO update showed.
The exchange rate has moved from N448 the state used to convert its foreign currency exposure last year to above N700 per United States dollar six months toward the end of the year.
Despite growing earnings sources, apart from the Federal Accounts Allocation Committee monthly disbursement, Lagos has the largest borrowings among other sub-nationals.
This has continued to boost the cosmopolitan city’s infrastructural development which is estimated to hit N3 trillion. However, state infrastructural spending is yet to meet the expectations of the fastest growing state.
“Fitch estimates a N3 trillion capital expenditure plan in the medium term, largely funded by the state’s own resources and new borrowing.
“Lagos’s ambitious capital expenditure plan aims to speed up the completion of several infrastructure projects and to boost the state’s technology capacity and food security”, the rating note said.
Prudently, the state government has continued to keep its debt service at no more than 30% of operating revenue, Fitch Rating said in an update.
The state’s net Fitch-adjusted debt is expected to reach N2.7 trillion by 2027, which is equivalent to 190% of the state revenue, under a scenario in which the exchange rate remains above 700.
In its rating note on the cosmopolitan state, Fitch noted that Lagos has good access to local financial markets with repeat bond issuance. At the end of 2022, Lagos state bond issuance represented 21% of its N1.3 trillion debt.
Due to positioning advantages, the state government has easy access to liquidity lines and short-term credit from domestic banks. The state has also been maintaining cash in a sinking fund to support its debt service on bonds.
It explained that the state’s ‘vulnerable’ risk profile reflects a very high risk that the state’s ability to cover debt service with its operating balance may weaken unexpectedly over the forecast horizon between 2023 and 2027.
This may be due to lower-than-expected revenue, higher-than-expected expenditure, or an unexpected rise in liabilities or debt-service requirements. Fitch said Lagos benefits from a broad tax base and a diversified economy that contribute to a stable revenue structure led by IGR.
The state’s IGR represented over 70% of its N893 billion operating revenue at the end of 2022 and is driven by moderately cyclical taxes such as personal income tax (PAYE).
The stability of tax revenue is counterbalanced by some volatility in other operating revenue sources such as sales proceeds, rents, land-use charges, fees, and fines.
Fitch does not view Lagos as being reliant on government transfers from the Federal Account Allocation Committee, as statutory allocations (excluding VAT) represent less than 10% of Lagos’s operating revenue.
Under its rating case of a stressed economy, Fitch said it forecasted a nominal average increase in operating revenue of around 9%-10% in 2023-2027, driven by moderate economic growth prospects.
However, Fitch believes that Lagos’s fiscal flexibility relies on the wide but not fully exploited tax base of PAYE – which corresponds to about 45% of operating revenue – on which it has no tax-setting power.
It said rigid revenue sources collectively represent more than 85% of Lagos’s revenue. Lagos saw its maximum peak-to-trough revenue fall of 9%, which is equivalent to N26 billion, in real terms over the last 10 years.
This could have been offset by increasing its PAYE tax base by leveraging on Lagos’s large informal economy or by increasing revenue sources such as land use charges, according to the rating note.
However, Fitch believes that Lagos will more likely absorb possible revenue shocks by reducing its operating margin towards 35%-40% from the last five years’ average of over 45%.
On the sustainability of the state expenditure, Fitch said Lagos is exposed to a deteriorating operating environment, which weakens the state’s control over total expenditure growth, influenced by high inflation, rising commodity prices, and supply constraints amid naira depreciation.
Lagos has a wide set of responsibilities and a high need for capital spending to maintain its attractiveness as Nigeria’s main economic hub, with demographic pressures to provide more infrastructure, health, and education services, limiting the scope for cutbacks.
“We expect Nigeria’s double-digit inflation to affect the 17% operating expenses growth on average, a faster pace than operating revenue growth”.
The central government does not have mandatory balanced-budget rules defined for Nigerian states, which are required to maintain their deficits at 3% of national GDP.
The rating note said capital expenditure makes up 40% of Lagos’s expenditure before debt service, keeping the share of inflexible costs well below 70%, meaning there is some scope for adjustability.
It was noted that the state expenditure cuts are moderately affordable, owing to better infrastructure and existing services compared with national peers. However, Fitch expects Lagos will continue to maintain a high level of capex to maintain its attractiveness for companies and residents.
Nigeria’s framework for local and regional government debt is evolving so borrowing limits are quite wide, Fitch Ratings said in the update. It explained further that Nigerian states have no restrictions on debt maturities, interest rates, or currency exposure.
However, Lagos prudently keeps debt service at no more than 30% of operating revenue.
To ensure timely debt service, its internal debt is assisted by a state-level irrevocable standing payment order while external debt is serviced by deductions from FAAC.
External debt with development lenders accounted for 44% of Lagos’s total debt in 2022, exposing the state’s debt service to the fast naira depreciation observed in June 2023.
“We expect a steep rise in Lagos’s debt stock by 2023, driven by the exchange rate expected at the end of 2023 at over N700 from N448 in 2022. Fitch estimates that Lagos could hit N2 trillion debt stock by the end of 2025.
All in, Fitch Ratings affirmed Lagos State’s Long-Term Foreign- and Local-Currency Issuer Default Ratings at ‘B-‘ with a stable outlook. It said the affirmation reflects Lagos’s vulnerable risk profile by international standards and Fitch’s expectations of rising but sustainable adjusted debt.
The rating note said that internally generated revenue underpins Lagos’s capacity to service its financial obligations, as evidenced by its Standalone Credit Profile of ‘b+’. #Naira Devaluation Deepens Economic Crisis in Nigeria
