Nigerian States' Ratings Challenged by Own Revenue Generation

Nigerian States’ Ratings Challenged by Own Revenue Generation

Nigerian states’ framework of fiscal rules is evolving, due to their limited own revenue-generation capacity and developing debt and liquidity-management regulations and practices amid the devolution of a wide set of responsibilities to the states, Fitch Ratings says in a new framework report.

Most Nigerian states’ main revenue comes via monthly transfers from the central government, and these mostly depend on volatile oil-related revenue, the global rating agency said in a recent report.

It noted that transfers represent a material share of the states’ revenue and are essential to cover recurrent expenditure, while the states’ ability to mobilise internally generated revenue (IGR) and to tap liquidity sources on the market is generally limited.

States are required to provide a wide set of key public services, creating vertical fiscal imbalances that can create structural funding gaps.

The states are important in the country’s development and modernisation since they carry out a significant proportion of investments with their own resources or through multilateral borrowings with institutional lenders.

The national government dominates Nigerian intergovernmental relations, as it controls the equalisation mechanism enacted through transfers. Therefore, the sovereign rating caps the Standalone Credit Profile (SCP) of states whose SCPs are above the sovereign.

To better differentiate Nigerian states, Fitch also assigns issuer-level national scale ratings, which evaluate local issuers’ relative vulnerability to default on local-currency or legal obligations, excluding transfer and convertibility risk.

Fitch Ratings views the institutional framework for Nigeria’s local and regional government (LRG) sector as evolving due to limited own revenue-generation capacity and developing debt and liquidity-management regulations and practices amid the devolution of a wide set of responsibilities to the states.

Oil Dependence for Most States

Most Nigerian states’ main revenue comes from the monthly transfers, which consists of oil-related revenue and VAT, made by the Federation Account Allocation Committee (FAAC).

Transfers represent a material share of the states’ revenue, and their ability to mobilise internally generated revenue (IGR) and to tap liquidity sources on the market is generally limited.

The federal government of Nigeria’s (FGN) dependence on oil revenue, which represents about two-thirds of FAAC transfers for LRGs, constrains the states’ ability to implement countercyclical policies and to fully display sovereign-like features as they continue to be tied to FAAC revenue to fund basic services.

This became evident in 2020 during the Covid-19 pandemic when the FGN compensated for the drop of oil-related revenue with a USD150 million withdrawal from the Stabilisation Fund to avoid a severe decrease of the FAAC allocation to states.

Expenditure:

Vertical Imbalances States are required to provide key public services, such as healthcare and education, creating vertical fiscal imbalances that give room for structural funding gaps, generating either mounting debts or propensity to offload risks off-balance sheet.

During the recession in 2015-2016, this gap become evident and the FGN intervened by providing temporary support in the form of budget loans at favourable rates to meet salaries, contractors and pension arrears accumulated by states.

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