Budget Speech Should be Market Neutral
Given that President Buhari’s 2018 budget speech didn’t deviate much from the Medium Term Expenditure Framework (MTEF 2018-2020), the impact on financial markets has been neutral. That said, the assumptions made, particularly on projected revenues, remain a tad ambitious and as such we see expenditure execution risks in 2018.
NGN1.7tr Budget Funding Split Equally Between Domestic and External Sources
The proposed 2018 budget deficit remains broadly unchanged at around NGN2.1tr (1.6% of GDP) with around NGN306bn being privatisation proceeds. Interestingly, authorities will attempt to split the funding balance of NGN1.7tr equally between domestic and foreign sources. The broadly unchanged net domestic funding proposal means that the yield curve should remain supported through most of 2018.
Given that the 2018 budget proposal is anchored on an exchange rate of 305 it is unlikely that the CBN will choose to engineer a convergence of the different segments within the FX market. Oil production is projected to remain broadly unchanged at 2.3m bpd, while real GDP growth is forecast at 3.5% y/y. Furthermore, the oil price benchmark is proposed to remain flat at USD45/bbl. However, it would not be surprising if the National Assembly were to increase the benchmark rate given current global oil price realities. This would be negative in our view, especially given the fact that lawmakers are now agitating for an abolishment of the Excess Crude Account (ECA).
Senate Calls for Abolishment of ECA
Agitation to abolish the ECA is certainly not new. However, such calls have traditionally come from State governors who want to enjoy the short term benefits of any rise in oil prices above the budget price, rather than save for future generations. As such, the fact that certain factions in the senate have now joined these calls is somewhat concerning. An abolishment of the ECA, which currently holds around USD2.6bn, would be negative for the prospects of further inflows into the Sovereign Wealth Fund (SWF).
NGN6.6tr Revenue Target is Ambitious
We remain concerned around the government’s ambitious revenue targets. While the authorities have outlined some planned revenue boosting reforms, including implementing the Voluntary Assets and Income Declaration reform as well as increasing VAT on ‘luxury’ goods, it is still hard to believe that these would suffice to produce the 40% y/y jump between what we anticipate will be the actual non-oil revenue collected in 2017 and the target for 2018. NGN2.4tr is budgeted for oil revenues, while NGN4.2tr is expected to come from the non-oil sector.
Meeting the NGN8.6tr Expenditure Target at Risk Given Revenue Concerns
Assuming we are correct and the authorities miss their revenue targets, it is likely that the fiscal deficit could widen more than the planned 1.6% of GDP. However, the Fiscal Responsibility Act stipulates a fiscal rule limiting the deficit to 3.0% of GDP in any given year. Should there be a need to limit expenditure, infrastructure spending plans may need to be deferred. Proposed capital expenditure makes up around 28% of the total expenditure envelope, while debt servicing takes up another 23%.
Moody’s Downgrade to B2 Not a Cause for Concern, in Our View
Given that the rating action was mainly motivated by the fact that the ‘country’s balance sheet remains exposed to further economic shocks and that interest payments as a share of total revenues remain elevated’, we argue that the action is belated. These are some of the concerns that we have warned about in previous research while the IMF and other ratings agencies have consistently flagged them for some time.
We anticipate that material changes will be incorporated in the final iteration of the 2018 budget. Specifically, we suspect lawmakers will attempt to increase the oil price benchmark, especially if international crude oil prices remain stuck in a USD58-62/bbl handle. This could result in some implementation risks should oil prices decline later in 2018.
Furthermore, given that the budget proposal has been presented slightly ahead of schedule, it may be approved earlier than usual, perhaps around the end of Q1:18. Finally, yield curve dynamics will continue being dictated by the central bank’s liquidity management stance especially as supply of NGN-denominated government paper is unlikely to rise. That being said, external borrowing will rise, starting with a possible USD2.5bn Eurobond issuance during the course of the next 4-m.