Eurobonds: Licence to Borrow

When you owe someone money, the last thing you want is for them to see you spending it. Governments, on the other hand, are expected to borrow and spend as loudly as possible for everyone to see – whether it is on transport infrastructure, or on social welfare.

But before it borrows, the Government must first decide where to borrow from; internal or external sources? As Nigeria continually seeks to increase its external debt portfolio, we must analyse how borrowing from international markets is likely to affect the economy.

Borrowing Spree

Nigeria's highly successful $1 billion Eurobond sale is the talk of the town. Despite the question marks over the presidency, the naira, and internal security, the process went so well that the Acting President is eager for another round. With so little to cheer in the last 18 months, the relatively impressive investor appetite for dollar-denominated Nigerian debt is an encouraging sign. Nevertheless, there are risks. 

With central banks in the developed world keeping interest rates near record lows in the face of sluggish economic recovery, it has been relatively cheap to borrow in the global market. After 2007, Eurobonds – sovereign debt denominated in a foreign currency like the dollar – became the "go-to" debt instrument for Sub-Saharan economies, with both Nigeria and Ghana getting in on the act. Though the commodity price crash cooled activity after 2014, an excess of $20 billion had been raised by that time. It was a sign that these countries were becoming more integrated into global financial markets.

But all that glitters isn't gold. In 2008, Seychelles defaulted on its $230 million Eurobond when a sharp drop in tourism revenue rendered it unable to repay the foreign-currency debt. 

For Sub-Saharan economies, one problem with issuing foreign-currency bonds to fund budget deficits is our dependency on commodity exports for foreign currency earnings. For example, Nigeria's reliance on oil exports cannot be overstated. But commodity prices are notoriously fickle. Unfavourable commodity prices or reduced export demand could put real pressure on their ability to service and repay foreign debt.  To combat this, externally raised funds must be managed responsibly so that Nigeria does not end up in the same situation as Mozambique's infamous tuna bonds.

Down The Rabbit Hole

The Mozambique case study is particularly relevant as they, like Nigeria, have a debt servicing ratio (DSR) above the IMF's recommended 20%. The DSR shows how much a country spends on debt repayment compared to its export earnings.

These debt repayments are important because they compete with other forms of expenditure. The proposed 2017 Budget provides some evidence for this as nearly a quarter of Federal Government spending is earmarked to repay debt, compared to just under a third for capital expenditure. Working hard to pay our creditors competes with funds that could otherwise be injected into the economy by building and maintaining public infrastructure. 

And high debt servicing costs can become a burden as debt begets debt. Countries that struggle to repay foreign currency loans are punished harshly by markets through even higher interest rates. At the extreme, this creates a cycle of indebtedness that can cripple an entire economy.

Out of Chaos Comes Order

This is why debt management is a crucial part of government borrowing activity. Borrowed funds should not be directed towards white elephant projects but to where they can be put to productive use. Unlike concessionary loans, Eurobonds do not have conditions attached to them; but these conditions often encourage good behaviour. In their absence, debt monitoring is even more important. Properly recording actual principal borrowings, repayments, and other outstanding obligations helps to avoid penalties on interest arrears. With this, the chances of debt spirals or unsustainability are much lower. 

No Such Thing as a Free Lunch

Internal borrowing has usually been the preference for Nigeria's fiscal authorities as it is seen as relatively low-risk. But over time, borrowing in the domestic market may have led to crowding out. Government debt is much more attractive to prospective lenders, and this leaves a smaller pool of loanable funds for private borrowers. The effect can be quite stark. In Nigeria today, the effective return on the one-year Treasury bill is over 20%. Naturally, private entities struggle to raise debt capital and interest rates below these levels. External borrowing could be the panacea to this. 

The Have’s and the Have-not-yet-paids

As well as the recent Eurobond sale went, caution should not be thrown into the wind. The proposed amount – $500 million – is small for Nigeria's size, but the country is also in the middle of a foreign currency crisis. And though higher oil revenues mitigate increases in external debt, this, like fame, is a fickle friend.  

Nigeria has a checkered history as an international borrower. Previous administrations have negotiated repayment plans with creditors through debt relief packages. Today, our total foreign debt is over $11 billion. Admittedly, we remain far from a situation of debt forgiveness; but new-normal low oil prices and Nigeria's poor savings position should offer some pause. So should the pace of proposed foreign debt expansion. 

Nigeria is not alone. Greece continues to tussle with its many creditors while even the U.S. and Japan sit on debt piles that account for all or more than their GDP. But these are only minor points of concern. Why? For governments, it's not really about how much you borrow. What matters is your ability to pay back. 

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