By Godwin Okafor
Nigeria’s Kaduna State’s has been affirmed Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B’ and National Long-Term Rating at ‘A+(nga)’ with Economic Outlooks Stable by Fitch Ratings .
The affirmation reflect Fitch’s expectation of an improved revenue mix for the state, driven by declining statutory allocations, offset by improving local tax revenues and fees. The ratings also factor in the state’s fast growing debt, although servicing requirements will be moderated by government subsidies, concessionary terms and a long grace period.
They further take into account the state’s developing economy focused on agricultural and service activities and low per capita revenue by international standards. The ‘A+(nga)’ rating reflects Kaduna’s low risk relative to the country’s best risk, given strong financial and revenue support from the central government.
The Stable Outlooks factor in Fitch’s expectation that growing direct local taxes and a flexible expenditure framework will allow Kaduna to weather structurally declined statutory oil-related transfers in the medium term.
KEY RATING DRIVERS
Weak Institutional Framework Like other Nigerian states, Kaduna’s finances are affected by weak revenue predictability and high budgeted capital spending being rolled over into following financial years due to a lack of funding and limited implementation capacity. Declining transfers from the Federal Accounts Allocation Committee (FAAC) amid the oil sector down cycle provide renewed stimulus for tax revenue diversification but structural benefits may only be visible with time.
Long-term Debt Challenge Kaduna is borrowing rapidly to fund core infrastructure capex to sustain GDP growth and diversify revenue sources. Total debt at the end of fiscal year 2016 totalled NGN98 billion, or nearly over 120% of current revenue. Fitch envisages the ratio will balloon at over 300% by end-2019 as a result of increased lending manly due to drawings under a USD350 million (NGN126 billion) loan with the World Bank signed by management in June.
The loan, which carries a 20 year grace period, together with current revenues and other domestic currency loans will fund an ambitious capex programme over the next three years in the power, transport, water supply, education and healthcare sectors. Foreign currency loans are credit-enhanced by an irrevocable standing payment order issued by the central government.
However, this does not represent a full guarantee of Kaduna’s obligations. Interest charges on foreign currency debt are deducted from the statutory allocations for the states on a monthly basis. Growing IGR The FAAC is the primary mechanism for funding Nigerian states. Its process determines allocated funding levels on a monthly basis and is derived from revenues accruing to the federal government, largely sourced from the oil sector.
Kaduna remains heavily dependent on statutory allocations, mostly oil revenue, which have been declining since 2013 (NGN62 billion), down to NGN38 billion in 2016. Fitch expects that 2017 final FAAC allocations should be slightly lower for the state, as the decline structurally moved operating margins away from the 30% territory experienced before the oil price crisis in 2015.
Kaduna’s fiscal capacity is constrained by an agricultural and service-oriented economy with low tax compliance. However, the incumbent administration has enacted measures to leverage fiscal autonomy to increase local tax revenues and compensate for the declining statutory transfers.
Fitch expects that the combined effect of gradually growing IGR and stabilised statutory allocation amid a flexible operating cost profile will allow the state to produce operating margins that on average will exceed 20% in the next three years. Weak Socio-economic Profile Within the national context, Kaduna’s fast-growing population and a traditionally strong primary sector contribute to weak socio-economic standards, including growing unemployment.
Dominant agricultural and service sectors drive the economy while Kaduna’s 2016-2020 plan is focusing on the state’s rich minerals resources by attracting foreign investors to key industrial projects.
Kaduna is the third most populous state in Nigeria (185 million inhabitants as of the end of 2016), boasting a growing population of 8.1 million in 2016 and headed to reach 9.5 million in 2020 from over 8.0 million in 2015, which drives higher demand for social spending in the medium term.
Improving Transparency Kaduna’s administration is committed to improving transparency and disclosure. Fitch believes that the future transition from cash to a more sophisticated accrual-based accounting will be credit positive, as it restricts the scope for discretionary initiatives and human errors visible in the past.
RATING SENSITIVITIES An upgrade could materialise if the operating margin sustainably strengthens towards 30% and debt levels are restored to 1x the budget size. Further improvement of the local economy giving an additional boost to IGR would also be positive for the ratings.
Conversely, an operating margin below 15% or financial debt growth leading to debt-to-current revenue ratios being consistently above Fitch’s expectations could result in a downgrade. Unrest damaging economic prospects or undermining oil-related revenue could also lead to a downgrade.