FG’s deficit monetisation may raise macro-stability risks — Analysts at Fitch Ratings
The federal government repeated recourse to its Ways and Means facility (WMF) with the central bank (CBN) highlights weaknesses in public finance management, says Fitch Ratings.
Sustained use of direct monetary financing could raise risks to macroeconomic stability – given the current weak institutional safeguards – but we expect the federal government to reduce its use of the facility in 2021.
The federal government directly borrowed 1.9per cent of Gross Domestic Product (GDP) from the CBN to fund its fiscal deficit in 2020, estimated by Fitch at 3.6per cent of GDP. A number of emerging markets resorted to central bank deficit financing in 2020 against a background of urgent spending needs and temporary market dislocations associated with the coronavirus pandemic. However, the use of central bank financing in Nigeria predates the pandemic shock.
We estimate that the balance of the government’s WMF with the CBN was around N9.8 trillion (6.7 per cent of GDP) at end-2019, up from N5.4 trillion (4.2 per cent of GDP) at end-2018. Unlike the government, we include this balance in our metrics for Nigeria’s government debt. Borrowing from the facility accounted for 30 per cent of the FGN’s debt at end-2019, on our estimates.
Repeated central bank financing of government budgets could raise risks to macro-stability in the context of weak institutional safeguards that preserve the credibility of policymaking and the ability of the central bank to control inflation.
The CBN’s guidelines limit the amount available to the government under its WMF to 5% of the previous year’s fiscal revenues. However, the FGN’s new borrowing from the CBN has repeatedly exceeded that limit in recent years, and reached around 80% of the FGN’s 2019 revenues in 2020.
The CBN’s guidelines require borrowing under the WMF to be repaid in the year in which it was granted. The government has stated its intention to securitise balances borrowed under the facility, but published statistics indicate that the amounts borrowed have been rolled over repeatedly in recent years.
Data published by the government indicate that the treasury paid N912.6 billion on the facility in 2020, equivalent to nine per cent only of the outstanding balance at end-2019.
The government has opted to use this source of financing, despite ample liquidity on its domestic debt markets, as illustrated by negative real yields.
Our understanding is that its ability to borrow from domestic debt markets is constrained by the authorisation granted by parliament in the budget law. The repeated resort to CBN thus reflects higher-than-expected deficits, pointing to entrenched weaknesses in public finance management.
Fitch views the Nigerian government’s fiscal revenue and expenditure projections for 2021 as broadly realistic, which should preclude further significant borrowing by the sovereign from the CBN facility this year. The government may nonetheless use the facility more extensively if the deficit proves wider than forecast or if external financing falls short of planned amounts.
Monetary financing of the fiscal deficit raises challenges to monetary policy implementation, as tight management of domestic liquidity is a key tool under the CBN’s policy of prioritising the stability of the naira. It could also complicate official efforts to bring inflation back under control.
High inflation in Nigeria is a credit weakness. Nigeria’s consumer prices rose by 15.7 per cent year-on-year in December 2020. However, at present, we view inflation as being driven primarily by cost-push factors – including restrictions on access to foreign exchange for imports, the impact of border closures on trade, hikes in minimum wages and VAT, and the removal of the fuel subsidy – rather than overly loose monetary policy.
