Following the release of the weak Q2’19 GDP growth figure (1.93% YoY), the Budget Office published its Medium-Term Expenditure Framework (MTEF) for 2020-2022 last week. The Budget Office, headed by Zainab Ahmed-Hon. Minister of Finance, Budget and National Planning-also included a review of the 2019 budget performance between January and June 2019 in the new MTEF document. In what follows, we discuss the highlights of the budget performance review and delineate our thoughts on the new fiscal projections for 2020-2022.
2019 Budget Implementation Review (January-June)
Oil is likely to remain a drag on FG’s revenue in FY’19 despite recent price spikes
- In line with expectation, oil revenue underperformed Nigeria’s ambitious budget estimate by c.41.0% in the review period. For context, the weaker oil revenue collection was enough to erode sustained improvements in non-oil revenue and drive a c.30.0% underperformance in total Federal Government (FG) revenue collection relative to prorated 2019 budget target of N1.54 trillion. In our view, the weaker than expected oil receipt reflected the difficulties associated with efforts to ramp up domestic crude production (c.2.0mbpd in H1’19) to the desired budget level of 2.3mbpd. Although average oil price remained enviably above budget benchmark of $60.0 per barrel by 20.0%, with the associated surplus likely to be directed to the Excess Crude Account (ECA) 1 , production weakness resulted in a 41.0% shortfall (actual: N900.0 billion vs prorated budget projection: N1.5 trillion) in retained oil revenue. We expect average oil production to remain around 2.0mbpd in 2019E on slow reform progress and frequent disruptions. Thus, while the recent shocks in oil prices, occasioned by severe attacks on Saudi Arabia’s operations, create scope for slight increases in ECA, ‘endogenous’ production concerns are likely to leave actual oil receipts significantly lower than projections in 2019E.
- Non-oil revenue exceeded pro-rata budget estimate by 4.7% (N614.6 billion vs 587.2 billion), largely due to the 33.7% positive variance in actual customs revenue generated. Non-oil revenue growth was also aided by the 3.0% positive variance in company income tax (CIT). We believe that the marginal improvement in tax revenues may be likely due to 1) the traction gained in the use of automation to drive collections; 2) the 43.6% YoY increase in imports occasioned by higher imports of manufactured goods and machinery & transport equipment; as well as 3) to a lesser extent, the recent increment in customs duty exchange rate from $306 to $326 effected in June. Given the current run rate, non-oil revenue is likely to outperform government projections in FY’18. Notably, Nigeria’s import duties on finished manufacturing goods(c.20.0%) are likely to increase in line with manufacturing imports.
- We highlight that there was no reported capital expenditure (CAPEX) in the review period, even though budgeted CAPEX (pro-rata)stood at N1.1 trillion. To our minds, the lack of expenditure on capital projects was likely due to increased focus on political activities and electoral campaigns in the first few months of the year as well as the delayed passage of the 2019 budget. The FG has, however, stated that c.60.0% of the capital allocation for 2019 will be rolled over into the next year.
- In contrast, recurrent expenditure exceeded the pro-rata budget estimate by 32.6% at N3.2 trillion, with non-debt recurrent spending overshooting the FG’s target by 21.1% at N2.1 trillion. The increase in recurrent expenditure was mainly driven by higher personnel costs which accounted for 55.0% of total non-debt recurrent spend. Debt service costs also surpassed pro-rata budget expectations by 18.1% at N1.1 trillion.
- Overall, while total actual revenue fell short of budget estimate by approximately N872.7 billion, the variance in actual expenditure was less than half that of revenue at N410 billion (10% less than budgeted spending). This suggests a higher budget deficit of over N400 billion and may have necessitated the government’s ramp-up in borrowing during the review period.
Medium Term Expenditure Framework 2020-2022 Highlights
- Despite largely flat GDP growth of 2.0% in H1’19 (FY’18: 1.9%), the FG retained its growth assumption of 3.0% for FY’19 pending the release of the Q3’19 GDP report. Growth assumptions were, however,revised lower for 2020 (previous: 3.6%; revised: 2.9%) and 2021 (2021: previous: 4.5%; revised: 3.4%). Irrespective, Nigeria’s economic growth has hovered around 2.0% since the recession of 2016 and is likely to remain around this level unless more growth-inducing measures and key structural reforms are implemented.
- The benchmark oil price per barrel was also revised downwards from $60.0/bbl in 2019E to $55.0 in 2020E. This is in recognition of a possible supply glut in 2020E and beyond, predicated on expectations of higher oil output by non-OPEC+ producers by more than 2.0mbpd per year according to major oil forecasters, including the Energy Information Administration (EIA). We believe the impact of the attack on Saudi Arabia’s oil installation is likely to be short-lived, with OPEC and non-OPEC forces likely to increase output to make up for the shortfall in Saudi’s output and ensure a stable market.
- The exchange rate projection was held steady at N305/$, while the inflation rate assumption was increased for 2020 (previous: 9.4%; revised: 10.8%) to reflect potential upside risks. In our opinion, the incoming 33.0% hike in electricity tariffs, together with the possible implementation of higher VAT tariffs (from 5.0% to 7.2%) and stricter enforcement of border controls will likely drive inflation beyond the budget estimate of 10.8%.
“Over ambition” seems to have shifted from oil to non-oil projections
- In line with the revised oil price and production assumptions, MTEF 2020-2022 projects a decline in oil revenue from the current 2019 budget estimate. However, total revenue is forecast to rise steadily over the same period, aided by strong non-oil revenue growth projections for 2020, 2021, and 2022. While we recognize the progress made on tax revenue retention in the last two years, we note that the hike in the MTEF non-oil revenue projections appears incommensurate with disclosed tax revenue generation plans such as the proposed increase in VAT. Instead, budgeted non-oil revenue appears to be bloated by stronger protections on the ‘special’ non-oil revenue front. Indeed, of the total budgeted non-oil revenue for 2020, the tax-related component accounts for only c.33.0%, with the balance coming from other non-tax revenue sources. For context, these special revenue items (such as FGN balances in special levies accounts, FGN share of the actual balance in special accounts, signature bonuses/renewals and domestic recoveries)account for 38.6% of non-oil revenue and 25.7% (N1.8 trillion) of total projected revenue in FY’2020. Interestingly, these line items have collectively failed to contribute more than 1.0% of non-oil revenue in each of the last three years. Besides, details on how and why the government expects to generate huge sums of money from such avenues, where they have not recorded previous successes, remains to be seen. Given this precedent, we take a sceptical position regarding the feasibility of FG’s non-oil revenue targets as set by MTEF. On this wise, we expect higher than expected budget deficits in the next few years and an accompanying increase in debt service burden.
We see scope for advances in tax revenue and pressure on short term growth estimates
- Tax-related non-oil revenue generation outperformed budget expectations in H1’19 and is on course to surpass actual collections of N1.1 trillion in 2018 (FY 2019 annualised: N1.5 trillion) and the budgeted N1.4 trillion for 2019. In 2020, tax revenue is projected to increase by 10.4% to N1.6 trillion. This growth may be driven by an expected 44.0% increase in VAT (from 5.0% to 7.2%) and the proposed 5.0% VAT on online transactions, both of which are likely to take effect next year, all else equal. These measures reiterate the FG’s drive to boost tax revenues, partly to offset the additional expenditure burden emanating from the recent hike in the minimum wage as well as to meet its goal of improving tax to GDP ratio from 6.0% to 12.0% in the next few years. In addition to this, FG’s aggressive drive may have been inspired by c.38.0% revenue misses in the last three fiscal years.
- Overall, while we welcome the recent improvement in tax-related revenues and the potential implications on the fiscal front, we are wary that the recent introduction of measures in quick succession (such as VAT increase, introduction of VAT on online transactions, border closures, upward review of exchange rate for the computation of customs duties, and review of electricity tariffs) appear contractionary in nature and could weigh on already depressed consumer wallets in the short term. We believe that the Nigerian economy is in dire need of a boost in domestic consumption to stimulate growth, given that several key drivers of GDP such as trade and manufacturing are dependent on consumer spending. Thus, we expect the government to struggle to reach its 2.9% YoY economic growth forecast for 2020 due to headwinds to consumption.
Recurrent expenditure is projected to rise in the near term while capital expenditure is forecast to remain flat
- Budgeted recurrent expenditure (excluding debt service costs) rose from N4.3 trillion in 2019 to N4.7 trillion in 2020 and is projected to grow by N100.0 billion in subsequent years. This implies that recurrent expenditure could average about 50.0% of the total budget between 2019 and 2022. We link the increase in recurrent expenditure to higher personnel costs(+18.1%), likely driven by the implementation of the 66.7% hike in the minimum wage and related adjustments.
- For capital expenditure (CAPEX), we note that President Buhari’s administration, since 2016, had made plans to invest more resources in capital formation and as such had increased and maintained projected CAPEX spend as a percentage of the budget at c.30.0%. However, we note that the newly released MTEF reflects a downward revision in CAPEX spend to N1.7 trillion in 2020, which is a material deviation from approximately N2.9 trillion budgeted in each of the last two years. This implies that CAPEX as a percentage of the budget is set to fall from c.30.0% in 2019 to 20.0% in 2020, 18.0% in 2021 and 17.4% by 2022. While the reduced CAPEX allocation appears to suggest a shift away from infrastructure commitments, as stated in the Economic Recovery and Growth Plan (ERGP), we think that the MTEF forecasts only better reflects FG’s actual spend in the last two years (an average of c.N1.4 trillion in 2017 and 2018), which was more than double what was spent on average in each of the preceding five years.
- Overall, we believe that the downward revision in CAPEX spends highlights funding concerns for the budget, further underscored by the impact of rising recurrent expenditure and debt service costs amidst weakening revenue prospects. We are concerned that the non-increase of CAPEX budget over the duration of the MTEF projects an ominous signal for the country’s capital formation trajectory and may likely cap the upside in infrastructure-related industries if followed to the letter.
CardinalStone Research