Limited budget forces to find ingenious financing options for infrastructure development
Nigeria’s infrastructure, currently valued at around 35% of the country’s gross domestic product (GDP), is widely seen as dilapidated and inadequate. By comparison, larger, more developed economies typically have an infrastructure base approaching around 70% of their GDP. This represents a huge funding gap for Africa’s largest country in investment projects such as roads, bridges, rail freight, ports, schools, hospitals, power grids, piped water , housing, broadband or internet coverage, etc. A report published in 2017 indicates that an injection of around $100 billion per year is needed over the next 6 years to provide decent quality infrastructure in Nigeria.
Using the 2022 budget as an index, with the total allocation including capital and other expenditures having been set at N16.39 trillion, it is evident that the disparity in infrastructure will continue to widen. This gap is further widened by the underperformance of the budget, ie the government does not meet its estimated revenues. The federal government is therefore forced to engage in heavy borrowing to fill the gap in order to meet a miniature of its infrastructure needs. Reports from the Ministry of Finance indicate that debt service obligations to our creditors engulfed 97% of the total revenue of the Nigerian government in 2020. This means that the federal government earned 4.39 trillion naira in 2021, of which the sum of 4.22 trillion naira was used in servicing its debt.
So, while African countries and those in other emerging markets have traditionally struggled to secure sustainable infrastructure financing, Nigeria now faces an imperative: to adopt an innovative way to finance growing infrastructure needs with indebtedness. minimal or stay in the black. age.
Nigeria Infrastructure Financing Framework
The Nigerian government currently finances the majority of its infrastructure projects through budgetary allocations, debt instruments (such as conventional bonds and Sukuk) and loans. Of the three, budget allocations represent the largest source of infrastructure spending. The 2022 budget allocations show that infrastructure projects received 1.45 trillion naira, or 8.9% of the total budget. But ironically, unrealistic budget allocations have resulted in the country’s huge physical infrastructure deficits. In most cases, if the Federal Government of Nigeria (FGN) is unable to raise the expected revenue to meet the capital projects budgeted, these important infrastructure projects are simply abandoned without consequence. .
Debt instruments such as domestic, Sukuk, euro or sovereign bonds would normally be considered a reliable source of funds, but for two limiting factors. First, although the underlying projects to which some of these funds have been applied have the potential to generate revenue, the government refuses to generate such revenue to service its debt. None of the roads built with funds generated from sukuk bonds were subject to tolls and this may be due to the socialist stance of the federal government. The other limiting factor is the cost of borrowing. The remodeling of the Nnamdi Azikiwe International Airport in Abuja and the reconstruction of airports in Lagos, Port Harcourt and Kano were financed by a $500 million loan from the Chinese government. The loan is subject to a seven-year moratorium; however, interest payments total $113.9 million (approximately N18.23 billion or in simple terms an interest rate of 22.78%).
It’s time to think outside the box – Securitization for infrastructure financing
It is imperative to seek more innovative and secure ways to finance Nigeria’s infrastructure development. Securitization could well provide a solution.
Securitization is a process that allows a company, financial institution or government to use its revenue streams from underlying assets to raise finance on better terms than it could otherwise obtain through traditional (debt) financing models. For example, one entity – the Railway Company of Nigeria (known as the Originator), expects to generate US$100 million in 10 years from the sale of its tickets. The private sector, represented by a sophisticated and tailored institution (also known as a special purpose vehicle, SPV) that acts as an agent of the private sector can lend (in legal and tax parlance this is represented as a sale) the railroad company 80 million dollars. The SPV will increase this debt by issuing “I owe you a note”, also known as bonds, to the private sector. The money raised is loaned to the railroad and in return the railroad transfers or assigns all future cash flows, otherwise due to the railroad, to the SPV. This will pay off the debt owed to the private sector.
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Two obvious and immediate benefits flow from this mode of financing: first, the railway company has the sum of $80 million to build more railways. More importantly, the risk of cash flows not materializing is also transferred to the private sector. The risk of default falls largely on the private sector with, of course, a cost. The implication being that this debt is owed to the private sector not by the railway company, but rather by the customers of the railway company. In economic jargon, the debt is said to be off the railroad’s balance sheet and indirectly off the federal government’s balance sheet. This frees up a budget allocation which can then be used for other purposes. There is also a salient benefit, being that with a substantial contribution of private sector funds, the railway company is compelled to use these funds wisely, allowing for a refreshing level of accountability.
Securitization is slightly more complex than that depicted above and involves a number of features that are essential to its success. An important feature of securitization is that the originator (ie the entity selling its receivables) does not actually borrow. On the contrary, he sells his cash flow which would have naturally accumulated in the future. To make this an attractive investment, the underlying assets must have a track record, otherwise some form of credit enhancement (guaranteed by the railway company) will be adopted to increase the creditworthiness of the “I owe you tickets” ( obligations). Moreover, the SPV is configured in such a way that the assets are only dedicated to the repayment of the bonds. As stated earlier, the initial proceeds from the sale are paid to the Offeror which can then be used to offset other operating or capital investment costs. Ultimately freeing up capital for even more projects.
How exactly can securitization reduce Nigeria’s infrastructure deficits?
Beyond generating capital on the back of existing cash flows, the beauty and appeal of securitization is that it could be used to develop new projects, predicting borrowing on cash flows existing and future cash flow. These cash flows can be calculated and based even on projects that have not yet seen the light of day.
Securitization has the multiple advantages of providing readily available capital, as well as minimizing the debt portfolio. The possible bankruptcy of the initiator (the railway company) will also not affect the covered SPV, nor the receivables that will be used to reimburse these investors. The sustainability of cash and its guarantee are, from a practical point of view, now in the hands of the private sector. So in the extreme, it doesn’t matter how badly run and mismanaged the railroad company is. In a way, separate railway lines that have been privately funded are structurally subject to separate management.
That Nigeria needs to invest heavily in infrastructure to achieve economic growth is no longer up for debate. To finance these projects, the country cannot afford to persist on the path of traditional debt financing, budget allocations and debt issuance, all of which are insufficient, given its fiscal realities. Creativity and innovation are badly needed, and securing might be the obvious solution the country has ignored for so long.
To develop a resilient and attractive securitization market, Nigeria will need to move quickly and carefully to establish the legal and regulatory foundations for securitization. There are three key areas that will need to be addressed. The appropriate tax treatment must be applied so that a securitized structure does not turn out to be more expensive than a traditional loan. Second, the appropriate and applicable accounting treatment should be given the utmost importance. Indeed, in many parts of the world, separate accounting rules are designed specifically for financial institutions that intend to securitize their assets.
Finally, the country’s legal structure must be able to distinguish between traditional borrowing and funds raised through securitization. This distinction is essential if the balance sheet of the originator (Railway Company and indirectly Nigeria) is to remain open or unencumbered. As a result, the funds raised by a well-structured securitization program should be used as intended, but certainly not to repay debt. (It is the underlying cash flow that is designed to pay debts). The Nigerian legal system, based on English common law, recognizes and accepts this distinction, albeit a fine one. Nevertheless, to remove any doubt about this distinction and to take account of other nuances, legislation has since been proposed and is awaiting a vote by the National Assembly.