Nigeria’s accumulated government debt is just 18.6 per cent of its annual economic output, one of the lowest levels in the world, implying that its debt burden is more than manageable.
But is this a fair reflection of reality? Using a different metric, the Nigerian government’s gross debt is 320 per cent of its annual revenues, according to figures from Fitch Ratings, one of the highest figures in the world and comfortably above the median of 196 per cent for countries in Africa and the Middle East that are rated by Fitch.
The striking disparity stems from the fact that the Nigerian federal government’s annual revenues are a pitifully low 5.3 per cent of gross domestic product, well below an average of 44.5 per cent in the developed world and even the 25.8 per cent seen across Africa and the Middle East, according to Fitch’s data.
Bangladesh has the next lowest ratio of the 115 countries rated by Fitch, at 10.4 per cent. This, in turn, is related to the gargantuan size of Nigeria’s unregulated and untaxed informal economy. An IMF working paper released this month estimates that, between 2010 and 2014, Nigeria’s informal economy accounted for 65.1 per cent of the country’s GDP, by far the highest level in sub-Saharan Africa, as the first chart shows.
Divide Nigeria’s government debt burden by the remaining 34.9 per cent of its economy, the only part it can tax, and its debt/GDP ratio jumps to a far less comfortable 53.5 per cent.
“Nigeria looks exceptionally positive if you look at its debt/GDP ratio, compared to the median [50.6 per cent for Fitch-rated African and Middle Eastern countries], but it’s debt/revenue ratio is significantly higher, and that’s because it has a very large informal economy,” says Jan Friederich, a senior director in the sovereigns and supranational group at Fitch.
“It’s always striking to see the level of government revenue in Nigeria about GDP, which is very small.” While Nigeria is an outlier, John Ashbourne, Africa economist at Capital Economics, a consultancy, fears the large role the informal sector plays in many African economies means the standard debt/GDP measures paint a “flattering picture”.
“The small size of formal economies has significant implications for sub-Saharan Africa’s debt outlook,” he says.
“The region’s public debts are small compared with notional total output but are much more worrying relative to the size of the formal economy that governments could more easily call upon to meet their financial commitments.
“Firms and workers in the informal sector do not pay direct taxes, though they still consume government services. For the foreseeable future, the size of the formal sector is probably a better gauge of government’s available fiscal resources than the larger, but mostly inaccessible, total GDP.”
Mr Ashbourne’s calculations paint a more sobering picture of the debt burden in many African states, as shown in the second chart. In Mozambique, where the IMF paper estimates that the informal sector accounts for 36 per cent of GDP, the debt/GDP ratio jumps from 115.2 per cent to 180.4 per cent when expressed as debt/formal GDP. Similarly in Angola, with an estimated informal economy of 49.6 per cent of GDP, the debt burden rises from 71.9 per cent to 143.5 per cent.
Tanzania, with the second-largest informal sector in Africa – some 52.8 per cent of GDP, according to the IMF – sees its ratio surge from 39 per cent to 82.8 per cent. Charles Robertson, chief economist at Renaissance Capital, a Moscow-based investment bank with a focus on emerging markets, believes this approach has validity. The leap in Nigeria’s debt ratio from 18.6 per cent to 53.5 per cent under the adjusted measure, for instance, “helps explain the problems Nigeria is having”.
“Nigeria is going to have a harder time servicing a debt burden of 17 per cent of GDP than Ghana [at 72 per cent of GDP] because they are not collecting much regarding revenues at the federal government level,” he says.
“For every 100 nairas they raise in tax revenues they are paying 67 nairas in interest, plus 90 nairas in wages. That is a good explanation as to why their budget deficit is as big as it is.” He notes that while Nigeria increased its official GDP reading by 89 per cent in 2014 as a result of a statistical revision, thereby improving its debt metrics, “what didn’t change was government revenues”.
Andrew Jones, one of the authors of the IMF paper, has one caveat to Mr Ashbourne’s approach, observing that those employed in the informal economy will spend some of their income in the formal economy, yielding indirect tax revenues for their government. But he agrees that a debt/formal GDP measure is, overall, probably a better guide to assessing debt sustainability than the traditional debt/GDP metric.
Likewise, Mr Friederich believes it is “an interesting exercise”, although he argues the best single measure in countries with a large informal sector is the debt/government revenue ratio, as illustrated in the third chart.
This measure, he says, is a major reason why emerging market countries often have worse credit ratings than developed countries with similar levels of debt/GDP, a discrepancy that often sees rating agencies accused of bias. Mr Robertson also favours the use of debt/revenue ratios.
He argues that the existence of large informal sectors means that traditional debt/GDP measures should come with a “health warning”, although the broadest measure of GDP may be the most relevant one for, say, a consumer goods or telecoms company trying to get a handle on how much business they can do in a country.
Informal economies are not only found in sub-Saharan Africa, of course. According to the IMF paper, informal sectors are estimated to account for 17 per cent of economic activity in rich OECD countries and 23 per cent in Europe – comfortably below the unweighted average of 38 per cent they found in Africa but still meaningful.
Matters are worse in South Asia, with an average of 34 per cent, while in Latin America informal sectors typically account for 40 per cent of GDP, higher than in Africa. Why this is so, given the higher level of development in Latin America, is not entirely clear.
Mr Friederich speculates it could be due to the importance of natural resources in many Latam economies, with the IMF paper having noted that African oil exporters tend to have larger informal sectors than non-oil economies.
“Countries that have strong oil revenues may put less emphasis on building and expanding their non-oil tax-raising ability,” he says.
Mr Jonelis speculates that Latin America’s large informal sectors might be related to these countries’ relatively high tax burdens, which again he and his colleagues found to be something that encourages more economic activity to remain in the informal economy.
Either way, it suggests a measure of caution when using debt/GDP metrics to assess the creditworthiness of heavily indebted Latin American countries.
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