DEBT RESTRUCTURING: NIGERIA’S EXPERIENCE

YAKUBU ALIYUPortfolio Management DepartmentDMO, Abuja

A Presentation to Workshop on Debt, Finance, and Emerging issues in Finance Integration, Commonwealth Secretariat, London,

March 6-7, 2006

2

Outline

Stylised Facts and Context The Paris Club Debt Exit Strategy: Prelude The Paris Club Debt Exit Strategy: Process Uniqueness of the PC Debt Exit London Club Debt Exit Domestic Debt Restructuring Current Policy Thrusts Key Challenges Conclusion

3

Stylised Facts and Context

1973-1985: Boom and Bust External debt negligible between 1970 and 1973 1980-1982 oil slump leading to drop in oil revenues from

US$25 billion in 1980 to US$12 billion in 1982 to US$6 billion in 1986

Wasteful consumption, ‘white elephant projects, uneconomic projects, etc. E.g. of 63 projects undertaken in the 1980s for which US$2.6 billion was borrowed only one project was viable.

4

Stylised Facts and Context

1986-1992: Debt Rescheduling and Debt Reduction Paris Club

1986 first trip to Paris Club (rescheduled US$7 billion debt in arrears)

1989 rescheduled another US$6 billion of arrears and future payments

1991 rescheduled US$3 billion

London Club 1987 and 1989: Brady Plan 1992 Brady Bonds (exchanged US$5.6 billion of commercial bank

debt for US$2.1 billion of Par Bonds at a discount of roughly 60%) 1992

Nigeria’s economic policies did not meet IMF’s benchmarks IDA status a requirement for debt reduction operation Ballooning of Paris Club Debt: new borrowing, high interest charges,

penalties and arrears.

5

Stylised Facts and Context

1993-1998: The Debt Overhang Payments to the Paris Club dropped well below scheduled

amount after substantial payment in 1992. Paris Club extended no new credit, only accumulation of

arrears. New disbursements came from the multi-lateral creditors

6

Stylised Facts and Context

Table 1: Nigeria’s External Debt (US$ billions)

1985 1991 1992 1998 2004

Paris Club Creditors

7.8 17.8 16.4 20.8 30.8

Non-Paris Club

1.9 1.4 1.2 0.1 0.0

Commercial creditors

7.8 10.5 5.4 3.6 2.2

Multi-lateral creditors

1.3 4.0 4.5 4.2 2.8

TOTAL 18.9 33.7 27.6 28.8 35.9

7

Stylised Facts and Context

From 1999 debt issues elevated to high political level, raising expectations for debt cancellation.

Push for the establishment of a Debt Management Office (DMO)

Widespread sentiments on debt-preference for debt repudiation. Significant parliamentary opposition to appropriations on

debt service budget. Difficulties in debt service deduction in respect of state

governments. the notion of “odious debts” dominates public

perception: the media, civil society organisations, etc.

8

Stylised Facts and Context

Other factors that fuelled the debate on debt policy: Considerable delay in reconciliation with creditors:

application of repayment to penalties first before interest and principal.

The level of poverty in Nigeria: GNP per-capita (2003) was US$350; poverty incidence 57%; Basic infrastructure in poor shape.

MDG’s promoted by the international community. Inability to get rescheduling of the debts on concessional

terms (Naples terms); Nigeria declassified IDA-only- Finally settled for the Houston Terms in December 2000,

linked to IMF programme.

9

Stylised Facts and Context Rescheduled amount in

2000 comprised 24% late interest; 21% interest; 48% principal; and only 7% principal balance.

Position subsequently worsened since December 2000, arrears accumulated to the tune of over US$6 billion.

Cross-currency exchange risks have added over US$5 billion to the debt stock in dollar terms since 2001, due to dollar appreciation.

Nigeria - Structure of Paris Club Debt -

Decem ber 2000

Principal

Balance7%

Principal

Arrears48%

Interest

Arrears21%

Late

Interest24%

10

Stylised Facts and Context

Combined external and domestic debt service exceeded Federal Capital Budget in 2004.

$1 billion paid to Paris Club in 2004, represented 70% of total (recurrent and capital) education budget and 110% of health budget (both States and Federal).Total debt stock by December 2005 was US$36 billion with US$30.8 billion or 85.82% owed to the Paris Club.

The dominance of the Paris Club debt in Nigeria’s total external debt, the failure of rescheduling arrangements to engender debt reduction, the prospects of arrears accumulation if debt relief is not secured all combined to push for a comprehensive treatment of the Paris Club debt

11

The Paris Club Debt Exit Strategy: Prelude

Making the Case for Debt Relief for Nigeria: Strong moral, religious, economic, geo-strategic and political

arguments underpinned the quest for debt relief. Analytical work to strengthen the case for debt relief

DSA [1] conducted by IMF indicates that Nigeria’s debt is unsustainable

A World Bank study has also indicated that even with strong economic performance and high oil prices, Nigeria cannot simultaneously meet MDGs and lower its indebtedness to manageable levels without debt relief. [2]

Oil Volatility Argument IDA Reclassification

[1] IMF Debt Sustainability Analysis for Nigeria, 31 March, 2005 [2] World Bank Staff Report “Nigeria’s Opportunity of a Generation: Meeting the MDGs, ReducingIndebtedness, 5th April 2005.

12

The Paris Club Debt Exit Strategy: Prelude

Domestic front 2003: A decisive shift towards economic reform [Formulation of a Home-Grown

Economic Strategy-NEEDS]. Improved political climate and disciplined economic management

March 8, 2005: The House of Representatives passed a motion asking the Federal Government to stop repayments to foreign creditors.

International front: International developments conducive for debt reduction for middle-income

countries (Argentina, Iraq, etc.) 2003: G-8 meeting in France (endorsement of “Evian Approach” which provides

for a case-by-case treatments, with attention to national specifics, namely: financial capacities, economic situation and political dynamics).

UK chairmanship of G8 provided window of opportunity G8 meeting of Minister’s in June Paris Club endorsed G8 deal for Nigeria at extraordinary meeting (June 29,

2005) Formalised a policy Support Instrument (PSI) with IMF as basis for engaging with the

Paris Club, October, 2005.

13

Phase 1Around

September

Write-off of 67% of debt stock after

payment of arrears.

Estimated to cost about $6 billion.

Reduces outstanding debt stock to about

$8 billion

Phase 2Around

May 2006

“Buy-Back” or prepayment of

outstanding debt stock at market-related discount.

Government-to-Government, fixed,

disclosed rate.

Estimated to cost about $6 billion.

Phase 3After

May 2006

Elimination of Paris Club Debts

Total and permanent exit from debt trap.

Escape from endless spiral of

indebtedness

The Paris Club Debt Exit Strategy: Process

14

The Paris Club Debt Exit Strategy: Process

Financing the “exit” option. Why use of oil windfall? Trade-off between spending on growth and

poverty reduction or paying creditors and remaining in “perpetual debt trap”.

Judgment call-inter-generational issues; risk of oil price collapse; risk of misgovernance; risk of interest rates and penalties; risk of subjugation/political control by creditors; national pride; etc.

15

Uniqueness of the PC Debt Exit

Historic deal-write off of $18 billion Biggest debt write-off in Africa.

Previous record: Congo’s $10bill write-off. Egypt and Poland - $10-$15 bill write-off. G-8 write off for 18 HIPC countries - $40 bill.

Major obstacles had to be overcome. Odds heavily stacked against Nigeria: Reputational overhang; images of corruption and

mismanagement; Oil-rich country – 6th largest exporter. High Oil prices – Calls for windfall to be shared. Rising External Reserves

16

Uniqueness of the Exit

Unprecedented deal-massive debt cancellation. Offers a “permanent exit” option from Paris Club. Debt relief sequenced over 6 months, as opposed to

the usual 2-3 years. First ever Paris Club debt buy-back at discount. First ever debt deal not premised on a formal IMF

Programme. Home-grown development strategy as basis for engagement.

17

Post-Paris Club External Debt Profile

June 30, 2006 (in US$ million)

Debt stock down from $35 billion to less than $5 billion

Debt service payment declined to $700 million from $1.7 billion before the landmark debt deal

Nigeria's External Debtstock

Non-Paris Club, 121.04, 2%

London Club, 2022.28, 42%

Multilateral, 2704.16, 56%

18

Post-Paris Club Public Debt Profile

Total Public Debt in US$(2001-2006)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2001 2002 2003 2004 2005 2006

External Debt

Domestic Debt

19

London Club Debt Exit:

Following the Paris Club Debt Exit attention was shifted to the London Club Debts:

Par Bonds: These are mainly arrears of commercial bank term loans, also include some

arrears of letters of credit, bills for collection, etc. accumulated during the 1980s.

Issued in 1992, collateralized with US Treasury zero coupon bonds maturing in 2020

Interest rate of 6.25% paid semi-annually amounting to $90 million a year Par Bond holders were issued with additional debt instruments-oil warrants

Oil Warrants Issued along with Par Bonds. Approximately 2 million oil warrants issued along with Par Bonds in 1992

maturing in 2020. Semi annual interest payment subject to rise in oil price above reference

price of $28 consistently for 6 consecutive months, but capped at $15. Current payment liability amounts to $52.7 million per year

20

London Club Debt Exit:

Promissory Notes Issued through the CBN, resulting from uninsured short-term

trade debt, accumulated in the early 1980s. Verification exercise carried out by Chase Manhattan in the

mid-1980s. Original amount= $4,891.3million. Amount currently

outstanding=$649.8million quarterly payments totaling $170.85 million a year; to be

fully amortized/paid off in 2010

21

London Club Debt Exit:

Two options were considered:A) Repurchase

The government will make budgetary provisions for the repurchase of Par Bonds and Promissory Notes.

Use embedded Call Option to redeem Par Bonds and Promissory Notes

Raise additional resources to retire Oil Warrants after verification process

B) Restructure Launch 2 benchmark bond issues of 5 and 10-year maturity

respectively for a total amount of US$1.5 billion. Use the proceeds of these issues to redeem Par Bonds and

Promissory Notes using their embedded call options. Balance of proceeds contribute towards the retirement of Oil

Warrants given completion of verification process.

22

London Club Debt Exit: Repurchase vs. Restructure

RESTRUCTURE:

Reduces debt stock and leads to savings in terms of interest burden..

Restores Nigeria’s standing in the international financial markets and assist in securing S&P ratings upgrade.

Enables corporate Nigeria to have access to international capital markets

Creates a complete reshuffle of investor base.

Begins process of establishing a benchmark yield curve

REPURCHASE:

Reduces debt stock and leads to savings in terms of interest burden

Provides permanent exit strategy for Nigeria’s London Club debt

Allows clearing of balance sheet

23

London Club Debt Exit

The Repurchase option was eventually implemented: Outstanding Par bonds (US$1.5 billion) were prepaid

in November 2006 [Exercise call option]. Promissory Notes amounting to US$500 million were

discharged [March 2, 2007]. Oil Warrants, the only remaining component-initiated

the 3-phase process of redeeming these through cash tender offer launched late February, 2007. Phase 1: reconciliation of positions in Oil Warrants Phase 2: Tender offer through an Investment Bank Phase 3: Inter-pleader action after the buy-back is

complete

24

Domestic Debt Restructuring Domestic Debt Profile

Securitized public debt amounting to $10 billion equivalent. comprising of short term T-Bills (60%), held predominantly by CBN (60%) and financial institutions (34%), while non- bank sector (6%)

Local Contractors debt amounting to $4.2 billion equivalent, these are contractors and suppliers that have rendered various services but are being owed by the government.

Unpaid pension liabilities of over $8 billion equivalent due to retirees in the public sector, which have accumulated over the years.

Accumulated arrears on allowances due to teachers, doctors and health workers, and liabilities of Foreign Missions, amounting to over $200million.

Contingent liabilities: notable from public enterprises and agencies still undergoing verification exercise

25

Domestic Debt Restructuring Domestic Debt Profile

Securitized public debt, $10,000, 44%

Other arrears, $200, 1%

Local contractors debt, $4,200, 19%

Pensions arrears, $8,000, 36%

26

Domestic Debt Restructuring Domestic Debt Profile

Before 2003, major deficiencies:• Domestic debt stock was disproportionately

short-tenored (60% in 91-day Treasury Bills).• Monetary financing of fiscal deficits• Low holding of public debt by Non-Bank Public• High rollover and Refinancing risks• Long absence of government from the capital

market

27

Domestic Debt Restructuring: Restructuring of T-Bills:

Smoothen and lengthen maturity structure 91 day NTBs into longer tenored instruments: Reduces roll-over and refinancing risks Reduces interest rate volatility in the money market Ensures better asset/liability match

28

Domestic Debt Restructuring: Securities Issuance:

Resuscitation of the bond market through issue of 1st FGN Bonds(N150 billion) in October, 2003.

Regular monthly issuances of long-term FGN bonds started July 2005. In 2005: 2 and 3- year Bonds issued In 2006: 3, 5 and 7-year Bonds issued In 2007 :3, 5, 7 and 10-year Bonds to be issued

Issued in monthly tranches of between N20 – N30 billion. Helps establish benchmark yield curve; develops alternatives to monetary financing of government

deficits. Pensions Arrears and Local Contractors Liabilities: Quantify and securitise

outstanding debts; cash payments for liabilities less than N100 million Domestic Debt Service Ceilings set on domestic debt service levels for 2007-

2009 Reduces fiscal impact of debt service costs

29

Domestic Debt Restructuring

Domestic Debt Stock by Instrument, 2004 Domestic Debt Stock by Instrument, 2005

Treasury Bonds31.01%

FRN Development Stocks0.09%

1st FGN Bonds5.30%

91-day T-Bills63.60%

Treasury Bonds27.48%

2nd FGN Bonds11.68%1st FGN Bonds

4.76%

FRN Development Stocks0.06%

91-day T-Bills14.73%

182-day T-Bills31.46%

360-day T-Bills9.83%

30

Domestic Debt Restructuring: Market Development

15 financial institutions (10 banks and 5 discount houses) pioneering the primary dealer/market maker (PDMM) system under general rules and regulations as specified by the DMO engenders a liquid, vibrant and efficient secondary

market through the institution of a two-way price quotes system

Strengthens market for government bonds

31

Current Policy Thrusts

The objective is to avoid a relapse into indebtedness Borrowing from only concessional sources (IDA or

near IDA terms) Official Bilateral borrowing at up to 3% interest rate

and not less than 10 years maturity. Proposed Fiscal Responsibility Law (about to be

passed by the National Assembly) Conducting DSA on regular basis. Focus on sub-national debt issues.

32

Current Policy Thrusts

Proposed Fiscal Responsibility Law provides among others : an oil-price based fiscal rule which imposes permanent

constraint on fiscal policy borrowing only for capital expenditure and human

development debt to GDP ratio is held at a sustainable level Sets limits for amounts of consolidated debt for Federal,

State and Local government Transparency & Reporting, disclosure of all transactions

and decisions, public hearings in preparation of medium term economic framework, disclosure of all audited accounts by all tiers and arms of government.

Focus on effective domestic debt management and building the local debt market.

33

Key Challenges

Need to build on progress to date and institutionalise reform in order to safeguard economic stability [Deepen NEEDS].

Enhancing resource flows. Development financing gap estimated at $4- $5 billion.

Need to increase ODA transfers. Nigeria currently lowest aid recipient at $2 per capita compared

with $29 for other African countries. Need to design new financing strategy to ensure a coordinated

approach to debt management such that the country borrows when: Borrowing is needed Borrowing is sustainable Borrowing provides good value for money

34

Key Challenges

Particular challenge include: [guarantees and contingent liabilities, sub-national debt, and asset-liability management]

Need to underpin policy framework with effective operational coordination to ensure effective dent management: still there are issues with multiple players, complex relationships and blurred responsibilities; the risk of line ministries operating autonomously.

Need for effective coordination between fiscal, monetary policies: dealing with portfolio inflows and liquidity management.

Stakeholder ownership of the strategy and consensus building. Strengthening governance and accountability framework:

clearly define objectives, authorities, and accountabilities Strengthening transparency: media and the civil society

35

Conclusion

Even after the exit from Paris Club and London Club debts overhang, the challenges of public management remain-may be, even more demanding.

Need for proactive management of the remaining external debt.

Need for a well-articulated new borrowing programme within the context of an appropriate national debt strategy

Development of the domestic bond market still at relatively early stages.

Sub-national debt management needs to be developed too, and synchronized with, the status at the Federal level.

36

THANK YOUFOR YOUR ATTENTION