DMO Strategy on Borrowing

It is being reported that the federal government of Nigeria seeks to reduce its domestic debt and channel into cheaper sources of fund through external debt for funding capital projects in line with the present administration on speeding up infrastructural development in the country.

According to the debt management office of Nigeria, the federal government’s exposure to the domestic market is tagged at around 15.03 trillion naira as at June 2017 while external debt is at 4.6trillion naira (about $64.19 billion at N305.9 / $1), taking the total public debt stock to 19.63 trillion naira. There is little wonder why the federal government might want to diversify their borrowings because federal government borrowing cost is currently at a high. Recently auctioned treasury bills (on 30^th August) had the following successful bid rates: 91 day treasury bills having a bid rate between 13.295 percent and 13.3 percent, 182 day treasury bills having bid rates between 16.8 percent and 17.36 percent and 364 day treasury bills having a bid rate between 18 percent and 18.52 percent (Nb: the bid rate is the interest rate you indicate on your principal amount, the CBN then picks rates that fall below the accepted marginal rates, which is the minimum marginal rate submitted for bids within the bid window). While newly issued FGN bonds are at a coupon rate of 13 percent to 16 percent depending on their maturity period.

The government’s argument is that the external debt is cheaper with lower interest rates and longer tenor than domestic debt. For example external debt tenor can be up to 15 years, while domestic debt like Treasury bills have a maximum tenor of 364 days). The debt management office (DMO) strategy 2016 – 2019 is to rebalance the debt portfolio from its domestic to foreign debt composition of 84:16 (as at the time of kick starting the strategy) to 60:40 by December 2019. The federal government is well on its way to achieving its target with foreign debt now comprising 23.8 percent of total debt stock.

In line with the above, the federal government of Nigeria recently announced its plan to borrow $3bn of external debt to finance domestic debt and reduce its exposure. The implication now is that most funds in Nigeria are heavily dependent on federal government security as that is an easy and risk free way of generating competitive returns. With the announcement, we predict a fall in the yield as available bonds become scarce and more valuable to its holders thereby increasing the demand for the bonds in the secondary market. This fall in yield is also backed by the fact that the external debt the government is targeting is at a cheap rate for longer tenor while phasing out the more expensive domestic debt. This will in turn help reduce inflationary pressures and make existing bonds more valuable. New domestic bond issues on the other hand would be issued at lower coupon rates

The problem now for pension funds and the likes is that they would need to diversify their investments by investing in other interest bearing securities as new domestic bond issues become less attractive.