How Nigeria can avert a Debt Crisis and Champion Reforms that Reflect African Perspectives Mma Amara Ekeruche

Various researchers and practitioners in the sovereign debt space have been drawing stakeholders’ attention to a looming debt crisis in Nigeria. Within seven years (2017 and 2023), public debt has grown by some 78% from US$64.2 billion to US$114.4 billion, with most of the new debt owed to private and multilateral creditors. This pace of debt accumulation puts the country on an unsustainable debt path, particularly as the current rise in global interest rates and increased borrowing further worsens the country’s debt burden. A clear example is the spike in debt service payments – principal and interest payments over the next five years (2024 to 2028) are estimated at an average of US$4.2 billion per year, an increase of 68% from US$2.5 billion per year over the last five years (2019 to 2023). As a result, without significant reforms to local debt management practices and the international debt architecture, the debt situation may escalate from a liquidity crisis-where the government has too little resources to meet its debt service obligations and at the same time invest in critical development sectors- to a solvency issue-where debt service payments become impossible and haircuts are required.

What sort of innovations are needed in local debt management practices?

It is noteworthy that Nigeria’s fiscal problem is largely the result of its heavy reliance on oil, whose price is volatile, unpredictable, and internationally-determined, for revenue and export earnings. Consequently, innovations capable of shielding the country from negative shocks by halting debt service payments when drastic changes to important state variables (oil price changes, for example) occur will contribute greatly to reducing the likelihood of a debt crisis. One way to circumvent this problem is to integrate state-contingent clauses, that allow debt obligations to be adjusted when pre-defined thresholds are breached, to loan agreements. In this way, debt service payments could be reduced when oil price falls below a previously agreed level, and vice versa. However, the issuance of state-contingent debt instruments requires responses to a number of technical questions: How do the parties scientifically identify the threshold that should trigger a higher (or lower) payout? Should breaching of the threshold lead to multiple adjustments to payout or is a one-time adjustment sufficient? Are issuing countries allowed to use more than one state variable (for example, oil export volume and oil price)? How should excess revenues (and losses) be shared between creditors and the issuing country?

It is important to state that the use of the term “innovations” in the debt management landscape does not necessarily translate to “new” concepts or instruments; this term is used because they have not yet been applied in the Nigerian context. Countries such as Mexico and France have already issued state-contingent debt instruments. Their experiences can provide valuable lessons for Nigeria.

Furthermore, many of the delays in debt treatment as we have seen in the cases of Zambia and Ethiopia are underpinned by a lack of agreement among the different creditor groups especially with regards to extension of payment periods, Net Present Value (NPV) reduction, and revisions to the cash flow position each group and specific creditor should provide to return the debtor country to sustainable debt levels (also known as, the Comparability of Treatment problem). To avert this problem, Collective Action Clauses (CACs) that impose decisions made by a supermajority of bondholders (usually 75 or 85%) on all other creditors should be included in loan agreements. While CACs have become popular among bondholders and even official creditors, and are being adopted by several countries such as Argentina, Barbados, and Belize, it is important to point out that such clauses cannot be included in certain types of debt, including syndicated loans and quasi debt.

Moreover, with unprecedented global shocks such as the COVID-19 pandemic, the Russia-Ukraine war, climate change, and disruptions to the global supply chain, countries are learning to better navigate the unpredictable effects of these shocks on regional and global markets. For Nigeria, whose economy is well integrated into the international trade and financial systems relative to its regional counterparts, anticipating and safeguarding against highly disruptive external shocks is even more pertinent. To this end, Growth-Linked Bonds (GLBs) that link debt service payments to the economic performance of the issuing country could prove useful. Similar to state-contingent debt instruments, the issuance of growth-linked bonds is extremely complex. Additionally, countries that issue GLBs may be stigmatized as the markets may assume that information asymmetry is involved.

What contributions are necessary in ensuring that ongoing reforms to the international debt architecture reflect African perspectives?

It is of primary importance that any process of reform to the international debt architecture give voice and representation to smaller developing countries in the decision-making and norm-setting. These include but are not limited to Least Developed Countries (LDCs), Landlocked Developing Countries (LLDCs), and Small-Island Developing States (SIDS). This is because reform processes that are not representative will face a problem of legitimacy and the results from such processes may be deemed undesirable and inadequate as these country groups face unique debt challenges. Therefore, it is necessary to involve representative institutions such as the newly established “borrowers club”, that is, the Common Leverage Union of Borrowers (CLUB) in order to arrive at balanced, inclusive, and suitable resolutions.

In the same vein, regional institutions should be promoted as strong complements to their international counterparts. The rationale is that the heterogeneity of the international system positions regional institutions as a superior alternative to multilateral institutions in giving stronger voice and sense of ownership to member countries, and responding faster and more appropriately to their needs. For instance, in the area of development bank lending and guarantees, home-grown institutions such as the African Development Bank (AfDB), African Export-Import (AFREXIM) Bank, and African Finance Corporation (AFC) can play bigger roles in the future of development finance in Africa. A landmark achievement worthy of emulation is the May 2024 decision by the International Monetary Fund (IMF) to rechannel unused Special Drawing Rights (SDRs) through the AfDB – this decision can potentially generate at least four times the initial amount of SDRs in additional lending for development and climate projects to member countries.

Lastly, there should be an increase in the availability of information and the quality of surveillance. Considering that publicly available data on sovereign debt allows debtor countries and creditors to make informed decisions, improving the quality of information will directly contribute to reinforcing the stability of the debt architecture. Moreover, an increased supply of good quality information is likely to have other indirect positive consequences such as improving the quality of analysis by credit rating agencies, enhancing Debt Sustainability Analyses (DSAs), and ensuring better targeting of (climate) finance.

Nigeria should make full use of its economic and diplomatic influence in championing these changes by engaging with civil society organizations, the private sector and the research community, fellow states, regional entities such as the African Development Bank, and global institutions including the World Bank, the International Monetary Fund, and the United Nations. While bearing in mind their limitations, Nigerian authorities should strongly consider adopting innovations such as state-contingent clauses, Collective Action Clauses (CACs), and Growth-Linked Bonds (GLBs) that have the potential to promote transparency, predictability, inclusivity, and timeliness and, in so doing, help avoid a debt crisis.

(This article builds on the analysis and research produced for the IDEAs Conference on the African Debt Crisis and the International Financial Architecture)