Experts say capital markets great for states, LG finance

• Propose capital market funding to sustain subnational government financing 

After many decades of relying on a revenue sharing formula that allocates funds from a central pool that has gradually become inadequate to meet basic and developmental needs, experts have challenged Nigeria’s subnational governments, comprising states and local governments, to put on their revenue generation creative cap and expand their view to see the capital markets as veritable exploration grounds to finance their small, medium and large ticket programmes.

At a recent webinar of the IGR Initiative, an initiative supported by Business A.M. and convened by Martin Ike-Muonso, a professor of economics and an investment banking expert, Teslim Shitta-Bey, managing editor of financial information service hub, Proshare Nigeria, observed that there is currently a low rate of subnational governments (SNGs) using equity and other relevant long term capital instruments to produce significant fundings for development projects.

The IGR Initiative is a network of IGR improvement experts and practitioners committed to the  revenue growth and economic independence of subnational governments (SNGs).

The capital market is considered an institutional financial arrangement that enables economic entities to raise medium to long-term funds either as equity or debt or both. The market consists of Securities & Exchange Commission (SEC), capital market operators, companies listed on the official exchange, federal and state government debt instruments, FMDQ where treasury bills,  bonds, and commercial papers are listed.

Shitta-Bey observed that between 2012 and 2016, annual budgets and revenues of states were relatively flat, with most states unable to achieve their revenue targets.

Emphasising the fact that climate change has further created the need for climate bonds, Shitta-Bey challenged SNGs to tap into the markets and  take advantage of the opportunities that they offer.

Speaking further on the ripple effects of global economic challenges such as the lingering Ukraine-Russia war, he envisaged that SNGs will experience reduction in VAT earnings, higher cost of borrowing, inability to service existing loan obligations, difficulty paying civil servants and potential for higher crime rates. 

Noting that this would lead to a drop in foreign direct investments, he advised that SNGs can raise funds by issuing bonds, with a high revenue generating state like  Lagos State playing a leading role with N766,890 billion issued at average coupon rate of 14.15 percent, while other states also partake considering on how credible they are and their capacity to repay bonds.

According to Shitta-Bey, SNGs pay a lot of attention to income and expenditures but not enough to assets of the state. He noted that SNGs can also invest in stocks which generate income and dividends, adding that as equity prices go up, proceeds can be invested in long term investment goals such as infrastructure.

Highlighting the benefits of equity markets to SNGs, particularly those facing low internally generated revenues and poor allocations from the federal government, he said: “Once the SNGs get access to the equity market, they can get a determined market value for state assets and the value can thereafter be utilised to raise economic development in the state. 

“If a state government for instance decides to list only five percent of a viable company on the NGX, it could, depending on the value chain of the company and cash flow, raise up to N200 billion,” he explained. 

State owned enterprises were also advised to negotiate and establish real market value for their assets at the stock exchange. This is expected to enhance the listing and financialisation of the state owned companies, leading to better valuation and revenue generation of the companies.  

On the recurring issue of taxing without creating value, he recommended that SNGs should have a list of investable projects for foreign and local investors, and also take a holistic review of state owned enterprises and decide which ones can be listed for private investment.

Banji Adebusuyi, a senior economist and a former Central Bank of Nigeria research analyst, also shared a similar sentiment in a report titled, “Financing State Government Projects  through the Capital Market: Problems and Prospects”.

According to Adebusuyi, some public sector projects, especially those that are infrastructural in nature, could be financed by variations of capital market instruments, notably bonds. 

The former assistant director of research and statistics, CBN,  further noted that as a result of the attractiveness of project financing through the capital market, state governments can approach the market to raise long-term capital for projects on their own merit. 

He highlighted other benefits of the capital market to subnationals to include:

• Execution of  more projects/infrastructure within a period without undue strain on the treasury of the state or local government.
• Better  accountability for utilised funds because the Stock Exchange will normally request for financial reporting on projects to be financed.
• Government subvention and other earnings can be judiciously utilised for other purposes that are necessarily income-generating.
• Strong possibility that much more economically viable projects would be financed, thus reducing the tendency to spend on white elephant projects.
• Raising of funds from the capital market encourages the pursuit of economies of scale in order to maximise the utilisation of resources, thereby allowing for achievement of larger output capacity.
• Raising of funds from the capital market would lead to broader shareholding which in turn would stimulate organisation’s desire for better performance, higher profit and employment of professional management.

He, however, pointed out that despite the numerous advantages of financing government projects through the capital market, certain conditions are necessary to be met in order to ensure efficient utilisation of available instruments in the market. 

“A major problem associated with the financing of government projects through the capital market is the lack of qualified personnel to effectively evaluate, appraise and monitor them. Although this is a general problem, it is markedly pronounced with the state governments,” he noted. 

He also pointed out the fact that even where projects are identified, they are often unattractively marketed and therefore do not elicit patronage of the investing public. 

“Many of the projects are packaged in such a way that they do not sufficiently meet the investment yearnings and aspirations of the investors. In a competitive economic environment where available funds have to be invested in competing projects, government projects have to be properly packaged and they should be investment worthy,”  he noted. 

The senior economist also touched on the absence of a track record of performance on the part of many existing government parastatals which handle major projects. He added that  many potential investors are scared to support the government in sourcing funds for capital projects, given the existence of an array of badly executed and mismanaged government projects.

The absence of well developed and articulate financial plans by many states was also identified as a challenge to gaining access to the capital market. “Thus, even when projects are well prepared there rarely exists a good financial plan. Even in cases where some financial plans exist, many state governments often lack the will and discipline to follow through,” he stated. 

Given the enormous prospects for raising funds by state governments, Adebusuyi proffered the following  recommendations:

• State governments that wish to increase their capacity to raise funds from non-bank sources and particularly the capital market must be willing to overcome their reluctance to pay realistic interest rates.
• The use of indexed bonds should be seriously considered since inflation is expected to continue for some time and there is greater uncertainty about its future rate.
• State government bonds purchases could be exempted from income tax as this will have the effect of lowering the cost of borrowing.
• The need  to consciously sensitise state government decision makers on the desirability of raising funds through the capital market.
• The need for state governments to maintain a consistent financial plan.
• State governments could also issue revenue bonds to finance such revenue-earning projects at stadia, municipal markets, viable industrial projects, housing programmes, shopping complexes, amusement parks, hotels and tourist centres amongst others. Adebusuyi also noted that caution should be exercised so that non-guaranteed bonds are not used for purposes that are not self financing.

Nigeria operates a federal system of government with three tiers made up of the federal, state  and local  governments.

The federal government is vested by the constitution with such roles as regulating interstate and foreign commerce, implementing taxes, allocating budgets, implementing national policies, among others, but  responsibilities that are of national nature are reserved for the state and local governments, known as subnational governments. 

To ensure efficient governance, subnational governments depend on fundings sourced from internally generated revenues (IGRs) which include, levies, personal income tax (PIT), tenement rates, fines, income from investments and commercial activities, and most importantly, revenue allocations from the Federal Account Allocation Committee(FAAC).

Despite these fundings, analysts have noted that one of the major challenges confronting  subnational governments is that the dependance  on FAAC monthly allocation has drastically reduced their capacity to  generate substantial IGR through proactive and productive means, with their performances tied to federal allocations rather than internally generated revenue.

The  taxes generated  internally by  the majority  of  the states  in Nigeria  have been found to be largely inadequate to fund their subnational budgets making most of the states in Nigeria unable to consistently operate effectively without FAAC allocations. 

The inability of subnational governments to independently finance budgets, pay salaries and undertake administrative expenses and  capital projects without reliance on FAAC revenue has brought out the need for subnationals to exploit an alternative funding channel to strengthen their economic capacity and minimise FAAC reliance to the barest minimum.