Federal transfers, reforms drive Nigerian States’ financial performance, Says Fitch

Joy Agwunobi

Federal reforms are significantly affecting the financial landscape of Nigerian states, Fitch Ratings says in a new report. Oil-related transfers, which are a major component of monthly revenue distributed by the Federation Account Allocation Committee (FAAC), influence state’s revenue.

Analysts noted that federal transfers are crucial for almost all states to cover their operating costs and to support investment. All Nigerian states rated by Fitch are on positive outlook, reflecting that of the sovereign and the Federal Government of Nigeria’s policies that affect states’ operating revenue, debt stock and debt service.

Fitch stated that recent macroeconomic drivers and sector reforms, such as the removal of fuel subsidies and the liberalisation of the exchange rate in 2023, have increased FAAC transfers, but also introduced volatility due to fluctuating oil prices, steep naira depreciation, and surging inflation.

Nigerian states face several challenges, according to Fitch, noting that internally generated revenue (IGR) growth remains subdued due to socioeconomic constraints and inefficiencies in tax collection.

Most states depend on FAAC transfers, with Lagos being an exception due to its higher IGR capabilities. Rising current spending, driven by high inflation and recent increases in the minimum wage, further pressures state finances.

The free-floating naira exchange rate has consistently increased external debt service, eroding the share of FAAC available for autonomous spending, as external debt is serviced

through direct deductions from transfers.

Most Nigerian states rely on subsidised facilities from the federal government to finance their investments, a situation that Fitch Ratings affirmed in its commentary note.

Despite significant capital expenditure needs, states struggle to fully utilise budgeted capital expenditure due to funding and implementation constraints, with an average of only about 60% of budgeted capex executed.

Nigerian local and regional governments (LRGs) may not be rated above the sovereign as analysts consider that the national government’s role predominates in intergovernmental relations, Fitch said.

The global rating agency stated that the federal government controls the equalisation mechanism that is enacted through a system of transfers of oil-related revenue to states, and that decides on additional funding when needed.

It said withdrawal of fuel subsidies and FX controls increased the flow of transfers to states, while debt service rose sharply with high external debt; however, direct deductions from federal transfers have preserved debt service.

Fitch views the institutional framework for the LRG sector as evolving due to limited own-revenue-generation capacity and evolving debt and liquidity-management regulations and practices amid the devolution of a wide set of responsibilities to the states.

It said states have to provide key public services, such as healthcare and education, creating vertical fiscal imbalances that can result in structural funding gaps, in turn leading to higher debt or a propensity to offload risks off-balance sheet.