Lagos Nigeria-05 May 2017: Fitch Ratings has affirmed Kaduna State’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B’ and National Long-Term Rating at ‘A+(nga)’. The Outlooks are Stable.
The affirmation reflect Fitch’s expectation of an improved revenue mix for the state, driven by declining statutory allocations, offset by improving local tax revenues and fees. The ratings also factor in the state’s fast growing debt, although servicing requirements will be moderated by government subsidies, concessionary terms and a long grace period. They further take into account the state’s developing economy focused on agricultural and service activities and low per capita revenue by international standards.
The ‘A+(nga)’ rating reflects Kaduna’s low risk relative to the country’s best risk, given strong financial and revenue support from the central government.
The Stable Outlooks factor in Fitch’s expectation that growing direct local taxes and a flexible expenditure framework will allow Kaduna to weather lower than the historical average statutory transfers (due to lower oil prices) in the medium term.
KEY RATING DRIVERS
Weak Institutional Framework
Like other Nigerian states, Kaduna’s finances are affected by weak revenue predictability and high budgeted capital spending being rolled over into following financial years due to a lack of funding and limited implementation capacity. Declining transfers from the Federal Accounts Allocation Committee (FAAC) amid the oil sector down cycle provide renewed stimulus for tax revenue diversification but structural benefits may only be visible with time.
Long-term Debt Challenge
Kaduna is borrowing rapidly to fund capex in core infrastructure to sustain GDP growth and diversify revenue sources. Total debt at the end of fiscal year 2015 totalled NGN73 billion, or over 110% of current revenue. Fitch envisages the ratio may more than double by end-2019 as a result of increased lending in both domestic and foreign currency and an ambitious capex programme over the next three years in the power, transport, water supply, education and healthcare sectors.
Foreign currency loans are credit-enhanced by an irrevocable standing payment order issued by the central government. However, this does not represent a full guarantee of Kaduna’s obligations. Interest charges on foreign currency debt are deducted from the statutory allocations for the states on a monthly basis.
Preliminary data for 2016 results show that Kaduna’s internally generated revenue (IGR) composed of local direct taxes and service fees, grew materially to over NGN20 billion or nearly 35% of operating revenue from NGN12 billion in 2015. The shift marks a positive result in the administration’s efforts to increase local tax revenues to compensate for lower revenues from FAAC statutory allocations.
The FAAC is the primary mechanism for funding Nigerian states. Its process determines allocated funding levels on a monthly basis and is derived from revenues accruing to the federal government, largely sourced from the oil sector.
However, given the low level of tax compliance and slowing growth from an agricultural and service-oriented economy, non-oil revenues may increase slowly as the administration pushes to further expand the tax base. Fitch will monitor whether the expected consolidation of the revenue mix takes place.
Weak Socio-economic Profile
Within the national context, Kaduna’s fast-growing population and a traditionally strong primary sector contribute to weak socio-economic standards, including growing unemployment. Dominant agricultural and service sectors drive the economy while Kaduna’s 2016-2020 plan is focusing on the state’s rich minerals resources by attracting foreign investors to key industrial projects.
Kaduna’s administration is committed to improving transparency and disclosure. Fitch believes that the future transition from cash to a more sophisticated accrual-based accounting will be credit positive, as it restricts the scope for discretionary initiatives and human errors visible in the past.
An upgrade could materialise if the operating margin sustainably strengthens towards 30% and debt levels are restored to 1x the budget size. Further improvement of the local economy giving an additional boost to IGR would also be positive for the ratings.
Conversely, financial debt growth leading to debt-to-current revenue ratios being consistently above Fitch’s expectations could result in a downgrade. Unrest damaging economic prospects or undermining oil-related revenue could also lead to a downgrade.