Stages of Nigeria's Public Debt Management. Dr. Abraham Nwankwo Director- General, Debt Management Office, Nigeria

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1 Stages of Nigeria's Public Debt Management by Dr. Abraham Nwankwo Director- General, Debt Management Office, Nigeria (Guest Lecture presented at the University of Nigeria, Nsukka, May 31, 2011) I. The Essence of Public Debt and Public Debt Management Why does government borrow? Government borrows when its spending requirement (expenditure) is larger than its current receipts from conventional sources, notably taxation and royalties. Just as in borrowing by a firm or a household, borrowing by government creates an obligation to pay what has been borrowed, that is, public debt. Public debt carries terms of repayment of, not only the amount borrowed, but also some agreed interest and other charges. In a modern economy, the government is responsible for co-coordinating and regulating the activities of all economic agents (the household, the firm and the government) so as to ensure economic stability. As a result, the government may sometimes borrow, not necessarily to augment its financing resources but to influence the direction, speed and size of economic activity. In this way, public borrowing could assume a character different from borrowing by households and firms. Public borrowing and public debt differ from borrowing and debt creation by households and firms in a second way: The size and quality of public debt could form a basis for assessing the health of the economy and for third parties' decision on whether or not to deal with households and firms, whereas the reverse is hardly the case. There is need to emphasis upfront that while governments of low-income countries depend significantly on borrowing from domestic and external sources to fund economic growth and social development, the alreadyindustrialized and developed countries also borrow to keep their economy running and making progress. As Table 1 shows, indeed, many developed countries tend to have higher debt-to-gdp ratios, compared to the less developed countries. This underscores the fact that public borrowing, public debt and public debt management are normal features of a modern economy.

2 TABLE 1: PUBLIC DEBT /GDP RATIO: NIGERIA COMPARED TO A SAMPLE OF COUNTRIES. (2010 Estimate) II. First Stage: Pre This stage was dominated by concerns for the country's unsustainable external debt and the quest for debt relief. By 1970, Nigeria's external debt was less than USDlbillion; by 1980 it had risen to USD3.4billion; by 1990 it had risen to USD 33billion; and, by 2004 it had risen to USD 36billion. The country's debt had become unsustainable as shown in Table 2. A major reason for the rapid increase in external borrowing in the1970's and 1980's was the need to fund major reconstruction and development projects after Nigeria's civil war ( ). Apart from the familiar borrowing from multilateral sources, borrowing from nonmultilateral sources, in particular, Paris Club creditors became prominent. Although Nigeria, a major exporter of crude oil, received huge revenues from the steep rise in the price of oil in the later 1970's up to early 1980's, it was considered as under- borrowed and credit worthy.

3 The oil burst of 1982 meant drastic collapse in oil prices and shrinking of revenue inflows for Nigeria, leading to the belt-tightening programme of Nigeria began to experience difficulties in meeting its external debt payment obligations. Massive build up of arrears crept in. Although multilateral and London Club debts (commercial bank debts) were serviced in full, bilateral debts, mainly in the form of export credit-agency guaranteed loans suffered poor servicing. Foreign creditors suspended newlines of credit to the country, thus compounding its economic problems. Nigeria was forced to approach the Paris Club for the rescheduling of its debts. There were three rescheduling agreements in 1986, 1989 and 1991 during this period, without any stock reduction. Hence, the debt stock continued to grow with the capitalization of arrears. Between 1992 and 1999, there was a virtual breaking off of negotiations and unilateral curtailment of debt service payments by the Nigerian military junta. Institutional Background Before the year 2000, the management of Nigeria's debt was characterized by systemic and structural deficiencies. The debt management functions were split across several departments in the Ministry of Finance, the Office of the Accountant General of the Federation and the Central Bank of Nigeria. The diffused responsibility and poor coordination implicit in such arrangement created a number of interrelated shortcomings, including: Operational inefficiencies and poor coordination. Inadequate debt data recording system and poor information flow across agencies, resulting in inaccurate and incomplete loan records. Extreme difficulty in the verification of creditors' claims due to conflicting figures from various bodies handling the debt anagement function. Complicated and inefficient debt service arrangements which created protracted payment procedure and often led to penalties that added to the debt stock and the pains of servicing. Lack of a coherent and well-defined debt strategy. TABLE 2: Trends in Nigeria's Debt Burden Indicators Year External Debt External Debt/Export (US$ million) Debt/GDP Ratio Ratio ,

4 , , , , , , , , , , , To redress this unsalutary state of affairs, the then Obasanjo administration established the Debt Management Office (DM0), in October 2000, which centralises the entire nation's debt management functions in a single, semi-autonomous and professionally run agency, charged with the following responsibilities: Maintenance of comprehensive, accurate and timely records of the country's debts; Prudent management of the debt portfolio and ensuring its effective servicing; Negotiating with, and ensuring debt relief from creditors; Assessing and advising government on new borrowing; Advising government on national debt strategy and borrowing policy; Issuance of FGN domestic debt instruments tradable in the capital market and having long term tenor, with a view to deepening the capital market and eliminating the monetary financing of deficits. Benefits Of An Effective Debt Management To The Nigerian Economy The centralization and professionalisation of debt management in an economy such as ours have myriad of benefits, which includes the following: Good debt management practices affect the economic growth and development positively. The effective management of the nation's debt has serious implications for government's ability to alleviate poverty (a high flow of resources for debt servicing erodes the capacity of government to alleviate poverty, whereas a well-engaged debt negotiation scheme would secure debt reduction and the savings would be directed to

5 poverty alleviation). Debt crisis distorts economic planning and management and constitutes a distraction from the positive preoccupation of orderly management of growth and development. When a country's debt status is regularized, borrowing could be used proactively to augment local savings and support orderly and sustainable growth. The country's debt status is an important determinant of her external image and national pride, to which the present government is committed to sustaining its cordial relationships with the international community. For Nigeria, the substantial debt relief from creditors (Paris Club), has freed up resources which are being ploughed into the revitalization of infrastructures and the reduction of poverty, thus facilitating the achievement of the Millennium Development Goals (MDGs). Achievements in External Debt Management Nigeria owed about $36 billion to its external creditors as at end December, Starting from the mid-1980s, Nigeria's external indebtedness ratios stayed at critical levels surpassing the thresholds for sustainability. The volatility of oil prices and the projected trends in their movement in the medium term suggested that the ratios could worsen over time, thus reinforcing the unsustainable nature of Nigeria's external debt (Table 2). It was against this background that the case and quest for debt relief was intensified in At the initial stage, to achieve substantial reduction in the debt stock, thereby reducing the debt burden of the country, the DM0 embarked on a number of initiatives and measures including: (i) (ii) Debt Rescheduling: This was the primary tool employed for alleviating debt since the debt crisis of 1980's only aimed at cash flow relief rather than debt stock reduction in net present value terms. Although this measure provided temporary cash flow relief, the debt stock continued to build up; Securing Waivers: Securing waivers from non-paris Club creditors was an important debt reduction strategy in external debt management. This was as a result of prompt debt repayments. However, the waiver was a temporary reduction in debt stock;

6 (iii) (iv) Debt Conversion Programme: This was used to reduce the debt stock while promoting foreign investment and creating employment. Through the Debt Conversion Programme a proportion of the external debt (US$1,748.7) was converted to finance some projects. However, the programme could not go far enough to bring long lasting relief due to its complexity; and, External Borrowing Guidelines: In order to avoid undue build-up of external debt, which could exacerbate Nigeria's debt servicing problem, the DM0 formulated Guidelines on External Borrowing for fiscal year 2003 up to 2005, subject to modifications that might be justified by new developments during the period. The Guidelines set out the broad parameters for borrowing by the Federal and State Governments, as well as their agencies and specify the terms and purposes for which borrowing could be contracted. It also outlines the general criteria for approval of these borrowings, as well as servicing arrangements, among other things. Since the Guidelines were aimed at new borrowings, they could not have achieved any significant reduction in the huge external debt stock. Nevertheless, by December, 2004, the DM0 had made considerable progress towards rationalizing the nation's external debt management in the following areas: a) Debt Reconciliation with creditors; b) Rejection of spurious debts and realization of savings; c) Establishment of a comprehensive and reliable database; d) Disaggregation and reconciliation of external debt of States' current debts; e) Timely provision of debt information to stakeholders; f) Review and implementation of a more efficient external debt service payment procedure; g) Buy-back of commercial banks' debt of $601.4 million at 23 cents per dollar face value of the Par Bonds in December, 2002; h) Downward negotiation of applicable interest rates from a range of 8-12 percent to %; i) Avoidance of annual commitment fees of US$305, through cancellation of over-aged un-disbursed amounts on ADB loans; and, j) Timely payment of debt service leading to waivers from some creditors, the total amount saved in waivers was US$10.3 million as at December, Debt Relief

7 In 2000, following the restoration of democratic governance in 1999, negotiations were resumed in what led to the last rescheduling agreement with the Paris Club in the December of that year. The rescheduling agreement was treated in Houston Terms, which provided for the rescheduling of Paris Club debt totaling about USD21billion over years. The agreement still left Nigeria's debt sustainability at precarious levels, since there were only flow reprofiling without any stock reduction. By December 2004, Nigeria owed about USD36 billion to external creditors, with USD30.8 billion (about 85.82%) being owed to the Paris Club. It was evident that for Nigeria's debt to become sustainable, it had to secure substantial debt relief from the Paris Club. In 2005, Nigeria obtained a 60% debt write-off of its Paris Club debt. The total relief package amounted to US$18 billion write-off, with Nigeria expected to pay off the balance of approximately US$12.4 billion to the creditors over a period of six months to completely exit from Paris Club. By April, 2006 with the payment of the required balance, Nigeria exited the Paris Club debts. This was followed by the redemption of London Club debt (Par Bonds and Promissory Notes) and part of associated Oil Warrants. In November, 2006, Nigeria redeemed all her Par Bonds at par amounting to about $1.44 billion. The external debt dropped to a sustainable level of US$3.5billion. Under an Obligor Substitution arrangement, Nigeria, in March, 2007 paid about $519million to exit obligations to holders of Promissory Notes, and retired about 21% of Oil Warrants at $220 per unit, via a tender offer, leaving an outstanding Warrants of 1.4 million units. Achievements In Domestic Debt Management Prior to the establishment of the DM0 in 2000, Nigeria had a grossly underdeveloped domestic debt market, which was characterised by the following structural and systemic defects: a) Absence of a sustained sovereign bond issuance programme for almost 18 years; b) Concentration of the government securities in 91-day Nigerian Treasury Bills (51.8 % of the total stock as at December, 2000) mostly held by the Central Bank of Nigeria (CBN); c) Significant holding of government securities by the Central Bank (55% of the total stock) and the deposit money banks and discount houses (32% of the total stock as at December 2000), which hampers the efficiency of monetary policy; d) Poor participation by non-bank public (only 12.9% of the total holdings);

8 e) Absence of active secondary market for bonds; and, f) High incidence of rollover and interest rate risks to the government, because of the bunching problem (concentration of maturities within the same period), which aggravated the already high interest rate environment, as the market prices a "volatility premium" into rates. With the centralization of the entire nation's debt, the DMO's first task was to articulate a domestic debt management strategy for the government. After intensive stakeholder consultations, it came up with the following objectives: a) Raising finance in the domestic financial market, in order to cover the government's borrowing needs; b) Funding the nation's debt in a non-inflationary manner, without recourse to monetary financing; c) Minimizing the cost of government's debt over the long term, while taking account of risks; d) Ensuring proper coordination between debt management and monetary policy management; e) Promoting the development of the domestic capital market; f) Restructuring of short-term debt into longer-term in order to reduce volatility in the market and protect government from roll-over and interest rate risks; g) Creating a market for long term debt instruments, which the private sector can build on to raise funds for the funding of long term investment in agriculture, manufacturing, mining and housing; and, h) Deepening and modernizing the capital market as part of the overall programme of the development of financial sector (this objective is consistent with the current Financial Sector Strategy (FSS) 2020). Further to its statutory role of covering the government's borrowing needs at lowest cost and minimum risk, the DM0 devised a multi-year domestic debt management programme, which included returning the Federal Government to the domestic capital market in October, 2003, as a more appropriate means of funding budget deficits. A key step in the implementation of the work programme was the introduction of the FGN Bond in 2003, after a lull of about two decades. The DM0, on behalf of the Federal Government offered to the investing public, the N150 billion 1 st FGN Bonds in September The objectives of the bonds were to:

9 a) Finance the 2003 deficit in a non-inflationary manner and with limited recourse to monetary financing; b) Lengthen the maturity structure of the current stock of domestic debt; and, c) Promote capital market development. Of the amount floated, total subscription and allotment for the four tranches amounted to N72.56 billion. The outcome clearly showed investor appetite for the short end of the market. The low subscription was understandable as the hang over arising from long absence from the market would naturally take some time to wear out, coupled with the lingering uncertainties about the macroeconomic environment. Further issuance was suspended in 2004, as a result of the banking sector consolidation then, which generated quite a lot of uncertainties in the financial sector. This period provided a good opportunity for addressing the issue of bunching, resulting from lopsided maturity distribution of NTBs, which were rolled over on a weekly basis, resulting in accentuating the volatility in interest rates in the money market. In collaboration with the CBN, DM0 commenced the process of smoothening the weekly issuance volumes, such that the fluctuations that existed in the weekly issuance of between N50b - N200b, was brought down to about N60 billion. This was immediately followed by lengthening the maturity profiles of these instruments, from the traditional 91-day instrument to 180- day and 365- day instruments. July 2005, marked the commencement of regular monthly auctions with alternating offerings of 2 & 3 year maturities of N20 billion offering size. In order to sustain the programme, N282 billion FGN Bonds ranging between 3 and 7 years were issued in To further ensure maximum subscription of FGN Bonds at the primary auctions and also provide a liquid and active secondary market trading, the DM0 in consultation with other key stakeholders selected fifteen (15) institutions as Primary Dealer Market Makers (PDMMs) who commenced operation in July III. Second Stage ( ) This stage focused on more aggressive development of the domestic bond market, which had been resuscitated in Following the achievement of relief from external debt burden, the DM0 had to redirect efforts towards the real job of public debt management, which is to mobilize resources to close the financing gap, towards the generation of growth and

10 development. In graphic terms, while initiatives taken to obtain debt relief and achieve debt sustainability could be likened to filling a hole, which is essentially a negative function, using debt resources to fuel growth and development is like building a mountain which is a positive function. In order to be effectively guided in its new focus, the DM0 formulated a five- year strategic plan, In line with its new posture, the Office articulated the following as its vision, mission and broad strategy. The Vision is "To manage Nigeria's debt as an asset for growth, development and poverty reduction." The Mission is "To rely on a well motivated, professional workforce and state-of -the art technology, to be among the emerging markets' top ten Debt Management Offices, in terms of best practice and contribution to national development, by the year 2012." The Broad Strategy is "To ensure that National and Sub-national Governments subscribe to the principles of prudent and sustainable borrowing, and effective utilization of resources, and to create a robust domestic debt market supportive of private sector development." The Strategic Objectives are as follows: To establish and develop effective institutions and debt management capabilities at the sub national level. To maintain a comprehension, reliable and efficient national and subnational debt database, and to ensure prompt and accurate settlement of debt service obligations. To build a first-rate and internationally competitive bond market, not only to support government financing needs but also to provide the private sector access to long-term financing, in line with the Financial Sector Strategy (FSS) To develop innovative approaches for optimally accessing external financing. To make Nigeria an exporter of debt management skills and major destination for out-sourced debt management services. To build and maintain a well-motivated and professional workforce that will drive DMO's Strategic Objectives. One of the implicit but unmistakable lessons from the crisis of Nigeria's unsustainable external debt in the 1970s, 1980s and 1990s was the need to have a reliable domestic bond market as a viable alternative source of borrowing by government. This would among other benefits protect the country from volatilities inherent in foreign borrowing. In line with this, the sovereign bond issuance which had been discontinued for about 18 years, was resuscitated in 2003.The progress made in the pursuit of this objective

11 could be observed in the structural transformations illustrated in Tables 3-7. First is the introduction, between 2003 and 2008, of long dated debt instruments, which span from 3 years to 20 years (Table 3). It could be recalled that before the resuscitation of the sovereign bond market, the government borrowing from the domestic market was mainly in the form of 91-day Treasury Bills. This meant that inappropriately, short-term liabilities were used to fund economic and social projects, which were essentially long-term assets. The overall success of the approach of raising money for government through the issuance of bonds is illustrated in Table 4. It shows a high level of oversubscription in response to the offers made between 2005 and In this regard, the objective of developing an alternative funding source for government was also achieved because while in 2004, external and domestic sources accounted for 78% and 22% of the total public debt stock respectively, by 2009 external source contribution had dropped to 15.5% while domestic source contribution had risen to 84.5%. Table 3 : SOVEREIGN BOND MARKET: Progression of TENOR ELONGATION Testing Phase Smoothenin g Phase* Regular Monthly Issuance Phase TENOR YEAR - V 3-YEAR V - V V V V V V 5-YEAR V - V V V V V 7-YEAR V - V V 10-YEAR V - V V V V 20-YEAR - V V V * During 2004, in addition to smoothening to eliminate large fluctuations in weekly issuance of the NTBs, the DM0 in conjunction with the CBN restructured part of the existing stock of 91-day NTBs to 182-day & 364-day NTBs. The Second structural transformation, as shown in Table 5, is that whereas 91-day Treasury Bills accounted for 63% of the domestic public debt portfolio in 2002, and active long-dated FGN bonds were nil, by 2009 and 2010, the share of Treasury Bills had dropped to about 25%, while FGN Bonds accounted for about 61% and 65%, respectively. This meant a

12 more optimal asset-liability matching. Thirdly, there was also a transformation in the holding structure, as shown in Table 6. In 2002, the Central Bank held about 46% of the total domestic debt outstanding, while the non-bank public held only about 15%. By 2009 and 2010, the Central Bank holding had dropped to 10% and 8%, respectively, while the holding of the non-bank public had risen to about 42% and 32%, respectively. This shift has two major salutary implications: one, it means that monetary financing of fiscal deficit has been controlled and that the Central Bank, which is the monetary authority, has been insulated from the conflict of doubling as a fiscal agent; two, it means that the investor base for sovereign debt instruments had been diversified and, indeed, that there has been a democratization of market participation. Table 4 : SOVEREIGN BOND MARKET: SUMMARY OF FGN BONDS ISSUED FROM 2005 TO 2010 (N Million)* 2nd I-GN Bonds Issued in rd FGN Bonds Issue Amount Subscription Allotment Percentage Allotted Oversubscription Rate 140, , , % % Issued in , , , % 89.37% 4th FGN Bonds Issued in , ,179, , % 95.35% FGN Bonds Issued in , , , % 64.26% FGN Bonds Issued in , ,340, , % 93.22% FGN Bonds Issued in /3, ,26/,/ ,244, lib. 9 6% 11.32% Total 3,437, ,740, ,693, % 96.07% * Before the regular monthly offers commenced in July 2005, there was a test offer in 2003 of 3, 5, 7, & 10-year Tenors amounting to N150 billion. The subscription amounted to N72.57 as a result of which only N72.57 billion was allotted.

13 Table 5 : SOVEREIGN BOND MARKET : Transformation of the Domestic Debt Stock by Instruments - Dec. 31,2002 Compared to Dec 31, Instrument Amount (N billion) % Amount (N billion) % Amount (N billion) % NTBs Promissory Note FGN Bonds nil nil 1, , Treasury Bonds Developme nt Stocks Total 1, , , Table 6 : SOVEREIGN BOND MARKET: Transformation of the Domestic Debt Outstanding by Category of Holder - Dec. 31, 2002 compared to Dec. 31, Amount Amount Amount Holder Outstanding % Outstanding % Outstanding % Central Bank ,14 8 Banks & Disc, Houses / 1,2/ ,60b Non-Bank Public , , Sinking Funds nil nil 284, Total 1, , , The fourth plank of the transformation is in the introduction and progression of the secondary market for bonds, where there are currently 21 Primary Dealer Market Makers (PDMMs). The PDMMs are banks and other financial institutions which are licensed by the DM0 to deal on Federal Government of Nigeria bonds, always open to buy or sell the bonds at quoted prices (two-way quotes), much in the same way as stock-brokers buy sell equities. As Table 7 shows, the number and values of secondary market transactions rose phenomenally between July 2006, when the

14 market was established, and The number of deals rose from 5,482 in 2006 to 135,874 in Similarly the value of deals rose impressively from about N585 billion in 2006 to about N16.7 trillion and 13.6 trillion in 2009 and 2010 respectively. The essence of an active secondary market is that it guarantees liquidity and specifically, easy taking and exiting of positions. When investors know that they can easily convert their promissory notes to cash even before the debt matures, they are encouraged to invest in bonds. The bourgeoning of the secondary market is a major factor that has encouraged the emergence of a sustainable long-tenured bond market of up to 20 years. TABLE 7: SOVEREIGN BOND MARKET: SECONDARY MARKET PERFORMANCE YEAR No. OF DEALS VOLUME (Units) FACE VALUE (N) % Change , ,410, ,410,867, ,241 3,947,284,982 3,947,284,982, ,135 10,090,235,806 10,090,235,806, ,374 16,789,262,632 16,789,262,632, ,874 13,677,151,566 13,677,151,566,000 (18.54) Primary Dealer-Market Maker System was introduced by 2 nd half of 2006: 20 Primary Dealer Market Makers were licensed. Currently, there are 21 primary Dealer Market Makers -16 deposit money banks and 5 discount houses. Effect on The Real Sector The link between the transformation of the sovereign bond market and economic development could be inferred from the portion of the deficit in the annual budgets, which is funded from proceeds of FGN bonds. Table 8 shows that this contribution has grown from N27billion in 2005 to N524billion in 2009 and is expected to be N917billion in In addition to general budget support, proceeds of domestic bond issuance were also used to fund special government stimulus spending initiatives between 2008 and It would be recalled that due to the global financial crisis which caused dramatic shrinkage of economic activities, many governments, prominently in the advanced economies adopted countercyclical, interventionist spending. In the case of Nigeria, example of such government special spending include: the N200 billion commercial

15 agriculture programme, whereby the funds raised by the Debt Management Office was made available to the Central Bank for lending to agriculture enterprises through the commercial banks; the Cotton, Textile and Garments revitalization programme, partly funding to the tune of N100 billion with FGN bond proceeds, the purchase of locomotives for the revitalization of rail transportation; and, the provision of seed money for the development of infrastructure in new districts in the Federal Capital Territory. But the more important impact is that the development of the sovereign bond market generates the benchmark that facilitates private sector issuing of debts instruments to raise money for the financing of real sector projects. As is well-known, real sector projects such as agriculture, solid minerals development, energy, manufacturing etc. are long-term in nature and require long-term resources. The development of the sovereign bond market means that the corporates can now issue their own long-dated bonds. Table 8: Portion of Federal Government Budget Deficit funded from the sovereign Bond Market (N'Billion) , , It is appreciated that there could be other factors which could constraint corporate from taking advantage of the resuscitated bond market. One of these constraints is the facts that while sovereign bonds were tax exempt, corporate bonds (and sub national bonds) were not. This means that apart from the risk premium on top of the sovereign coupon, an investor in corporate bonds would also mark up the bid rate by the implied tax to be paid on the income earned from the corporate bond. For these reasons, the corporate bond would be comparatively less attractive to an investor. To remedy this disadvantage on corporate bonds, the President of the Federal Republic in 2010 approved a waiver of taxes on all categories of bonds (Federal, Sub-national, Corporate and Supra-national bonds). This has created a level playing field for all bonds, irrespective of the issuer. Hence, making corporate bonds more attractive. A special initiative in developing the domestic debt market in particular and public debt management in general, is one that recognizes that Nigeria is a Fiscal Federalism. In this regards, the DM0 is implementing a programme of assisting each State of the Federation have its own debt management institution, called Debt Management Department (DMD). A case study of

16 cooperation in a strong federalism is that all States have subscribed to the programme. Working together with the States, the DM0 developed a Template for the establishment of DMDs and the States are at different stages in implementing the Template. The key objectives include: coordination and regulation of borrowing; maintaining macroeconomic stability by regulating fiscal expansion; entrenching fiscal responsibility; and, facilitating reliable debt database for states. The major area of activities and achievements so far include: strengthening of legal framework for public debt management; capacity building for sub-national debt managers; and, reconstruction of domestic debt data of states. As at end April 2011, the domestic debt data reconstruction (DDR) which is part of the final stages of the development of public debt management institutions in states, had been completed in twenty two States. The goal is that by the end of 2012, every State in the federation will have a functional DMD. Why is it important that States have functional Debt Management operations? Sub-sovereigns - States and Local Government - like the Federal Government also do need to and indeed, do, borrow to fund economic and social projects and programmes. It is, therefore, important that they have the institutions, human capacities and processes and procedures for effective and prudent debt management. Of course, the public debt history of federalist countries like Brazil, Argentina and even Nigeria show that the debts of sub-sovereigns, whether guaranteed by the central government or not, constitute a contingent liability for the Central Government. Accordingly, responsible, responsive and proactive debt management demands that the Federal Government of Nigeria through the Debt Management Office would have to be interested in the status of public debt management capabilities in the States. IV. Third Stage (2011 -?) Going forward, the debt management office will focus on five major issue of public debt management starting from 2011, and prominently in 2011 and These issues are: Strengthening portfolio management; improving the quality of the bond market; catalyzing the exploitation of the opportunities of the bond market by the real sector; harnessing resources from the Nigerian Diaspora; and, managing new externalities, for example those related to the bail-out of banks.

17 Portfolio Management As has been demonstrated, under Stage 2, the DM0 has been effectively sourcing long-term funds from domestic market for financing fiscal deficits and special interventions. This capability needs to be complemented with a well - structured and integrated cash management system. Hence, instruments, processes and procedures will be introduced to enhance efficient portfolio management. In particular, commercial papers (CPs) will be introduced to smoothen the troughs and hills resulting from the fact that while monthly bond issuances are in amounts of more or less simple averages for the 12 calendar months, the real cash needs of budgetary expenditure are in irregular amounts. This calls for the use of short-term securities (CPs) to remove the temporary shortages in budgetary funding. The Market The bond market will be strengthened from two angles. From one angle, the market will be deepend and made more stable through the introduction of instruments that address short-term hitches that are natural features of a free market financial system. Specifically, securities lending and repurchase orders (REPOS) will be introduced to enable bond trade take short positions within reasonable limits and remove the frustration that arises if a bond trader is unable to supply securities on demand by a client. Real Sector Support As has been described already, a relatively reliable domestic market for long term debts has been developed over the past seven years. A yield curve of up to 20 years was achieved since November This means that the benchmark and the market environment now exist for the private sector to issue long term debts to raise money for financing the real sector of the economy. This has been complemented on the external front with the successful sovereign debut offer in the international capital market in January, Every effort will now have to be made to encourage the Nigerian corporates to exploit the opportunities for accessing long - term stable capital, for investment in critical infrastructure and social development projects. The DM0 will intensify interaction with the private sector over the next two years to ensure maximum exploitation of these opportunities. Support in the form of fiscal and physical incentives may be required. In particular, there may be need to package appropriate sovereign guarantees to support the private sector. The essence, from the public debt management point of view is to substitute much of public investment with private investment, hence reducing the pressure on government to borrow.

18 The Diaspora It has been established that Nigeria has a large diaspora population. Many high net worth Nigerian individuals and corporates are resident in Europe and the America. The DM0, as part of the strategy for supporting rapid closing of the infrastructure deficit, whilst protecting the public debt portfolio from ballooning out of control, will structure investment vehicles that would enable the diaspora to repatratriate substantial funds for investment in housing, agriculture, energy and the social sector. In this regard, it is anticipated that a variety of fiscal support, including sovereign guarantees, would be needed. Financial Sector Bailout Support Central to the ongoing initiatives to salvage and strengthen the Nigerian banking sector, the Asset Management Corporation of Nigeria (AMCON) was established. AMCON is issuing long-term bonds worth over &1.7 trillion to banks in exchange for the letter's non-performing loans (NPLs). The bonds so issued are backed by sovereign guarantee in order to make definite, the restoration of healthy balance sheets for the banks. In this way it is hoped, the banks would be enabled to resume normal activities, particularly, lending to the real sector. In due course, AMCON will sell the assets it has acquired, hopefully, realizing the full value of the bonds it has issued; in this case, the sovereign guarantee would not have crystallized at all. However, if the sale of the assets does not fully cover the face value of the bonds, the crystallized portion of the guarantee simply transforms from a mere contingent liability to a real public debt. In view of this, AMCON, the DM0 and the banks agreed to put in place a remedial mechanism. In particular, is the plan for all banks in the country and the Central Bank to contribute to a sinking fund towards offsetting any shortfall after the disposal of the assets. However, what is important is that there is a clear externality or neighborhood effect on public debt management from the development in the banking sector. USD500M 10-year Sovereign Bond Issued in the International Capital market These initiatives are coming on the heels of Nigeria's impressive outing in the international capital market. The Federal Republic of Nigeria successfully issued its debut sovereign bond in the International Capital Market (ICM) on January 28, The USDSOOmillion 10-year offer was closed at a fixed coupon of 6.75% per annum. The principal reasons for the Bond Issuance are entirely strategic and

19 include the following: i. To present Nigeria's Economic Status and Potentials to the International Community: This has been achieved through the comprehensive information on Nigeria (economic, social, political and judicial) contained in the Prospectus and the Meetings with major international investors in Europe and the United States of America during the Roadshows. The Meetings revealed that the international community was very interested in several aspects of the Nigerian economy and needed a good understanding/interpretation of several macroeconomic variables. The high powered Teams that undertook the Roadshows ensured that the investors had first hand and detailed knowledge about Nigeria's economic strengths and potentials. ii. To provide a Benchmark for Future Borrowings: Through the Bond Issuance and the secondary market trading of the Bond, a benchmark for future borrowings by the sovereign, sub-nationals and corporates has been created. The importance of having a benchmark in the ICM is underscored by the large need for funding by governments and the private sector to raise large amounts of capital to finance infrastructure, expansions, acquisitions, etc. The detailed information about Nigeria contained in the Prospectus and the yield on the Sovereign Bond, together, provide a sound basis for the efficient pricing of any new Bond issue in the ICM coming out of Nigeria. iii. To attract Foreign Direct Investments: The availability of comprehensive information about Nigeria in a concise manner (the Prospectus) and the existence of a sovereign benchmark in the ICM, are expected to attract foreign investments into various sectors of the Nigerian economy including participation in Public Private Partnership opportunities that are expected to emerge from various government initiatives. Overall, the Bond Issuance represents a significant landmark in Nigeria's history as the country aspires to become one of the top 20 economies in the world by the year Sustainability Of course, emphasis will continue to be laid on maintaining overall debt sustainability. As at end-march 2011, Nigeria's Total Public Debt - GDP ratio was about 18.9%. Currently, for countries in Nigeria's peer group

20 (medium performers in the Country Policy and Institutional Assessment (CPIA) critical framework), the critical thresholds are: Debt GDP ratio, 40%; Debt -Export ratio, 150%; Debt-Revenue ratio, 250%; Debt Service- Export ratio, 20%; and Debt Service-Revenue ratio, 30%. Hence the country is operating within acceptable limits. Conclusion Public debt management is an integral part of modern, money-based economies. In the Nigerian case, professional public debt management came about as a salutary response to external debt overhang. But beyond solving the legacy problem of external debt overhang, Nigeria's Debt Management Office has organized itself as a platform for growth, development and poverty reduction. In view of this posture, the country's public debt management will continue to be proactive, creative and dynamic so as to appropriately respond to new realities that emerge on the country's transformation trajectory.