Nigeria’s Ponzi Finance: The Looming Debt Crisis

Ponzi Finance is named after Charles Ponzi, an Italian immigrant who became infamous in the United States for running a fraudulent investment scheme in the early 20th century. 

Charles Ponzi promised investors high returns on their investment within a short period for what he claimed was an investment in the international mail coupons of time. He claimed that he makes money by taking advantage of the difference in currency exchange rates between the United States and other countries. However, what he was doing was taking money from new investors and using it to pay off earlier investors, while keeping a portion of the funds for himself. At first, the scheme appeared to be successful, encouraging many to invest their savings with Charles Ponzi. 

Unfortunately, as more investors joined the scheme, it became increasingly difficult for Charles Ponzi to keep up with the promised returns. Eventually, Charles Ponzi’s scheme collapsed, leaving many investors with most emerging markets and developing economies (EMDEs) that are in or at high risk of debt distress engaged in sovereign Ponzi finance. 

Sovereign Ponzi finance refers to a situation where a government engages in a Ponzi scheme-like behaviour by issuing debt to pay for current expenses with the expectation of rolling over that debt with new debt in the future, rather than generating sufficient revenue or cutting expenses to repay the debt. This leads to a situation where the government’s debt burden grows unchecked, eventually becoming unsustainable. 

Countries like Sri Lanka, Zambia, Lebanon, Ghana, Pakistan, Tunisia, Egypt, Malawi, and El Salvador that have either defaulted or are at risk of defaulting are guilty of running a sovereign Ponzi scheme.

How Nigeria got engulfed in Ponzi finance 

In a sovereign Ponzi scheme, the government sells bonds to investors, promising to pay interest and principal on those bonds in the future. However, instead of using the money from the bond sales to invest in infrastructure or other productive assets that can generate future revenue, the government uses the funds to finance recurrent expenditures, such as salaries, pensions, and subsidies. 

To pay off the bonds when they mature, the government issues new ones and uses the proceeds to repay the old ones. This creates a cycle in which the government is constantly issuing new debt to pay off old debt without generating sufficient revenue to repay the debt entirely, resulting in a debt trap where the government’s debt burden grows larger and larger, eventually becoming unsustainable. 

The Nigerian government began building up sovereign debt after the debt forgiveness of 2004–2005. However, what seems like a Ponzi finance scheme began in 2015 when the national debt rose 22% to ₦19.4 trillion from ₦15.8 trillion in 2014. By 2020, the debt had spiked by 175% to ₦53.3 trillion.

The Nigerian government thought that cheap international finance would continue ad infinitum. So, new borrowings were used to finance obligations that are due. Also, borrowed funds were used to finance recurrent expenditures such as salaries and the purchase of stationery and other supplies. 

By the end of 2022, total government contractual obligations had risen to ₦76 trillion[ IMF (April, 2023). World Economic Outlook. Note: Total government contractual obligations include subnational and central government debts excluding noncontractual debts. This does not include private sector debts.],[]with the fiscal deficit amounting to 62% of revenue (2022) and recurrent expenditure totalling ₦23 trillion (80% of total expenditure). At least ₦5 trillion of the borrowed funds in 2022 were spent on recurrent expenditure. 

Nigeria’s borrowing does not reflect in economic growth 

Nigeria’s Ponzi finance scheme appears to have peaked. After raising the debt stock by 419% in 10 years, productivity growth lulled at 0.2%, while infrastructure stock stagnated at 30% of the GDP and the FGN’s debt service to revenue ratio exceeded 90%. Notwithstanding that the debt-to-GDP ratio is still below the self-imposed benchmark of 45%, the inability to invest borrowed funds in productive projects has weakened the nation’s ability to repay its debt. 

A high debt service-to[1]revenue ratio, rather than debt-to-GDP, is a good indicator of economies that are caught up in the doldrums of Ponzi finance. For example, the debt-to-GDP ratio in the United States (US) amounts to 126%, while the ratio of debt service to revenue is less than 10%. Also, in Mauritius, the debt-to-GDP ratio is estimated at 73.8%, while the debt-service-to[1]revenue ratio stands at 18.7%.

This story is different for Nigeria, Zambia, Sri Lanka, Lebanon, and several other countries in debt or at high risk of debt distress. 

Most countries that put their hands into Ponzi finance got burned. 

Most countries that, intentionally or inadvertently, went into Ponzi finance became the true example of the saying that ‘he who goes a-borrowing also goes a-sorrowing’. A classical case was Sri Lanka. Sri Lanka defaulted on its international debt for the first time in its modern history last year, after raising its debt stock by 240% to $85.8 billion from $21.2 billion a decade ago. Similarly, Lebanon had its first loan default in 2020 after accumulating a debt stock exceeding 170% of its GDP. Its sovereign debt doubled to $9.6 billion in 2020 from $4.7 billion in 2010, while its revenue plummeted to 16% of GDP from 22% of GDP a decade ago. On the African continent, Zambia, among others, was caught up in the wide fire of Ponzi finance. Zambia defaulted on its sovereign debt obligations in 2021 after its debt spiked by 2680% in the past ten years amid dwindling revenue. In all cases, the countries in debt distress had borrowed massively to finance recurrent spending, including repayment of maturing debt obligations. 

Macroeconomic consequences of sovereign Ponzi finance 

One thing that is certain about a Ponzi scheme is that it will collapse someday. When debt is mismanaged, resulting in a debt overhang and eventual sovereign default, one of the first effects is a credit downgrade by rating agencies. This, in turn, will trigger capital flow reversals and asset selloffs, leading to a financial and currency crisis, as well as hyperinflation For instance, inflation rose to 189.67% and 50.3% in Lebanon and Sri Lanka, respectively. In Zambia, the Kwacha (Zambia’s local currency) depreciated by 14% a year ago. Sadly, Nigeria is already on this path! 

Policy options for Nigeria’s looming debt crisis. 

There is no doubt that Nigeria is on the cusp of a debt crisis. In 2022, the FGN spent ₦96 out of every₦100 it got as revenue. The fiscal sustainability scores are red for the subnationals and FGN. Moreso, interest rates will remain elevated globally in 2023, and this implies that the debt service burden will heighten further, capping the available fiscal headroom. With dwindling revenue amid maturing debt obligations, there is no doubt that the choices are hard and the options are few.

Option 1: Approach the IMF for a policy support instrument (PSI). The PSI is an instrument used by the International Monetary Fund (IMF) to provide policy advice and support to countries that need its expertise and guidance on economic policies. The PSI is intended to provide a flexible and tailored approach to policy support, with the goal of helping countries develop and implement sound economic policies and promote sustainable economic growth. The PSI will necessarily usher in the implementation of critical reform policies such as exchange rate reforms, subsidy and pricing reforms, and other market reforms aimed at removing production impediments and increasing public revenue. This may come with some short-term tradeoffs; after all, there is no gain without pain.

Option 2: Go for debt restructuring. This is not necessarily a separate option from the first. Sovereign default is a kiss of death and, thus, not an option. The PSI will help Nigeria meet the “conditionalities” for a talk with its creditors. A sovereign debt restructuring can take several forms, depending on the severity of the country’s financial situation and the willingness of its creditors to negotiate. Some possible forms of debt restructuring include debt cancellation, debt restructuring, and debt conversion. Sovereign debt restructuring can be a complex and challenging process, as it often involves negotiating with a large number of creditors with different interests and priorities.. 

Option 3: Fiscal consolidation. This option could be undertaken in addition to the others. Fiscal consolidation focuses on reducing a government’s budget deficit and debt levels through a combination of spending cuts (e.g. trimming down the size of the government, removing subsidies), revenue increases (e.g broadening the tax base) . and structural reforms (e.g. privatising state-owned enterprises, deregulating industries, or reforming public sector pensions). Fiscal consolidation involves difficult choices that eventually have significant social and economic impacts. In the end, doing nothing is not an option. The new administration must make the hard choices to save the economy from collapse. Flagrant violations of the Fiscal Responsibility Act must be discontinued. Ponzi finance is sweet at first, but as the obligation compounds, it becomes a bitter pill. As such, it must be avoided by developing countries.

Source: Proshare