The recent flurry of State Bonds issued indiscriminately by state governments has got me wondering what is really going on? The reasons for the issue of these bonds by the governments in question range from financing of existing and new infrastructural development to funding of governmental programs aimed at the poor.
So why has bond issue become so popular over the last few years? It’s quite difficult to ascertain. Bonds are mostly issued by governments to raise funds which are used in infrastructural developments. They use the money raised to construct roads, provide pipe borne water, provide health care services , build schools etc. They can also be used to fund government budget deficits in years when tax revenues are expected to fall short. They all sound like lofty ideas and as such always seem to fly whenever it is presented to congress, press and populace in general.
But that’s one side of the story. State bonds are not free money and as such come with a price tag. They are mostly sold to the private sector via banks, private equity firms, finance houses etc. Repayments (tenors) range from 5 years to 20 years with interest rates of between 8-14% in some cases. As such issuers of Bonds are expected to pay back this money at a cost and with conditions ranging from freeze in increase in workers pay, spending cuts in critical sectors of the economy such as education and health etc.
Governments will typically repay those bonds via tax receipts, government allocation, and virtually any revenue source available to the government. So countries even rich ones issue out bonds as a form of borrowing with the hope that they will repay from the tax receipts generated from the businesses that may have been created because of the attendant infrastructural developments brought about by the bonds themselves.
So where then lies my worry? Bonds that are issued without any proper longterm financial planning and prudence can become a recipe for disaster for the issuing party. For example, if the issuer of the bond, in this case the state, mismanages the funds raised then there is a huge danger that the terms of the Bonds may not be fulfilled. This may lead to the stay being unable to repay it’s obligations leaving it insolvent and utterly bankrupt. How is this possible? Supposing a state decides to borrow N100b like Ogun state is planning to and to repay over 20 years at 8% interest rate per annum. It means the state will have to invest that money in infrastructures that should generate at least the N446m monthly or N5.3b annually to repay the loans and avoid defaults. That’s a huge amount especially for a state that earns a monthly allocation of about N2b and internally generated revenue of N1b. With repayments of approximately 14% of it’s revenue. In the event that the funds are misused, this adds further pressure on the states revenue which will more likely than not increase the percentage above. Even when the funds are used properly, a good project may end up being a monumental waste if the state doesn’t have enough human resources that can effectively utilize the infrastructures available. For example what’s the use of spending huge sums on building nylon tarred roads with pre independence houses flanking it from all sides. All of this may mean that the tax revenue anticipated by the state falls short of expectation leading the state to default. The creditors in this case Bond holders requiring they get their money back will hold the state to ransom thereby creating a defacto banana republic.
The effect of this is that some of these states may end up leaving a huge burden for their children and children yet unborn to pay. Leading the state further into gross underdevelopment, unemployment and hunger. Sadly states to have the power of the Federal Government to print money if doesn’t have enough tax revenues to pay thus increasing the risk.
It’s not as if Bonds cant be turned into good use even from a state saddled with high illiteracy. My fear is that some of these governors are issuing Bonds towards the last year of their tenor or first term. With state allocation being an effective tool in the hands of the Federal Government during election years Governors maybe seeking this alternative to help fund their reelection or that of their supporters.
Having seen the stock market crash in 2008and unlikely to rebound anytime soon, I fear an in road into the bond market from some of these states may even dampen the already illiquid funds market. Thus starving the private sector of probably the only source of funding available. This even more worrisome going by one of the reasons why the Ogun state governor thinks his foray into the bond market is timely. “In Ogun State, we have also determined not to allow this trend to pass us. And that is why we have come to the market with the Ogun State Bond Issue. I have no doubt in my mind that from the totality of what we have seen of our state last few years, we’ll do what is needful to ensure that our Bond Issue is very successful.”
Already the governor is threatening that if the bonds “have to be taken in order for the state to avoid bankruptcy”. Sighting that the reason for the bond issue was that it is required to refinance a loan which is probably costing the state high interest of about N400m every month. The loan was mostly used to finance the state secretariat an example of miss use of funds by the government.
Yes we do need our state and governments to be creative in the way they generate funds for badly needed infrastructural developments, however it must be done with the best intentions, openness and without any ambiguity in its usage. The Governor must allow for debate over the reason for the bond issue and clearly spell out how the state intends to pay.
One thing is for the state to issue bonds another is for it to be subscribed. However, the last thing we want is another potential morale breaker to an already depressed debt and equities market.