Mission Concluding Statement 

1. The IMF mission¹ that visited Abuja and Lagos during
March 8-25, 2005, conducted the discussions for the 2005 Article IV consultation. The Executive Board of the IMF is expected to discuss the report on the consultations in May/June 2005. The mission met with his Excellency President Obasanjo and held discussions with Dr. (Mrs.) Okonjo-Iweala, Honorable Minister of Finance, Mr. Nasir El-Rufai, Honorable Minister of Federal Capital Territory, Mrs. Usman, Honorable Minister of State for Finance , Professor Soludo, Governor of the Central Bank of Nigeria (CBN), Professor Ojowu, Economic Advisor to the President, Mr. Kupolokun, Group Managing Director of the Nigerian National Petroleum Corporation (NNPC), Mr. Agusto, Director General, Budget Office of the Federation, Mr. Naiyeju, Accountant General of the Federation, Dr. Mansur Muhtar, Director General, Debt Management Office, Mrs. Ezekwesili, Senior Special Assistant to the President for Budget Monitoring, Mrs. Chigbue, Director General, Bureau of Public Enterprises, other members of the economic team, and other senior officials. The mission also met with Dr. Adewusi, Honorable Commissioner for Finance of Lagos State, members of the private sector, including the banking industry, civil society, and the international community. The mission would like to thank the Nigerian authorities for their assistance, hospitality, and cooperation.

I. Background

2. In 2004, policy implementation under NEEDS signaled a clear break from the imprudent macroeconomic policies of the past . Overall macroeconomic policy implementation in 2004 was commendable. The key objectives of the 2004 program were achieved, namely to restore macroeconomic stability, enhance predictability and transparency of policies, and reduce the economy's vulnerability to oil price shocks. Prudent management of the significant oil revenue windfall, along with tight monetary policy, contributed to lower inflation, a more stable exchange rate, and a significant build-up of international reserves. Several important reforms have been initiated to enhance the transparency and accountability of public sector policies and institutions and to address Nigeria's deep-rooted macroeconomic and structural challenges.

Developments in 2004 and early 2005

3. Preliminary data of the Federal Office of Statistics (FOS) suggest that the economy grew strongly, benefiting from the improved macroeconomic environment. Real GDP is estimated by the FOS to have increased around 6 percent, on the back of higher growth in the non-oil economy (7.4 percent). The authorities further reported about US$2 billion in new foreign direct investment commitments in the non-oil economy, mainly in food and beverages, leather goods, and telecommunications. However, employment growth remained sluggish and the cost of doing business in Nigeria continued to be unfavorably high.

4. The restrained fiscal stance supported by tight monetary policy was consistent with achieving the disinflation and external reserves objectives. All three tiers of government adhered to the oil price-based fiscal rule and saved oil revenue windfall in excess of the budget reference price of US$25 per barrel. The three tiers of government deposited about US$6 billion in oil revenue windfall in the Central Bank. The consolidated government overall surplus amounted to 10 percent of GDP, compared to balance in 2003. Aided also by a strengthening of the naira, the end-year inflation rate decelerated sharply, notwithstanding domestic fuel price increases. The improvement in Nigeria's terms of trade combined with prudent macroeconomic policies strengthened Nigeria's external position and international reserves rose by about US$10 billion to US$17 billion, the equivalent of 6.5 months of imports of goods and services projected for 2005, or 11 months of imports of goods in 2004.

5. The authorities also made commendable strides in pursuing their agenda to improve governance and transparency and fight corruption. The Economic and Financial Crimes Commission (EFCC) has seized US$670 million in assets from corruption cases, and a number of high level public officials have been arrested for committing economic crimes. Top level management at the customs administration was replaced on corruption and inefficiency charges. The publication of monthly oil revenue distributions to the three tiers of government has sustained pressures for accountability of the state and local governments (SLGs).

6. Progress has also been made in implementing the structural reform agenda. The civil service reform in pilot ministries, monetization of in-kind benefits, restructuring of the Nigerian National Petroleum Company (NNPC) and the CBN resulted in the retrenchment of 17,000 workers. In addition, the Federal Capital Territory has eliminated over 5000 ghost workers from its payroll. The Federal Inland Revenue Service (FIRS) has been restructured to provide integrated tax services to taxpayers, and enhance collection and audit functions. Under the EITI, external auditors have been appointed for financial, process, and physical audits of the oil sector over the last five years. Within line ministries, due process is being decentralized and procurement practices are being set up.

7. Several key legislative initiatives have been prepared and some of them passed with the aim of improving the enabling environment. Most significantly, with the passage of the Power Bill, the Nigeria Electric Power Authority (NEPA) can now be unbundled to create an enabling environment for private investment in electricity generation and distribution. The passage of the public-private partnerships bill will also help attract private investment, including into public utilities. Passage of the procurement bill would mandate open and competitive public procurement. Preparations have been made for concessioning Nigeria's ports, and an international company has been awarded a concession to manage the biggest, Apapa port in Lagos, in March 2005.

8. Although some sales were made, the pace of privatization was disappointing. While preparations for the sale of a number of large companies were ongoing, very few sales were concluded during 2004, although some companies had been planned to come on the market already in 2003. The authorities have replaced the management of BPE in order to revitalize privatization and the pace of work has picked up.

9. Steps have also been taken to strengthen the financial sector with the announcement in July 2004 of a bank consolidation program. All banks are required to meet the minimum capital requirement of N25 billion (US$200 million) by end-2005. To this end, several banks have made share offerings, and a number of bank groups have agreed to merge.

II. Medium Term Challenges and Prospects

10. While the authorities have made great strides in stabilizing the economy, the challenges remain formidable. Nigeria continues to suffer from the legacy of decades of misguided policies. Corruption, the poor state of basic infrastructure, and weak institutions remain the major deterrents to investment, sustainable growth, and improvements in social welfare. The reform program still meets resistance from entrenched interests which may make it difficult to pass crucial legislation. Capacity constraints and poor data management continue to impede the pace of reform implementation, requiring more focused technical assistance, stronger donor coordination, and careful reform prioritization.

11. Nigeria now has a window of opportunity to build on the achievements of 2004 and lay the foundation for faster growth and poverty reduction and achieving the MDGs. The mission concurs with the authorities' emphasis on the need to institutionalize the reforms in order to make them irreversible, and to bolster overall macroeconomic management and institutions, particularly with regard to the fiscal framework, to ensure more effective use of the country's resources. Consistent implementation will be essential to enhance prospects for successful reforms. The structural reform agenda in particular is essential to achieve higher growth in the non-oil economy where about 80 percent of the labor force is employed.

12. Nigeria's medium-term prospects are good, provided the authorities continue to build on the achievements made during 2004. Policy choices and resource constraints will determine the medium-term path of Nigeria's economy. The 2005 fiscal stance is of critical importance. The mission's baseline scenario is built on the assumption that fiscal policy in 2005 is in line with macroeconomic stability, and a low deficit rule at a prudent budget reference oil price for the federal government is followed in the medium-term.

13. Prudent policies would be conducive to robust economic growth of 5-5½ percent over the medium-term, well above the historical average. Inflation would decline to low single digit levels in line with Nigeria's commitments under NEEDS and regional convergence criteria. To achieve the high-growth in the non-oil sector deemed necessary to achieve the poverty MDGs (estimated by the authorities at 7-8 percent per year), private non-oil investment would have to almost double to about 20 percent of GDP, equivalent to about US$4-5 billion per year in additional savings. Fiscal spending would have to leave room for the private sector to be the driver of growth in Nigeria. The mission cautions, however, that it may take time to reap the benefits of the key infrastructural investments and structural reforms.

14. On the other hand, a highly expansionary fiscal policy in 2005 would open the door for a more pessimistic or "muddle-through" scenario reflecting a continuation of past expansionary policies. Under this scenario, higher fiscal spending along with weak reform implementation crowds out the private sector, the non-oil economy grows below potential, and the external current account weakens sharply. Inflation reaches double digits. Gross international reserves fall rapidly as the monetary authorities attempt to defend an overvalued exchange rate.

15. The scenarios show the critical importance of maintaining fiscal prudence, addressing infrastructure bottlenecks, and implementing structural reforms in determining Nigeria's development path. The high growth rates envisioned in the NEEDS require a pronounced effort to make the private sector the engine of growth. Measures to reduce the costs of doing business in Nigeria, including by removing significant infrastructure bottlenecks, and enhancing labor productivity should be given highest priority. As the recent World Bank report on doing business in 2005 indicated, Nigeria has one of the least efficient systems for registering property and one of the slowest procedures for enforcing contracts.

Macroeconomic policies for 2005

16. On balance, the outlook is positive. Real GDP is projected to grow by 7 percent on the basis of higher crude oil and gas production, and non-oil GDP by 5 percent. Given the favorable projections for oil and gas, the external current account surplus is expected to widen, despite higher import demand, and gross international reserves to further increase. The authorities intend to implement in 2005 a budget with a significant spending increase primarily reflecting their desire to address the country's vast development needs, consistent with NEEDS. The focus is on removing existing structural impediments to growth and poverty reduction, and on funding public expenditure reform programs.

17. There are nonetheless risks to the economic outlook. The highly expansionary fiscal stance as implied by the 2005 appropriations bill would complicate the conduct of monetary policy and jeopardize the inflation objective. Oil and gas output could be affected by social tensions and OPEC production quota cuts, while agricultural output remains vulnerable to climatic conditions. Finally, the mission is concerned that enforcing banks' new minimum capital requirement will require careful management if it is not to lead to loss of confidence and exert pressures on the financial system.

Fiscal Policy

18. The greatest risk to macroeconomic stability is presented by the 2005 appropriations bill. It implies a 52 percent increase in federal government spending financed by higher oil revenue, the use of half of the 2004 savings of oil revenue windfall, sales of government assets, and privatization receipts. Higher oil revenue would result from the increase in the budget reference oil price from US$25 to US$30 per barrel. In addition, oil revenue projected at this price appears to be too high because of underestimated cost offsets against companies' petroleum profit tax liabilities, which increases the resources available to SLGs. There is also a risk that the oil revenue windfall from domestic crude oil sales would be distributed for spending, as in 2004, which would greatly increase SLG spending.

19. As a result, the implementation of the appropriations bill, and distribution of much higher oil revenue to SLGs would lead to a sharp widening of the non-oil primary deficit to 47 percent of non-oil GDP (from 35 percent in 2004).² The significant expansion in domestic liquidity following from such loose fiscal policy would reignite inflationary pressures and undermine the achievements of 2004.

20. The authorities recognize the risks associated with the 2005 appropriations bill. They intend to implement a fiscal policy in line with macroeconomic stability, the NEEDS objectives, and Nigeria's absorptive capacity, and limit the increase in spending to 25-30 percent over 2004. They will carefully calculate the level of oil revenue at the budget reference price, including for domestic crude oil sales, in order to distribute amounts consistent with the oil price-based fiscal rule to the federal government and SLGs, and save the windfall in the CBN. In addition, the first quarter has largely passed, and the authorities intend to strictly apply due process to capital spending and continue the effective work of the cash management committee. They will also contain recurrent spending and are taking additional steps to enhance the effectiveness of expenditure management.

21. With these measures, primary federal government spending on a cash basis would still increase by 15-20 percent in real terms. The lower distribution of oil revenue to SLGs would mean that the consolidated non-oil primary deficit would widen by about 6 percent of non-oil GDP compared with 2004 (to 41 percent of 2005 non-oil GDP). All levels of government would record a sizable cash surplus at the WEO projected oil price of US$46.5 per barrel for 2005. This budget is more in line with macroeconomic stability, but would still place a heavy burden on the central bank to implement a sufficiently tight monetary policy to contain liquidity expansion, limit real appreciation, and loss of competitiveness of the private non-oil sector. For the implementation of the fiscal containment measures, further public expenditure management reforms, a very high level of discipline at all levels, and additional efforts for good policy coordination between the budget office and the accountant general's office are needed.

Fiscal Reforms

22. There is a pressing need to ensure that the large increase in spending is accompanied by improvements in efficiency. The new Chart of Accounts (COA) introduced in 2005 could greatly help monitoring budget execution and expenditure tracking, and facilitate moving toward functional classification of budgetary allocations. The accountant general decided to roll-out the Transaction Recording and Reporting System (TRRS) to all line ministries and agencies immediately after the OAGF staff in the line ministries have been trained on the new COA. The mission understands that manpower would be available for the new TRRS to be rolled-out to some ministries in addition to the pilot sites. Rather than wait for training to be completed, the mission recommends to build on the momentum of the success of the pilot sites.

23. The mission commends FIRS for the fast pace of reform implementation to improve tax administration. It encourages FIRS to continue to make good use of the technical assistance recommendations provided by the Fiscal Affairs Department of the Fund in this area, in particular regarding proposed tax policy changes.

24. For the 2006 budget, the budget office plans to move to a more goals-oriented approach to budgeting by the line ministries. The budget office would set specific spending limits within a medium-term expenditure framework. In addition, the mission recommends to also determine allocations to programs within line ministries in order to permit a more meaningful functional classification of the budget and improvement of information on budget execution at the level of the spending units. Expenditure tracking surveys that allow a comparison between budgetary allocations and amounts used by spending units would help identify useful improvements in financial management, monitoring, and institutional arrangements. The mission welcomes the creation of a poverty monitoring and tracking unit to ensure that the allocated resources reach their intended purposes and the establishment of a unit for cost/benefit analyses of large investment projects.

25. The sharp increase in revenue likely to be available to SLGs in 2005 gives rise to concerns, particularly given their weak budget systems and accountability. 24 out of the 36 states have so far committed to developing SEEDS. In addition, the donor community and the federal government are creating an incentive system with matching grants to encourage progress in implementing reforms at SLG level. About one third of SLGs have agreed to establishing due process procedures similar to those at the federal government. Efforts to extend public expenditure reforms to SLGs need to be continued, given their important role in meeting the MDGs, and more needs to be done to improve availability of information about SLG budgets and whether they are aligned with the country's development objectives.

26. In this context, the Fiscal Responsibility Bill (FRB) is of critical importance. The FRB's passage and full implementation would markedly enhance fiscal transparency and accountability at all levels of government, introduce formal fiscal rules to budget policy, and be conducive to medium-term fiscal sustainability.

27. Regarding the authorities' strategy for clearing outstanding contractor and pension arrears, the mission suggests that high importance be given to proper due diligence and equitable burden sharing. The mission calls for a review of the costs and affordability of payments under the old PAYG system. It also encourages a quantitative analysis of fiscal implications when setting the value of the retirement benefit bonds that will be issued for workers that migrate toward the new system.

Monetary and exchange rate policy

28. In light of the envisaged increase in fiscal spending, more of the burden of consolidating macroeconomic stability will fall on the central bank. The CBN's objective is to maintain inflation below 10 percent. Given that money targeting has acquired credibility by lowering inflation sharply in 2004, the mission considers that moving to a narrow exchange rate band is very much a second-best option to continuing money targeting to anchor inflation in Nigeria. Over the medium term, the CBN should return to a flexible exchange rate regime as part of a strategy to adopt an inflation-targeting framework.

29. Liquidity management will be challenged by fiscal expansion. The mission encourages the CBN to move to use domestic market-based instruments actively in order to sterilize excess liquidity and limit broad money growth in line with the inflation objective. In this context, the mission welcomes the lowering of the statutory limit on the FGN's overdraft (ways and means) account to 5 percent of current tax revenue, and notes progress made in developing repos for use in open market operations.

30. The mission recommends that the CBN improve its communications and clarify its operational framework. It welcomes the CBN's efforts to strengthen liquidity management.

Banking Reforms

31. While the mission recognizes the objective of the bank consolidation, the CBN's strategy carries significant risks. The mission hopes that the implementation of the recommendations of the Fund's technical assistance will help manage the restructuring to avoid a loss of confidence in the financial system when depositors become aware that some banks may fail to reach the new requirements. The mission calls on the CBN to develop a strategic plan to deal with failing banks, seek to strengthen its legal powers to close failing banks, and strengthen its capacity in supervision as a matter of urgency. It further urges the authorities to ensure that sound accounting standards are applied in valuing banks' assets. It calls also for progress in the legal processes for establishing asset management companies, since proper handling of failing banks' assets will be critical in order to minimize costs to the public sector if banks have to be closed. Finally, banking supervision needs to be substantially strengthened in view of the heightened challenges that the future banking system, likely to comprise large groups, will bring. Here, the mission welcomes the move to a risk-based supervision, but encourages the CBN to seek technical assistance so that the new supervisory framework can be developed without delay.

Foreign Exchange Market

32. The mission welcomes the CBN's commitment to introduce a daily wholesale Dutch auction for foreign exchange management in early 2006. The necessary infrastructure and implementing regulations could be put in place by the third quarter of 2005. In light of the ongoing banking sector reforms, however, it seems prudent to wait until after end-2005 to minimize risks for the banking system. A timetable for preparatory measures was developed with the MFD's technical assistance mission overlapping with the Article IV mission.

Other Structural Issues

33. The mission broadly agrees with the priorities of the structural reform agenda. It is appropriately focused on improving governance and transparency, enhancing the efficiency of the public sector, and improving the business environment. In particular, the mission supports plans to institutionalize reforms with several important bills now being discussed in the National Assembly, including for the CBN and Banking and Other Financial Institutions (BOFI), the Fiscal Responsibility Bill, procurement, the EITI, and tax policy.

34. A comprehensive trade reform is scheduled to go into effect on July 1, 2005. The reform entails the adoption of the proposed ECOWAS common external tariff (CET) schedule together with an additional higher tariff band of 50 percent. The expected lowering of the average tariff would reduce distortions and rent seeking, and the adoption of the proposed CET should help deepen regional integration. Looking ahead, the authorities also intend to phase out all import bans and fully adopt the CET by January 2007. The mission welcomes the authorities' trade policy intentions, but encourages them to replace import bans with the temporarily higher tariff protection provided by the 50 percent tariff rate. At the same time, the mission notes the importance of not introducing new bans prior to fully implementing the CET.

35. The mission agrees with the ambitious agenda for privatization in 2005 as a way to streamline the role of the government in the economy. The agenda includes the privatization of Alscon, NITEL, and other government assets in the tourism, chemical, oil, and financial sectors. In addition, concessions of critical ports are to be granted and NEPA will start to be unbundled with a view to privatizing it in 2006 as part of a comprehensive power sector reform.

36. The mission has prepared a debt sustainability analysis (DSA) using the current low-income template. The DSA suggests that Nigeria's external debt is sustainable at current and prospective high oil prices. Sensitivity analysis shows that debt sustainability is vulnerable to oil price shocks. A 2-standard-deviation oil price shock would render Nigeria's external debt unsustainable. The mission is also cooperating with the World Bank to prepare a DSA that integrates the costs of additional measures needed for Nigeria to achieve the MDGs and looks into different options for financing these additional measures. At end-2004, Nigeria maintained external payments arrears of US$5.7 billion to bilateral creditors, the European Investment Bank, and holders of oil-price linked payment adjustment warrants. The DMO indicated that arrears to the EIB, which were due to administrative delays, have now been cleared, and those on the oil warrants are being processed for payment. The mission encourages the authorities to regularize its relations with all of Nigeria's external creditors.

III. Other Issues

Statistics

37. The mission stresses the importance of improving the reliability and timeliness of economic statistics to support the formulation and monitoring of macroeconomic and social policies. While acknowledging progress in some areas, including the more regular meetings to reconcile oil revenue data, the ongoing weaknesses should be addressed as a matter of urgency . There are serious deficiencies in data availability and coverage, in particular with regard to monthly economic indicators, including sectoral and external developments and the labor market. The mission also encourages the authorities to collate information on foreign direct investment in the economy. The mission reiterates the need for monthly provision of key economic data as agreed during the 2004 Article IV consultation discussions for the intensified surveillance.

Intensified Surveillance

38. The authorities have indicated that they would like to continue with the current intensified surveillance. Staff believes the intensified surveillance has served Nigeria well, will continue with the policy dialogue, and assist the authorities with the preparation and monitoring of quarterly fiscal and monetary targets, as well as key structural reform measures.

39. The mission emphasizes that the Fund remains committed to helping build capacity in Nigeria to support the NEEDS. Key areas of possible future technical assistance include tax administration and policy, public expenditure management, banking supervision, liquidity management, foreign exchange market unification, and the quality of statistics. The mission will convey the authorities' interest in undertaking a Fiscal ROSC to the colleagues in the Fiscal Affairs Department.

¹ The mission comprised Mr. Katz (head), Mr. Bartsch, Ms. Gobat, Mr. Villafuerte, and Mr Nielsen. The mission was assisted by Mr. Thiam, IMF Senior Resident Representative in Nigeria. Ms. Kwakwa of the World Bank participated in most of the meetings. The mission overlapped with a technical assistance mission of the Monetary and Financial Systems Department (MFD) of the IMF.

² If oil revenue windfall from domestic crude were to be distributed as in 2004, the non-oil primary deficit would widen to 52 percent of non-oil GDP.