Public Information Notice No. 04/80

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Nigeria

August 3, 2004

On July 16, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Nigeria.¹

Background

Economic performance over the past 18 months has been mixed. Despite favorable developments in the real economy, overall macroeconomic policies have been expansionary. However, the government moved quickly to articulate the National Economic Empowerment and Development Strategy (NEEDS), aimed at addressing Nigeria's deep-rooted macroeconomic and structural challenges. Moreover, macroeconomic developments for the first half of 2004 have been encouraging, with considerable oil savings achieved, signaling a reversal of the expansionary policies of the past years.

Real GDP growth in Nigeria accelerated in 2003 on account of sharply higher oil and gas production and continued robust growth in the non-oil economy. Due to favorable terms of trade developments, the external current account deficit narrowed sharply. This, however, masks rising non-oil import pressures and a widening non-oil external current account deficit.

Fiscal policy continued to be procyclical and expansionary in 2003, with the non-oil primary balance deteriorating as a percent of non-oil GDP. Although the federal government achieved some fiscal tightening, this was more than offset by higher spending of the oil windfall by state and local governments (SLGs). The overall deficit would have been higher had the federal authorities not introduced several measures to enhance revenue collection and restrain spending in the second half of 2003, particularly with regard to the capital budget and the supplementary budget that was approved in early December 2003. Government oil revenue also improved after the Nigeria National Petroleum Corporation (NNPC) was required to pay the market price for crude oil allocated for domestic refining.

Monetary policy was expansionary. Net credit to the government expanded rapidly in the first three quarters of 2003. Lax monetary conditions led to a monetary overhang and negative real short-term interest rates by end-2003 and early 2004. Inflation accelerated in 2003 on the back of expansionary macroeconomic policies and fuel price liberalization. Gross public debt continued to rise as the federal government resorted to a mixture of market-based and monetary financing to finance its expansionary policies. As a result of further arrears accumulation and valuation effects, external debt increased by US$2 billion to US$32.8 billion at end-2003. Nevertheless, the authorities made efforts to improve relations with Paris Club creditors, with all but four bilateral negotiations concluded under the 2000 rescheduling agreement.

Despite record high oil revenue, international reserves continued the downward trend that started in 2002. Reserves fell for the year by US$213 million to US$7.5 billion (3.8 months of imports). In line with the terms of trade improvement, expansionary fiscal stance and higher DAS sales, the real exchange rate has appreciated by 6 percent since end-2002, and remains about 11½ percent above its 1999 level (when a major realignment took place).

Macroeconomic conditions have improved considerably since late 2003, due largely to fiscal prudence. The fiscal restraint that began in the last quarter of 2003 continued in the half of 2004. Around US$2 billion in oil revenue was set aside by all tiers of government during the first six months. The fiscal restraint allowed a net repayment by the government to the banking system. In addition, the CBN's shift to daily open-market operations—introduced in November 2003—has helped lower excess liquidity in the banking system. Consequently, 12-month growth in broad money slowed considerably in the first six months, and foreign exchange market pressure has eased, facilitating a sharp increase in gross international reserves to US$10.1 billion at end-May 2004, and a narrowing of the parallel market exchange rate premium to 4½ percent. After moderating to 17½ percent at end-April, the 12-month inflation rate picked up again to 19½ percent at end-May 2004 due to higher food prices.

Structural reform efforts have been positive since mid-2003. Several initiatives to improve oil sector efficiency and enhance public sector transparency and accountability were introduced as part of NEEDS. First, the price subsidy to NNPC on its domestic crude allocation was eliminated in October 2003. Furthermore, prices on retail petroleum products were liberalized. Second, the authorities volunteered to participate in the Extractive Industries Transparency Initiative (EITI) and agreed to participate in the African Peer Review Mechanism of the New Economic Partnership for African Development (NEPAD) and the G8 Transparency Initiative. Third, the financial sector and the payment system were strengthened in line with Financial Sector Assessment Program (FSAP) recommendations. Overall trade protection, however, increased due to the imposition of ad hoc import bans.

Confidence in the Nigerian economy has improved since the elections and with the appointment of the new economic team. Nigeria's spread over the overall JP Morgan Emerging Market Bond Index Global has tightened by about 550 basis points since April 2003.

Executive Board Assessment

Executive Directors welcomed the notable recent improvement in prospects for sustained adjustment and economic reform in Nigeria, and the authorities' articulation of the National Economic Empowerment and Development Strategy, NEEDS—a homegrown medium-term economic strategy aimed at addressing Nigeria's deep-rooted macroeconomic and structural problems and reducing poverty. They fully agreed with its overall policy thrust and direction for tackling economic development and unleashing Nigeria's growth potential. Directors viewed the reform priorities as broadly consistent with the recommendations of previous Article IV consultations, and marking a clear break from the policies of the past. They stressed that consistent and determined implementation of NEEDS, backed by complementary strategies at the sub-national level as well as the support of the international community, will be essential if Nigeria is to confront successfully the daunting economic and social challenges that lie ahead.

Directors were encouraged by the authorities' initial progress in implementing the policy agenda in engagement with the private sector and civil society. A number of policy actions taken since late 2003, combined with higher oil prices, have contributed to an overall improvement in macroeconomic performance so far in 2004. Directors commended the fiscal restraint that allowed much of the oil windfall to be saved, resulting in lower inflation and a sharp increase in gross international reserves. They saw the elimination of the subsidy on petroleum products as a bold demonstration of the authorities' commitment to reform. On the structural front, Directors welcomed the introduction of an oil price-based fiscal rule at the federal level, improvements in governance practices, the strengthening of the budget process, and increased policy coordination, in part through the new Cash Management Committee.

Notwithstanding the recent progress, Directors underlined that economic reform in Nigeria faces serious risks and challenges, owing primarily to weak institutions, limited technical capacity, and resistance of entrenched vested interests. Careful prioritization and sequencing of reforms will be essential to avoid overstretching administrative capacity. Directors endorsed the suggestion that the authorities should focus their immediate effort on a few reforms that will produce tangible results and garner public support quickly, and underlined the importance of a sound communication strategy to persuade public opinion of the benefits of reform. The ongoing civil service reform and other actions being taken to increase public accountability and transparency will be crucial steps to strengthen institutions and render the reforms permanent. Directors commended the authorities' commitment to improving governance and tackling corruption—as reflected in Nigeria's participation in the Extractive Industry Transparency Initiative; the African Peer Review Mechanism of New Partnership for Africa's Development; and the G8 Transparency Initiative. They welcomed the establishment of the Economic and Financial Crimes Commission and the publication of the monthly revenue allocations to sub-national governments.

Achievement of macroeconomic stability will require continued fiscal tightening at the federal level and the participation of all states in the oil price-based fiscal rule. Directors noted that the federal government faces a major challenge in reaching agreement with the states to save oil windfalls, and urged timely passage of the Fiscal Responsibility Bill to provide the legal foundation for a prudent consolidated fiscal policy. They were disappointed that the consolidated non-oil fiscal deficit is expected to rise significantly, undermining efforts to restrain inflation, and called on the states to implement the oil price-based fiscal rule to ensure fiscal prudence. Fiscal prudence will also require measures to boost non-oil revenue and control spending, while ensuring that social and developmental needs are met.

Directors observed that the 2004 federal government budget embodies a positive change from past budgetary practice. The adoption of a fiscal policy framework incorporating an oil price baseline should help achieve sizable cash savings to buffer against future oil price shocks and reduce macroeconomic volatility. Directors called on the authorities to build on this progress and begin the 2005 budget cycle early. They stressed the need to further prioritize the capital budget, design a strategy to address domestic arrears, and develop a medium-term expenditure framework consistent with NEEDS.

Directors encouraged the central bank to implement a credible monetary policy framework aimed at achieving price stability and rebuilding Nigeria's international reserves. Given the monetary overhang from 2003 and the persistent inflationary pressures, Directors underscored the need for the central bank to be vigilant in implementing its monetary program. In particular, the central bank should avoid financing the budget deficit and should adjust the minimum rediscount rate if inflationary pressures accelerate. Directors encouraged increased reliance on indirect monetary policy instruments and reforms to enhance the independence of the central bank. In addition, they urged the central bank to develop an effective strategy for public communication of the objectives and stance of monetary policy, so as to establish the credibility of the monetary framework.

Directors commended the implementation of the recommendations of the Financial Sector Assessment Program aimed at strengthening the financial sector and the payments system. They underscored the importance of decisive action against misreporting and under-provisioning and of an exit strategy to address the problem of weak banks, and supported the authorities' request for a follow-up FSAP to help address these issues. The establishment of a Financial Intelligence Unit to strengthen the framework for anti-money laundering was welcomed.

Directors welcomed the authorities' intention to unify the foreign exchange market and move toward a market-determined exchange rate, and supported the authorities' request for technical assistance to implement this reform. They also encouraged the authorities to work toward accepting the obligations of Article VIII of the Fund's Articles of Agreement. Directors welcomed the authorities' launch of a formal review of the import tariff structure with a view to implementing the lower common external tariff of the Economic Community of West African States. However, they expressed concern about Nigeria's continued reliance on import bans. They noted that, going forward, comprehensive trade liberalization will be needed to enhance Nigeria's competitiveness and boost investment.

Directors welcomed Nigeria's efforts to improve its debt management practices and address its domestic and external debt burden. They agreed that development of a treasury bill market would be helpful in restructuring the domestic debt and reducing rollover risks. Directors commended the authorities' improved dialogue initiated with the Paris Club. A number of Directors called on the authorities to service external debt to the fullest extent possible, and emphasized the importance of comparable treatment of all creditors. Several Directors encouraged the authorities to work closely with their creditors towards finding a sustainable long-term solution to Nigeria's serious debt problems.

Directors urged the authorities to sustain the privatization effort and create a more business-friendly environment to boost private sector growth. A regulatory and monitoring framework that ensures an open and transparent privatization process will be key to encouraging investor interest in the enterprises concerned.

Directors welcomed the authorities' request for Fund staff to monitor the implementation of their program. In view of this request, they generally endorsed the proposed intensified surveillance, which will involve quarterly staff visits to Nigeria and semi-annual information reports to the Executive Board. They encouraged the authorities to give highest priority to capacity building, and reiterated the Fund's commitment to help Nigeria in this regard. Directors urged the authorities to continue to make full and effective use of technical assistance based on their recent initiatives to prioritize technical assistance needs. They called on the authorities to improve their statistical system, as an essential basis for effective monitoring of economic policy implementation.