1. The Nigerian authorities appreciate the constructive dialogue with the Fund on their economic and structural reform policies aimed at sustaining macroeconomic stability and high growth necessary for poverty reduction and attainment of the MDGs. They thank staff for the lucid and comprehensive set of papers and broadly agree with their analyses and recommendations.
Economic Developments and Outlook
2. The implementation of prudent macroeconomic policies and ambitious structural reforms, supported by a favorable external environment, including high oil prices, has contributed to impressive macroeconomic performance since the last Article IV consultation in July 2005. Real GDP growth rose from 6.5 percent in 2005 to a projected rate of 9.0 percent in 2008; inflation has declined substantially and is now in the low single digits; the exchange rate has stabilized; and there has been strong fiscal and external positions.
3. The immediate economic outlook is favorable. Real GDP growth is expected to be robust, at 8.3 percent in 2009 and 8.1 percent in 2012, supported mainly by sound sectoral policies and private and public demand. The authorities expect an increase in oil and gas production as new investments come on stream and downside risk in the Niger Delta is mitigated through government mediation efforts and public-private sector development activities in the area. Non-oil sector growth, especially agriculture, communications and financial services, which has been very strong, is expected to be sustained in the medium- term in line with increased investments in the sector. Inflation is projected to rise slightly to 7.3 percent in 2008, compared to 5.4 percent in 2007 because of pressure from factors underlying expected higher real GDP growth, but increasingly more effective monetary policy of ensuring price stability would ensure that it remains at its relatively low level. Fiscal spending has been increasingly contained during high oil prices to manage demand pressures by saving revenue windfalls in an oil savings account. The monetary authority’s success in facilitating much needed bank consolidation, along with improved macroeconomic conditions, has not only enhanced rapid growth of private sector credit, but is also driving the fast pace of integration of the country’s financial sector into the global financial system.
4. Notwithstanding the many policy achievements and relatively favorable medium-term prospects, significant challenges still remain, including sustaining high GDP growth, with low inflation; saving oil revenue through reliance on the oil price-based fiscal rule; maintaining fiscal prudence; further improving the effectiveness of bank supervision; safeguarding gains made through structural reforms by strengthening related new institutions; and having the benefits of economic growth reach all segments of the population.
5. The authorities have made considerable progress in implementing prudent fiscal policy, the success of which has continued to result in high oil savings and consolidated budget balance since 2005. The authorities consider their medium-term fiscal strategy (MTFS) for 2008–10 as an adequate guideline for preserving macroeconomic stability. The implementation of the consolidated non-oil primary fiscal deficit, projected to remain at about 25 percent of non-oil GDP in line with the levels in recent years, and supported by the Fiscal Responsibility Act’s oil price-based fiscal rule, is also deemed consistent with macroeconomic stability. The non-oil deficit target envisaged would accommodate resumption of large infrastructure projects previously put on hold.
6. The federal government has continued to emphasize the importance of saving oil revenues against lean times. Its success in making such savings in recent years has generated pressure from state and local governments for increased sharing and spending of some saved oil revenues. The federal government has resisted these pressures and has encouraged and supported the two tiers of government to adopt and apply the provisions of the Fiscal Responsibility Act and the Procurement Act of 2007. In this regard, the National Economic Council (NEC), the apex body responsible for coordinating economic policies of the various tiers of Government, has approved that all states should pass similar versions of the two Acts. At present, the process for adoption of the Acts has reached advanced stage in all the States. Additional measures being proposed by the federal government to enhance oil revenue savings by the two tiers of government and eliminate adverse macroeconomic effects of allocation of oil savings include: distribution of a small proportion of oil savings; adoption of savings fund; and participation in high import-content infrastructure development to suppress demand pressure.
7. Regarding the development of relevant institutions, fiscal institutions such as the Federal Inland Revenue Service (FIRS) and the Office of Accountant General of the Federation (OAGF) are being strengthened through Fund TA. The Staff’s Debt Sustainability Analysis indicates that the authorities have developed a debt management strategy for effective debt management; and that the country faces a low risk of debt distress. The federal government has reaffirmed its commitment to limit borrowing to concessional sources so as to preserve the current strong external position, while states are being provided TA on setting up their Debt Management offices.
8. A judicious combination of suitable policy instruments by the Central Bank of Nigeria (CBN), and increased coordination of monetary and fiscal policies have strengthened the conduct and effectiveness of monetary policy in Nigeria. The Bank has, thus, been successful in bringing inflation to single digits from a rate of more than 20 percent during the last Article IV consultation. In order to further strengthen the capacity to meet inflation objective going forward, the authorities have the intention to put in place a credible mechanism for setting realistic inflation targets through increased alignment of fiscal and monetary policies. However, they would only do so once they are satisfied that all the requisite conditions, including the necessary capacity, are in place. As there is pressing need to spend on essential infrastructure (power, transport, water supply, security), any assessment of possible inflationary impact of fiscal expansion should take into account the composition of the increase in public spending.
9. The adoption of the whole-sale Dutch Auction System and increasing role of the interbank foreign exchange market have strengthened the flexible foreign exchange regime, while the exchange rate has been stable. The authorities, therefore find it difficult to agree with staff characterization of the exchange rate regime as "a managed float". The Bank has reservations about the validity of quantitative estimates of possible undervaluation of the exchange rate on grounds of data quality and structural changes in the economy, while it remains vigilant to ensure that banks are the main conduit for foreign exchange inflows to avoid undue appreciation of the exchange rate that would be inimical to real sector economic activities and exports. The authorities are of the view that the need to increase interest rate in response to the estimated output gap should be nuanced, in the light of the challenges involved in establishing output gap for a country like Nigeria and the fact that core inflation remains very low. The Bank is also having its research efforts focused on better understanding of the link between its policy lending rate and bank’s lending and deposit rates, given the antecedent of past wide-spread loan delinquency rates and high lending rates.
10. On banking and financial sector stability, it is evident that the bank consolidation undertaken by the Central Bank in the last three years, has significantly strengthened soundness of the sector. The banks are now well capitalized, liquid, profitable, and resilient to shocks according to stress tests by staff, while portfolio quality has improved, and provisioning levels high. A key challenge is how to manage monetary policy effectively and preserve financial stability as strong economic fundamentals induce increased capital flows; and new financial instruments and products are introduced at a fast pace by highly capitalized banks seeking profitable outlets. The monetary authority’s strategy for addressing these challenges include ongoing Fund TA on the development of capacity to better assess risks and carry out effective risk-based supervision; strengthening of prudential regulations and ensuring better compliance; deepening the financial sector; and encouraging improved economy-wide financial intermediation, given bank’s huge capital base.
11. The authorities have implemented extensive structural reforms under the recently completed PSI arrangements, including privatization of many public enterprises, liberalization of the communications sector, and concessioning of ports. They, however consider that much remains to be done. Infrastructure gap has been identified as the main impediment to private sector growth. The authorities are committing huge resources to infrastructure development, especially power generation, while ensuring value for money. They have therefore, instituted and are relying on the Public Procurement Act, which provides due process in public contract awards and procurements. To fund new infrastructure projects, with private sector expertise, the authorities are considering a cooperative public private partnership (PPPs), with clear regulatory and legal framework. The authorities have provided resources in the 2008 budget to help address concerns about uncompleted and delayed projects, especially in the power sector. While the authorities are aware that following due process in order to institutionalize the reforms may give the impression of delayed visible results, such an approach would lead eventually to a robust legal and regulatory framework and serve as a building block for acceleration of economic activities and future reforms.
12. The authorities recognize further development of the financial sector as a priority since financial intermediation ratios are still low and capital and asset growth of financial institutions have not been significantly translated into financing of long-term productive investments and improved access to credit for small and medium-sized enterprises. The CBN is focusing on meeting these priority needs, including adoption of suitable strategies in the context of vision 20/20 financial sector development.
The authorities have sustained an encouraging record of economic performance and are committed to continued implementation of necessary reforms to maintain macroeconomic stability essential for growth and meeting the country’s MDGs. They value the Fund’s policy advice and engagement and look forward to continued strong support for the country by the International community, including the Fund.