This Selected Issues and Statistical Appendix paper presents an assessment of Nigeria’s past economic reform efforts—in particular the program supported by the 2000–01 Stand-By Arrangement (SBA). The paper also reviews weaknesses in the current fiscal management framework in Nigeria and proposes reforms to further strengthen the budget process. It describes weaknesses in the current public debt management framework and the government’s reform strategy. It highlights the reform implication and addresses further actions that will be needed to put the government’s domestic debt reform strategy on a solid foundation.


This Selected Issues and Statistical Appendix paper presents an assessment of Nigeria’s past economic reform efforts—in particular the program supported by the 2000–01 Stand-By Arrangement (SBA). The paper also reviews weaknesses in the current fiscal management framework in Nigeria and proposes reforms to further strengthen the budget process. It describes weaknesses in the current public debt management framework and the government’s reform strategy. It highlights the reform implication and addresses further actions that will be needed to put the government’s domestic debt reform strategy on a solid foundation.

IV. Federal Government Debt Management Reforms27

A. Introduction

85. The government of Nigeria has embarked on a set of reforms aimed at establishing sound and effective public debt management practices as part of its strategy to promote debt sustainability. The main objectives are to commit to market-based financing for the government’s budget, lengthen the maturity structure, and promote the development of the government bond market. The aim of this section is to describe weaknesses in the current public debt management framework and the government’s reform strategy, review the reform implications, and address further actions that will be needed to put the government’s domestic debt reform strategy on a solid foundation.

B. Background

86. Over the past two decades, public debt management in Nigeria has not been effective. It has suffered primarily from the absence of a sound fiscal framework, which has led to excessive debt levels and debt servicing difficulties. The government’s large borrowing needs have also been poorly managed. Scant consideration has been given to the implications of risky debt structures and the extensive reliance on non-market sources of financing on macroeconomic stability and the functioning of financial markets. The central bank’s role as debt manager of the government has also undermined its ability to effectively control liquidity. Moreover, shortcomings in monetary management have impeded the development of the government securities market.

Debt structure and risks

87. Nigeria’s public debt burden is high. Total public debt amounted to N 5.6 trillion, equivalent to 74½ percent of GDP and 138 percent of non-oil GDP at end-2003 (Tables IV-1). External debt—US$32.8 billion (57 percent of GDP)—continues to account for the bulk of total public debt, with most of it owed to Paris Club creditors (Figure IV-1).28 Total domestic debt amounted to N 1.3 trillion (about 18 percent of GDP) at end-2003, and most of it is securitized. Total bank loan advances to the government are rather small. Including federal and subnational deposits with the banking system, net public debt amounted to 71½ percent of GDP at end-2002.

Table IV-1.

Nigeria: Public Sector Gross and Net Debt, 1990-2003 1/

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Source: Authorities and Staff estimates

Does not include state government securitized debt and domestic arrears of the federal and subnationals.

Figure IV-1.
Figure IV-1.

Nigeria: Debt Dynamics, 1990-2003

Citation: IMF Staff Country Reports 2004, 242; 10.5089/9781451828948.002.A004

Source: Nigerian authorities; and Fund staff estimates.

88. The total public debt burden is estimated to be much higher, however. The public debt figure excludes both domestic expenditure arrears, contingent liabilities, and domestic securitized debt of state and local governments.29 The authorities have indicated that although no official tally has been taken yet, accounting for supply contractor and pension arrears could double the domestic debt level to 40 percent of GDP. The federal government debt also excludes potential liabilities such as the domestic debt of major state-owned enterprises, including that of Nigerian Electric Power Authority (NEPA) which is estimated at about N 350 billion (4 ½ percent of GDP) at end-2003, and expected to be transferred to the Debt Management Office (DMO) by end-2004.

89. Nigeria’s debt burden compares unfavorably with most non-HIPC African countries and most emerging market economies and (Tables IV-2 and IV-3). Indeed, the high debt burden has led to periods of debt servicing difficulties. Nigeria has largely been cut off from international finance since the late 1980s when it defaulted on its external debt obligations. It continues to accumulate arrears on its external debt with external debt service in local currency terms equivalent to the size of the federal government’s 2004 capital budget. The government also faced domestic debt-servicing difficulties in the late 1980s as market rates rose significantly in the wake of interest rate deregulations. The government, however, bypassed most of these difficulties by borrowing at below market rates and at longer maturities from the central bank.

Table IV-2.

Nigeria: Sub-Saharan African Countries, Domestic and External Debt 1980-2000

(in percent of GDP, unless otherwise indicated)

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Source: Christensen (2004).

TB=Treasury bills; TC=Treasury certificates; B=bonds; S=Government Stocks; DN=Discount note series

Includes Ethiopia, The Gambia, Ghana, Guinea, Madagascar, Malawi, Mozambique, Rwanda, Sao Tome and Principe, Sierra Leone, Tanzania, and Uganda.

Includes Burundi and Democratic Republic of Congo.

Includes Angola, Botswana, Cape Verde, Kenya, Lesotho, Mauritius, Namibia, Nigeria, Seychelles, South Africa, Swaziland, and Zimbabwe.

Table IV-3.

Nigeria: Public Debt Burden for the EMBI Global Countries, 1990-2002

(In percent of GDP)

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Source: World Economic Outlook (2003); Nigerian Debt Management Office and staff estimates

90. Nigeria’s domestic debt is heavily concentrated in maturities of less than one year. Most of the debt is in the form of 91-day treasury bills—the government’s main marketbased funding instrument. Treasury bonds and development stocks have been issued for specific funding purposes in the past, and, although marketable, are largely held by the Central Bank of Nigeria (CBN).30

91. The short-term maturity structure exposes the government to high rollover risk with about N 825 billion (equivalent to 75 percent of end-2003 base money and 40 percent of end-2003 broad money) being refinanced on average every 91 days in 2004. The short-term nature exposes also the budget to high interest rate risk. Changes in money market conditions feed through to higher debt-servicing costs. Indeed, over the past few years, the domestic debt service burden has increased from its lows in the mid-1990s, reflecting the rapid increase in short-term debt in the face of highly expansionary fiscal policies and higher real interest rates (particularly between 1999–2000) in order to make the treasury bills attractive to the market. Domestic interest payments are almost as high as external interest payments (3 percent of GDP) although domestic debt accounts for a smaller share of total debt (Figure IV-1).

92. There is also a pronounced bunching problem, with large volumes maturing at certain dates. This reflects largely the lack of cash management planning and developed issuance strategy to manage the federal government’s gross borrowing needs prudently. Instead, the federal government typically finances its borrowing needs by borrowing from the CBN and converts its overdraft balance at year-end into three month treasury bills. In addition, there is an inherent mismatch in the duration of the government’s assets and liabilities, with longer-term investment projects being financed with short-term money.

93. These fiscal risks are further accentuated by the shallowness of the domestic financial system, as reflected in the low M2/GDP ratio (26 percent at end-2003), high domestic debt/M2 ratio (67 percent at end-2003), and narrow investor base, with the banking system the main holder of government securities (Figure IV-2). The shallow financial market adversely influences interest rates and risks also crowding out private sector credit in the face of the government’s large borrowing requirements. It also complicates the CBN’s conduct of monetary policy as more forceful use of liquidity management to pursue price stability would adversely affect the government’s debt-servicing costs.

Sources of funding

94. Cut off from the international markets since the late 1980s, the government has largely relied on the domestic market for funding its borrowing needs. The CBN has been the government’s main source of funding, and is also the largest holder of government securities. The government borrows from the CBN through its overdraft account and through CBN’s purchases of government securities in the primary market. There is no legal limit on how much the CBN can purchase in the primary market, except that by law it is not allowed to purchase government securities with maturities in excess of 25 years.

95. Advances through the ways-and-means account are intended to be temporary, covering cash shortfalls during the course of the year, and should at any point in time not exceed the statutory limit of 12½ percent of the projected government’s revenue for the year the advances are granted (equivalent to about 1½-2 percent of GDP) and should be repaid in full by the end of the financial year.31 In practice, the government typically clears the entire end-year balance by issuing 91-day treasury bills in the primary market at the end of the calendar year rather than periodically throughout the year. This has over time created a serious bunching problem, with the market unable to absorb the large issuance it is offered except at a much higher market-clearing rate. However, the CBN, acting as de facto underwriter and administrator in the primary auctions, has typically purchased most of the issue at a rate that is below the market-clearing rate (i.e., the cut-off price). This has kept the government’s domestic borrowing costs artificially low.

96. However, these actions have also had unintended consequences in terms of macroeconomic stability and financial market development. They have resulted in significant monetization of fiscal deficits over the years. Borrowing from the CBN at below-market rates may appear less costly to the government, but such borrowing can result in inflation. Also, the non-market-determined interest rates in the primary market have led to distortions in the cost of capital (as the treasury bill rate is used as benchmark reference rate) and discouraged secondary market trading. Moreover, the soft budget constraint and high access limit on the ways-and-means account have permitted weaknesses in the federal government’s cash management practices to perpetuate, as there has been very little need for accurate cash flow projection in order to forecast and schedule the government’s borrowing requirement.

97. Commercial banks have been the government’s other major source of funding. Banks face a very high liquid asset ratio (40 percent) and hold government paper to meet this requirement. Banks also have, at times, held more government paper than necessary by regulatory standards. This reflects the weak macroeconomic environment but also institutional factors such as the inadequate legal system, including inefficiencies in operating the court system (delays and backlogs) and difficulties in foreclosing and collecting nonperforming loans, all which discourage banks from lending to the private sector.

98. The nonbanking financial sector (e.g., insurance companies, public and private pension funds)—typically the natural investors in government securities in most advanced economies—are not large buyers and holders of government securities. They invest primarily in equity and real estate in Nigeria, but have more recently been an active buyer of longerdated state bonds.

C. Public Debt Management Reforms

99. The main objective of the public debt management reforms is to improve the effectiveness and soundness of overall public debt management in Nigeria. The reforms are focused around three key areas: institutional reforms, external and domestic debt management, and reforms at the subnational level.

100. Institutional reforms are focused on strengthening control, accountability, and oversight over public debt management. As a first step, all functions related to debt management have been consolidated into a newly constituted DMO, which began operations in late September 2001.32 Previously, debt management was divided between the CBN and the Federal Ministry of Finance, but also scattered across several departments within the government with very little oversight and control over borrowing operations and loan guarantees contracted. Furthermore, a new legal framework that addresses the DMO’s role in overall public debt management went into effect.33 The DMO’s formal mandate is limited to making proposals and providing advice to the Minister of Finance who also evaluates its activities, while the National Assembly has the final say on the terms and conditions for the federal government’s borrowing program. Organizationally, the DMO is located outside the Ministry of Finance, under the presidency, and has some autonomy regarding staffing and salary policies.

101. Progress has also been made in upgrading external debt management. The DMO has introduced a data recording system to help reconcile all external debt obligations of both the federal and subnational governments, including guarantees, and structuring them by creditor, currency, and terms. Furthermore, a centralized electronic external debt reporting system has been put in place, helping to improve transparency in external debt service.

102. In close collaboration with market participants, the DMO initiated reforms in the area of domestic debt management.34 The main objectives of these reforms are to (i) finance the deficit in a noninflationary manner, at least cost, and with minimal risk to the government, (ii) lengthen the maturity structure, and (iii) promote capital market development.

103. At the core of these initiatives is the government’s bond issuance program, consisting of a combination of fixed issues and floating rate notes. The bond issuance program would allow for reopening at these maturities so as to gradually build up the outstanding volume to the desired levels and develop a yield curve at key benchmarks. The bonds would be listed at the Lagos Stock Exchange (LSE) to allow for secondary market trading. Clearing and settlement and the depository of the securities are expected to be with the Central Securities Clearing System which is automatically linked with the LSE. The DMO also envisages the development of a primary dealer network to operate as market makers in the primary and secondary market for government securities. The DMO has also reached an agreement with the CBN by which the fixed rate bonds and the floating rate notes could be used as repo collateral as well as be used against banks’ liquid asset ratio requirements for those securities with less than two years remaining until maturity.

104. As part of the domestic debt management reforms, the federal government in early August 2003 announced that it would seek to raise N 150 billion through the issuance of long-term bonds—its first issuance since 1986—to finance the 2003 budget deficit. The federal government (FGN) bonds were issued in tenors of three years, five years, seven and ten years. The former two were structured as fixed-rate bonds while the latter two were floating notes (priced at a premium to the 91-day treasury bill rate). The government hoped to raise a total of N 120 billion in five and more years in maturity, and N 30 billion in three-year fixed rates.

105. The overall take-up fell somewhat short of expectations. Subscription amounted to N 72.5 billion. While the three-year fixed-rate bond was oversubscribed, with the government subsequently raising the amount offered on the three-year fixed issue, there was very little interest for the longer-dated FGN bonds, suggesting a continued high perceived default risk. The bond issue, however, contributed little to lengthening the maturity structure and reducing the rollover and interest rate risks, as the government issued an additional N 91 billion in 91-day treasury bills at end-2003 in order to clear its overdraft balance with the CBN.

106. According to market participants, several shortcomings may have curtailed demand for the October 2003 FGN bond issue. In particular, institutional investors felt that more time should have been given between the announcement (in August) and the closing (in October), to allow them to restructure their existing portfolio in a cost effective manner. Furthermore, several practical issues (such as the establishment of the trading platform, listing on the LSE, as well as regulatory issues of whether the FGN bonds could be counted toward the liquid asset ratio) had not be resolved yet. Finally, the uncertainties in the macroeconomic environment and lack of medium-term budgeting also made it difficult to predict future gross domestic borrowing needs and, hence, risk exposure. Market participants indicated that there was a need to develop a medium-term fiscal framework, with a planning horizon of at least 3-5 years.

Nigeria: October 2003 Auction Results

(in billions of Naira, otherwise indicated)

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107. The DMO has also initiated discussions with the subnational governments on designing rules and guidelines for their domestic and external borrowing. This is an important area, given the growing domestic debt at the subnational level. While the DMO is not liable for debts incurred by subnational governments, increased subnational borrowing in an environment of weak oversight and accountability could endanger macroeconomic stability and debt sustainability. As experience in other countries, such as Brazil, has shown, agreements reached on borrowing limits between the federal, state, and local governments can help achieve fiscal discipline and establish a more sound fiscal regime, and lower in the process the risk premium, and the borrowing cost to the government.

108. The DMO has already tightened external borrowing guidelines, limiting subnational borrowing to concessional terms and for investment purposes only. Subnational governments also cannot borrow externally without the DMO’s approval. The DMO and subnational governments are now in the process of developing rules and guidelines for domestic borrowing and reporting requirements. This initiative, which is taking place in the context of the draft Fiscal Responsibility Bill (Box IV-1), will take time to develop. The World Bank is also providing technical assistance in this area. In the meantime, until the bill gets passed, the CBN, for precautionary purposes, has set limits on domestic subnational borrowing from the banking system, requiring banks to provision 50 percent for loans extended to federal and subnational governments.

Nigeria—Fiscal Responsibility Bill

The government of Nigeria has prepared a draft Fiscal Responsibility Bill that is comprehensive, covering virtually all aspects of fiscal management and fiscal federalism. Among others, it would also introduce guidelines on debt management for the federal, state and local governments and on their borrowing operations. Both the DMO and the Minister of Finance are given a central role in coordinating, gathering, reporting and enforcing the guidelines as spelled out in the Bill. The Bill also addresses the role of the CBN in the financing of the government, and proposes reforms that would address help enhance the CBN’s operational independence.

If passed by the National Assembly and enacted, the Bill would go a long way to establishing a sound and prudent framework for asset and liability management at all levels of government. To summarize the key aspects affecting the area of debt management:

  • The government (all three tiers) would be allowed to borrow only for investment purposes. All its consumption obligations would have to be met through the current revenue base.

  • All levels of government would be subject to a debt limit—defined as a percent of current revenue and net of deposits. There would also be a consolidated public debt/GDP limit for the entire public sector. This ratio should be stable and at a prudent level. There would also be a limit on federal government’s securities (e.g., T-bills). Any deviation from these debt limits would need to be explained, and reduced within three quarters with a minimum reduction of 25 percent in the first quarter. The Minister of Finance would have to disclose on a monthly basis those government entities (federal, states and local) in excess the debt limit. The president would have the power to change the debt limits, subject to the National Assembly’s approval.

  • The DMO is responsible for maintaining a centralized updated electronic record of all domestic and external public debt at all levels of government. The data base is to include terms, conditions, balances, limits, and be made available to the public.

  • Parastatals and other government agencies would not be permitted to borrow. State governments would not be allowed to borrow from their own state financial institutions (where they have a controlling stake). Issuing IOUs (borrowing against anticipated tax revenue, against revenue from parastatals in which the government has an ownership stake) is prohibited. Liabilities to suppliers without budgetary authorization would not be permitted.

  • All borrowing against cash shortfalls would have to be cleared by the end of every financial year.

  • The CBN would be prohibited from purchasing new issues of government securities in the primary market (new borrowing). The CBN would only be allowed to underwrite those securities that are being rolled over by the government to refinance maturing securities. This, however, is somewhat unclear as the CBN could increase its holdings of government securities.

  • The CBN would not be allowd to guarantee loans on behalf of the federal and subnational governments.

D. Reform Implications and Sequencing Issues

109. Overall, the reforms are broadly in line with best practice recommendations as reflected in the Guidelines for Public Debt Management (IMF and World Bank, 2001 and 2003). They would represent a significant break from current practices, address several shortcomings governing debt management in Nigeria and could spur complementary reforms in fiscal and monetary policy and in the financial sector:

• The issuance of government securities at increasingly longer tenors would reduce rollover risk, and the inherent mismatch between assets and liabilities, while the issuance of fixed-rate bonds would help reduce exposure to interest rate risks.

• Accepting market-determined pricing will make the consequences of expansionary fiscal policies more visible to the public, remove distortions in the cost of capital, and improve the allocation of capital in the Nigerian economy.

• Developing a term structure for government securities could spur financial market innovation and encourage longer-term lending which is largely, absent in the Nigerian financial system.

• Consolidating debt management policies and functions within the DMO should help improve overall debt management, while setting borrowing guidelines regarding domestic and external debt for subnational governments should help improve overall fiscal management in the public sector.

110. The debt management reforms are of particular relevance to monetary policy. They would provide a viable alternative for funding of government deficits other than that provided directly by the CBN. This would remove the negative effects of monetary financing on macroeconomic stability. Furthermore, the development of the government securities market would help facilitate the move toward greater reliance on market-based operations for day-to-day liquidity management. It would allow a greater use of repo and reverse repo transactions (with the government security used as collateral) or outright sales and purchases of securities in the secondary market. This would also help improve liquidity in the secondary market and enhance transparency of monetary policy.

111. The reforms are an important step toward achieving separation of debt management from monetary operations. This would be consistent with the recommendations made in the 2002 FSAP report, which called for a discontinuation of the CBN’s practice of being the de facto underwriter of the treasury bills in the primary auction and the requirement that all primary issuance of government securities bear market-determined interest rates. For both effective monetary control and financial market efficiency, interest rates need to be market-determined. The DMO Act transfers all responsibility of debt management from the CBN to the DMO. This would also allow the federal government to determine the risk/cost trade-off on its debt structure, and removes the CBN from the primary market. It is expected that the CBN would continue to administer the primary treasury bill and FGN bond auctions on behalf of the federal government.

112. Notwithstanding these steps, there are several risks with the current reform strategy. Effective implementation will require establishing initial conditions that are conducive to market development as well as addressing shortcomings in the area of monetary policy and regulatory framework.

Macroeconomic stability

113. A critical component, if not a precondition, to developing the bond market, is the need for macroeconomic stability and a prudent fiscal and monetary framework. In an environment characterized by a high degree of macroeconomic instability, investors in Nigeria would prefer to invest in short-term rather than take longer-term fixed positions that will expose them to sharp changes in the value of their investment. Experience shows that extending the yield curve for fixed-rate instruments continues to pose a major challenge for countries with a history of weak macroeconomic polices, and that even well-managed economies have faced difficulties extending the yield curve. Hence, the gradual development of the yield curve, starting with the short end, and supplemented by the issuance of floating rate notes may be more realistic in extending the debt maturity structure in Nigeria, although floating notes do not necessarily protect the government against interest rate risks.

114. However, the government needs to be mindful of the fact or possibility that moving to market pricing and lengthening the maturity structure of the current stock of domestic debt to address the rollover risk, particularly in an environment characterized by a high degree of macroeconomic instability and lack of medium-term oriented fiscal policies, can sharply increase the government’s borrowing costs. These costs need to be made transparent, as they can be counterproductive to the objective of promoting capital market development, if they are not offset by prudent fiscal and monetary policies, and if not properly sequenced. Hence, it is critical a gradual restructuring of the domestic debt take place. As stability firmly takes root, the government’s borrowing costs would decline, permitting a more sustainable development of the government bond market.

115. In this regard, the implementation of the 2004 budget would go a long way to addressing these macroeconomic risks and fiscal sustainability concerns. With the current favorable outlook for oil prices, the implementation of an oil price-based fiscal rule to guide fiscal policies in 2004 would generate a large cash surplus which could be used towards domestic debt restructuring as well as reduction and/or accumulation of financial assets.35 This along with an appropriate monetary framework focused on achieving price stability, would help lower the risk premium and, hence, the borrowing costs to the government. Going forward, it would be important that the federal government start to formulate macroeconomic policies within a medium-term fiscal and macroeconomic framework and based on the implementation of a price-based fiscal rule. This would help anchor investors’ expectations, allow them to better plan their investment decisions, and help reduce the risk premium over time.

Treasury bill market

116. Another critical condition for developing the government bond market is a working treasury bill market (i.e., securities with maturity of less than a year) and an active secondary market.36 The treasury bill market is underdeveloped in Nigeria with the three month treasury bill the only funding instrument for the federal government. As a matter of comparison, Kenya has two benchmark treasury bills—the 91-day and 182-day treasury bill—and has also developed a bond market in the one- and two-year maturity, and more recently launched a three-year instrument. Furthermore, many regulations and practices continue to hamper more active secondary market trading in government securities in Nigeria.

117. A 2003 MFD TA mission that reviewed the government’s domestic reform program recommended that, in line with practices in most countries, the authorities develop the treasury bill market prior to the government bond market and focus on reforming regulations and practices hampering secondary market development. With an already reasonably well functioning market infrastructure in place, the TA mission assessed that if treasury bills of six and twelve month maturities were issued along with the three-month treasury bill, the government’s entire stock of treasury bills could be fully restructured within a short period. In addition, the bunching problem could be addressed separately by ensuring that issuance volumes in the maturing debt become more evenly distributed.

118. This would help reduce somewhat the rollover risk while lowering the pace at which the CBN would have to mop up the liquidity injection that comes from redeemed three-month treasury bills. It would also help develop yield curve for treasury bills and lessen the need for the CBN to intervene in the primary market as dates for scheduled repayments would be more evenly distributed. Developing a 3-, 6-, and 12-month treasury bill program would also improve CBN’s ability to manage excess liquidity and help accelerate the process of separating monetary from fiscal borrowing operations.

119. Experience shows that secondary market trading has been slow to develop in most developing and emerging market countries (BIS 1996). However, a liquid and active secondary market for government securities is important as it helps lower the liquidity premium. It allows financial institutions to convert government securities into cash at low cost. It provides an avenue for risk management, and thus helps broaden the investor base. All in all, this also helps lower the borrowing costs to the government.

120. Greater reliance on market-based operations for day-to-day liquidity management by the CBN would help improve the functioning of the secondary market for treasury bills and increase liquidity in this market. There are, however, a host of other factors that may be affecting trading volume and incentives for banks to actively manage liquidity and interest rate risks in Nigeria, such as (i) lack of market-clearing rate; (ii) high liquid asset requirements; (iii) easy access to the central banks’ discount window; (iv) absence of mark-to-market accounting; (v) the presence of excess bank liquidity; and (vi) more generally, weak banks and poor risks management capacity in the financial system.

Market-clearing pricing

121. The manner in which the cut-off price in the primary auction for treasury bills is administered by the CBN undermines market development. A basic requirement for the successful development of the government securities market is accepting the principle that all debt instruments be priced at market-clearing rates in the primary market.37 While accepting this principle may constitute the most difficult challenge for the federal government as it can lead to much higher debt-servicing costs, over the medium term it would remove the distortions inherent in the financial system. In this regard, the cut-off price should be set at a level that clears the amount offered. Well defined and transparent rules should be developed to address the problem of outliers and collusion. Market-determined interest rates would also stimulate secondary market trading, which would lower the liquidity premium and, hence, the government’s borrowing cost over time.

Liquid asset ratio

122. A gradual reduction of the liquid asset ratio would help stimulate secondary market trading, and provide for a better indication of the true cost of capital as the government would have to draw on the market for funding. To achieve the gradual reduction, it will be important to address the main sources of excess liquidity in the financial system, such as expansionary fiscal policies, inadequate real investment opportunities, and ineffective liquidity management.

Discount window

123. The current modalities governing the CBN’s rediscount window are not appropriately designed to encourage active secondary market trading in government securities and, more broadly, liquidity management in the interbank market. While the CBN’s secondary market window—in place since the early 1990s—served a useful transitional role in helping the development of the government’s treasury bill market, it has since become a deterrent. The main problem is that the cost of borrowing from the CBN’s discount window—the minimum rediscount rate (MRR), which is the policy rate applied to all transactions within the CBN’s discount window—and which is administratively set—has, at times, fallen below the interbank offer rates and primary treasury bill rates. The accommodative policy has made it easy and cheap for banks, in particular weak ones, to transact with the CBN rather than with the market. More restrictive access—by raising the MRR at a premium above the interbank offer rates and treasury bill rate and more frequent adjustment—would require banks to manage liquidity in the market, and strengthen the CBN’s control over its reserve money base.

Mark-to-market accounting

124. The Nigerian statement of accounting standards (SAS) applies historical cost accounting for tradable instruments. This implies that government securities held by banks do not reflect on a daily or monthly basis their market value, and that valuation losses and gains are registered only at the point of trading. Adopting mark-to-market accounting—which requires that financial institutions regularly and frequently revalue securities or other assets in accordance with market prices—could encourage more active secondary market trading, as banks would have to more prudently manage their balance sheet exposure to market risk. However, given the highly volatile environment, judgment will need to be used when moving toward mark-to-market reporting requirements, in particular for pensions and insurances which tend to hold to maturity.

Weak banks and risks management

125. A sound government bond market is also built around competitive financial institutions which have adequate financial capital and capacity for managing risks. The 2002 FSAP identified shortcomings in banks’ risk management capacity. Since banks are expected to play a dominant role in the government securities market (as dealers, holders, and custodians), their weak risk management capacity could have adverse consequences for the profitability of the banking system. Hence, it is important that the regulatory framework continue to be strengthened, in line with recent efforts by the CBN and the Nigerian Deposit Insurance Corporation, to ensure that banks and other financial institutions have adequate financial and risk management capacity to prudently manage their balance sheet exposure to market risks.

126. For a sustainable development of the government securities market, it will be important to broaden the investor base. A more diversified base—in terms of time horizon, risk preferences, and trading motives—ensures higher liquidity and a more stable demand for government securities, lowering the liquidity risk premium and borrowing costs to the government. In this regard, the government’s announced pension reforms—moving from a pay-as-you-go to a fully funded system—would be helpful to foster demand for longer-term government instruments.

Cash management and coordination

127. The success of the domestic debt reforms will also hinge on effective cash management in executing the federal government budget. The capacity to articulate a clear annual and quarterly debt issuance and redemption strategy will depend on the federal government effectively executing the budget, and its ability to develop accurate cash-flow projections during the course of the year. This will also require understanding the seasonality in revenue flows and cash spending, as well as the timing mismatch in government revenue and expenditures. Moreover, a market-oriented funding strategy would require that the DMO and the Office of the Accountant General of the Federation (OAGF) coordinate with the CBN, and give careful consideration to market liquidity conditions in its issuance strategy. This is important to minimize borrowing cost and improve asset-liability management. In this regard, the establishment of the Cash Management Committee in early 2004 has been useful in helping improve coordination between the CBN and the OAGF, and in developing cash flow and borrowing projections for 2004.

128. However, more needs to be done to enhance the transparency of fiscal and debt operations. This would help reduce risk perception and broaden investors’ interest in a sustainable manner. The DMO and the CBN should provide the market with reliable and frequent information on all aspects of debt management operations (i.e., size of deficit, sources of financing, composition of debt, maturity and redemption profile). All materially relevant information on government finances would need to be disclosed, in particular any explicit and implicit government liabilities such as expenditure arrears. The government may also want to consider designing a realistic and affordable strategy to deal with any such liabilities so as not to undermine debt sustainability. Furthermore, the DMO would need to start preparing and publishing both an auction calendar for the year and quarterly auction calendar. Finally, the auction results should be made available on a timely basis by reducing the time lag between bid closing and announcements of results (at the moment, more than one working day).

Operational autonomy of the central bank

129. Finally, further reforms are warranted to formally separate debt management from monetary functions. This would help address the investors’ concern that the government will resort to inflationary financing, which could expose them to capital losses on their government securities’ holdings. It would also help improve effectiveness of liquidity management, and allow the CBN to focus on price stability.

130. Recognizing the importance of price stability to sustainable capital market development, countries have strengthened the autonomy of their central banks. They have introduced restrictions, either by legislation or written agreements, that prohibit or sharply restrict central bank financing of the government. In particular, strict regulations have been introduced in, inter alia, Brazil, Chile, Peru, and Poland where lending to the government is prohibited by the constitution. Moreover, some have passed regulations that set clear rules for the central bank’s intervention in the primary market. For instance, in the U.S. and Mexico, the central bank can replace maturing government paper, but cannot be a net purchaser of government paper.

131. Such provisions should form a core part of the government’s overall debt management reforms. This would also reinforce the perception that the government is committed to market-based financing, developing the government securities market in a sustainable manner, and enhancing transparency of government funding operations. In this regard, immediate consideration should be given to sharply reducing the statutory limit on the overdraft facility to no more than 5 percent of the projected tax revenue in the current fiscal year (similar limits are in place in Kenya; in Mexico the limit was set at 1½ percent). In Botswana, a 5 percent limit is set on overall lending to the government, including purchases in the primary market. The overdraft facility should be strictly used to meet short-term cash needs and be cleared within the financial year, to remove any source of inflationary financing. A lower access limit would also facilitate liquidity management and force the government to improve its cash management operations. Moreover, all temporary advances to the government should bear market interest rates. In Kenya, for instance, the central bank law stipulates the use of market-determined interest rates for government borrowing. Similarly, the CBN should stop being a net buyer of government securities in the primary market (similar reforms have been called for in the Fiscal Responsibility Bill). This would also ensure that the CBN cannot influence the interest rate in the government securities market. In line with best practices, once a good cash management system has been put in place, the government should be required to finance all its borrowing needs—short- and long-term—in the market.

E. Conclusion

132. The government’s public debt management reforms represent a significant break from past practices of financing and managing public debt. It also addresses several shortcomings in the institutional framework governing debt management. These notwithstanding, the reforms will only be successful and sustainable if accompanied by responsible fiscal and monetary policy. The undersubscription in longer-dated bonds in the October 2003 auction was a good indication that in the absence of credible fiscal and monetary policies, investments in longer-dated fixed-income products will be highly unlikely. In line with best practice guidelines, the authorities’ near-term focus should be on developing a working treasury bill market and active secondary market. The implementation of the 2004 budget would go a long way to addressing the macroeconomic risks and fiscal sustainability concerns, and help support the domestic debt management reforms. The reforms’ success will also critically hinge on improving cash management capabilities and coordination between the monetary and fiscal authorities. Improving transparency in fiscal and monetary operations and enhancing the operational independence of the CBN will also be critical elements in establishing market credibility. In this regard, the federal government should develop a strategy to deal with its large stock of expenditure arrears. Finally, a well-functioning government securities market can only develop in an environment supported by sound regulations and a healthy financial system.

F. References

  • Bank for International Settlements, 2002, “The Development of Bond Markets in Developing Countries,” BIS Paper No. 10 (Basle)

  • Debt Management Office of Nigeria, 2002, Overview of the Domestic Debt Issuance and Management Program.

  • International Monetary Fund and World Bank, 2001, Developing Government Bond Markets: A Handbook (Washington).

  • International Monetary Fund and World Bank, 2003, Guidelines For Public Debt Management (Washington).


Prepared by Jeanne Gobat.


Most of the external debt was accrued in the 1980s. The government borrowed heavily to finance large investment projects. It encountered external debt servicing difficulties as oil prices deteriorated sharply starting in the mid-1980s. These payment difficulties were further exacerbated through subsequent exchange rate devaluations. See Lane (2003) for a detailed discussion on the origins of Nigeria’s external debt crisis.


Several states have tapped into the domestic capital market, with bond issuance totaling about N 28-30 billion since 2000.


The government issued treasury bonds in 1989 mainly to avoid paying market interest rates. Interest rates on those bonds were set at 5 percent, well below market clearing rates. Given the price, investors did not take up the bonds and the CBN was left with absorbing almost the entire issue and continues to face difficulty offloading these bonds. In subsequent years, the treasury bonds were issued to the CBN whenever the government wanted to raise money at artificially low rates. The development stocks, which are listed on the Nigerian Stock Exchange, were issued to finance various capital projects. Both will be retired as they mature (Debt Management Office, 2002).


One convergence criterion for the West African Monetary Zone, which Nigeria has endorsed, calls for a ceiling on central bank lending to the government of 10 percent of the previous year’s revenue base.


Examples of countries with specialized debt agencies include Australia, Finland, Hungary, Poland, Sweden and the U.K., while in African countries they include Malawi, Namibia, Zambia and Zimbabwe.


The DMO Act went into effect in early 2003, while at the same time, the CBN Act 39, which deals with CBN’s role as debt manager, was repealed.


A USAID-sponsored resident advisor has been working with the DMO on a full-time basis since late 2001, to provide technical assistance in developing the government securities’ primary and secondary market.


The expected cash surpluses in 2004 and over the medium term are virtuous as they lower domestic debt which in turn reduces net interest payments.


IMF and World Bank (2001).


IMF and World Bank (2001).