Nigeria: Staff Report for the 2013 Article IV Consultation—Debt Sustainability Analysis

This 2013 Article IV Consultation highlights Nigeria’s poverty and income inequality that remain high and social and governance indicators that are below averages for sub-Saharan Africa. Growth is expected to remain strong, driven by agriculture, trade, and services. Inflation should continue to decline, in line with a tight monetary policy, and a lowering trend in food prices from higher rice and wheat production. Transparency and governance in the oil sector should be enhanced, including by strengthening the regulatory framework through the passage of a sound Petroleum Industry Bill featuring stringent enforcement clauses.

Abstract

This 2013 Article IV Consultation highlights Nigeria’s poverty and income inequality that remain high and social and governance indicators that are below averages for sub-Saharan Africa. Growth is expected to remain strong, driven by agriculture, trade, and services. Inflation should continue to decline, in line with a tight monetary policy, and a lowering trend in food prices from higher rice and wheat production. Transparency and governance in the oil sector should be enhanced, including by strengthening the regulatory framework through the passage of a sound Petroleum Industry Bill featuring stringent enforcement clauses.

Background

1. At end-September 2013, external debt of the federal government, is US$8.3 billion (2.9 percent of GDP), comprised:3

Nigeria’s External Debt Stock, end-September 2013

(Millions of U.S. dollars)

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This includes the issuance of a Eurobond of US$1 billion in 2013

Macroeconomic Assumptions

2. The assumptions used in the baseline scenario for 2013–33 are:

  • Average GDP growth of 6.8 percent in 2013–33 (slightly below the average of 7 percent for 2012–2032).

  • Consistent with the WEO projections of an anticipated decline in oil prices over the medium term, the analysis assumes a Nigerian oil price of US$104.5 a barrel in 2013, moderating to US$86.7 a barrel by 2018, and then remaining constant in real terms thereafter.4

  • Non-oil primary deficit (NOPD) would decline from 27.4 percent of non-oil GDP in 2012 to about 15.7 percent of non-oil GDP in 2018. This takes into account the consolidation plans embedded in the 2014–2016 Medium Term Expenditure Framework, including policies to control personnel expenses and contain the growth of capital expenditure. In addition, it is assumed that the oil-price-based fiscal rule continues to be applied, with a budget oil price assumed to be on average about 20 percent below the projected oil price. On that basis, the Excess Crude Account accumulates over time, reaching about 6 percent of GDP by 2018 (more details in the accompanying Staff Report for the 2013 Article IV Consultation). After 2018, it is assumed that the government budget remains balanced, i.e., well within the deficit limit enshrined in the Fiscal Responsibility Law (FRL). This implies the primary deficit of 3.3 percent of GDP in 2018 will have to turn to a surplus of 0.3 percent of GDP in 2033.

  • Following the strong total export growth in 2010–11, exports are projected to stagnate 2012–19 and recover thereafter. Imports are also expected to increase strongly in 2013–18, reflecting strong economic growth. Consequently, the current account surplus declines to about 1.4 percent of GDP by 2018, followed by a small deficit after 2019. Growth in non-oil exports is expected to partially offset the declining oil exports in the medium term.

  • To finance much needed infrastructure investment, new borrowing of US$1.5 billion is contracted during the medium term and $500 million thereafter. The grant element of these loans is assumed at 1.7 percent.

  • N1 trillion of contingent liabilities (bonds) from the Asset Management Company of Nigeria (AMCON) materialize as ultimate fiscal cost for the federal government in 2023 (equivalent to 0.7 percent of GDP).5

External Sustainability6

Baseline

3. In the baseline scenario (Table 1 and Figure 1), the nominal gross external debt burden is projected to moderately increase in the next three years but decline gradually after.7 The external debt-to-GDP ratio would rise from 2.5 percent in 2012 to 2.8 in 2013 and then return to 2.0 in 2018. The initial increase reflects the external borrowing to finance scaled-up public investment during the next years. The external debt-to-GDP ratio is projected to decline gradually to 0.3 percent by 2033. The debt service-to-exports and the debt service-to-revenue ratios also decline gradually throughout the projection period. All debt and debt service indicators remain well below their respective threshold levels throughout the projection period.

Alternative Scenarios and Stress Tests

4. Standardized stress tests were carried out (Table 2 and Figure 1). Under all scenarios, (i) the PV of debt is not likely to exceed 10 percent of GDP throughout the projection period; and (ii) the PV of debt-to-exports ratio is far below its indicative debt burden threshold of 150 percent.8

5. A country-specific alternative scenario was conducted to illustrate the impact on the external accounts and the debt dynamics of a prolonged oil price shock (in light of Nigeria’s high dependency on oil, as well as the high level of oil prices projected in the medium term). The oil price shock is calibrated at 20 percent lower than the baseline during 2014–18. All indicators worsen from the baseline under this country-specific scenario, but remain within the country-specific thresholds relevant for Nigeria. If the oil price were to go below 30 percent of WEO projections (about 1 standard deviation), however, all indicators worsen considerably and especially the PV of the debt-to-exports ratio can exceed the threshold for several years.

Fiscal Sustainability

Baseline

6. The amount of federal government gross debt outstanding is estimated at 18.4 percent of GDP at end-2012, and is projected to decline to about 3.4 percent of GDP by 2033 (Table 3). The current maturity structure of domestic debt is favorable, with short-term debt only accounting for a quarter of total debt. Under the baseline scenario (Table 3 and Figure 2), the consolidated government debt-to-GDP ratio would decline slightly to about 18.2 percent in 2018, reflecting the ongoing consolidation efforts envisaged in the authorities’ Medium Term Expenditure Framework. This implies continued expenditure restraint, including policies to control personnel expenses and contain the growth of capital expenditure. After 2018, the public debt-to-GDP ratio would gradually decline to single digits by 2031. This is largely because of the assumption that the authorities would reduce expenditure or raise non-oil revenue in the medium term, to offset the projected decline in oil revenue (as a share of GDP) implied by WEO projections for oil prices. Thus, these findings are highly sensitive to the resolute implementation of the fiscal consolidation and recovery in oil revenue assumed in the analysis.

Alternative Scenarios and Stress Tests

7. The standardized stress tests underscore the need for fiscal policy to adjust to the economic environment. In particular, debt in 2033 may increase from 4 percent in the baseline to 32 percent if the primary balance is unchanged from its 2013 level. With oil prices stabilizing over the medium term, public debt dynamics would become more susceptible to adverse economic growth shocks. This is shown under the “permanently lower GDP growth” scenario, under which gross public debt-to-GDP ratio in 2033 would increase from 4 percent in the baseline to 15 percent. In addition, a persistent revenue shock would also result in debt reaching about 14 percent of GDP by 2033. In such adverse scenarios, fiscal policy would need to adjust accordingly (Table 4 and Figure 2). To the extent that the staff’s fiscal policy assumptions under the baseline scenario (including gradual improvements in the primary deficit over the medium term) do not materialize, the debt outlook will be negatively affected. In this case, risks to debt sustainability may appear.

Authorities’ Views

8. The authorities concurred that the external debt risk was low. They agreed, however, that timely policy responses would be necessary in the event of a prolonged adverse oil price or economic growth shock. In their view, the sinking fund will be sufficient to cover the negative net worth by the end of 2023.

Table 1.

Nigeria: External Debt Sustainability Framework, Baseline Scenario, 2010–2033 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1 + g)]/(1 + g + ρ + gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 2.

Nigeria: Sensitivity Analysis for Key Indicators of Public and Publicly-Guaranteed External Debt, 2013–2033

(In percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Export values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assum an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 3.

Nigeria: Public Sector Debt Sustainability Framework, Baseline Scenario, 2010–2033

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

The public sector refers to federal, state, and local governments. Debt refers to gross debt and public sector assets such as the excess crude account (ECA) are not netted out.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium- and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Table 4.

Nigeria: Sensitivity Analysis for Key Indicators of Public Debt 2013–2033

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Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Figure 1.
Figure 1.

Nigeria: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2013–2033 1

Citation: IMF Staff Country Reports 2014, 103; 10.5089/9781484357903.002.A002

Sources: Country authorities; and staff estimates and projections.1 The most extreme stress test is the test that yields the highest ratio in 2023. In all figures, it corresponds to the oil price shock.
Figure 2.
Figure 2.

Nigeria: Indicators of Public Debt Under Alternative Scenarios, 2013–2033 1

Citation: IMF Staff Country Reports 2014, 103; 10.5089/9781484357903.002.A002

Sources: Country authorities; and staff estimates and projections.1 The most extreme stress test is that which yields the highest ratio on or before 2023.2/ Revenues are defined inclusive of grants.
1

For instance, in 2012 errors and omissions were 10 percent of total imports.

2

The authorities recently made information available on domestic debt of state and local governments (estimated at about 1.7 percent of GDP in 2011 in commercial bank loans and State bonds and 1.5 percent of GDP in arrears and other liabilities see http://bit.ly/1fjOmpD). Sub-national borrowing is currently limited and tightly regulated. However, the exposure of the multiplicity of off-budget funds is unknown.

3

External debt data provided by the authorities do not include publically-guaranteed debt.

4

The DSA is based on the WEO’s latest projections for Brent crude prices. Nigerian oil price is projected by using the relation for the previous period between the Nigerian oil prices and Brent oil prices.

5

The Sinking Fund is estimated to be worth N6.4 trillion at the end of 2023: the annual contributions of 0.5 percent of total assets by Deposit Money Banks (DMBs) (about N23 trillion at end-2013) are assumed to grow at 20 percent) and the 50 billion by CBN every year are assumed to accrue 10 percent return. The fund will be used to fill the gap in the AMCON’s balance sheet of about N3.4 trillion (assets and bond liabilities are about N2.3 trillion and N5.7 trillion respectively as of September 2013). It will also pay for net interest expenses on its bonds, which over 10 years is estimated to be about N4.0 trillion. All assets are assumed to be sold at face value or higher to cover other operating costs.

6

The LIC debt sustainability framework (DSF) provides a methodology for assessing external debt sustainability that is guided by indicative, country-specific, debt-burden thresholds based on the relative strength of a country’s policies and institutions. Given Nigeria’s rating of 3.5 (medium performer), which is the three year average of the World Bank’s Country Policy and Institutional Assessment (CPIA), the relevant country-specific thresholds are a PV of external debt-to-GDP ratio of 40 percent, a PV of external debt-to-exports ratio of 150 percent, and an external debt service-to-exports ratio of 20 percent.

7

The historical average of the noninterest current account surplus is much higher at 9.6 percent than the average of about 3 percent for 2013–18, and treating the difference as “residual borrowing” becomes explosive over time.

8

Note that the projection does not fully capture a possible volatility in real GDP growth. For instance, if one were to replicate the same level of volatility in real GDP growth in the next five years (2014–18) as was observed in the 2004–2008 period, the PV of debt-to-export ratio would breach the indicative policy threshold at least once (in 2018).

Nigeria: Staff Report for the 2013 Article IV Consultation