Nigeria: Staff Report for the 2014 Article IV Consultation
Author: International Monetary Fund. African Dept.
Publication Date:
30 Mar 2015
eISBN:
9781484306307
Language:
English
Keywords:
ISCR; CR; exchange rate; band vis-à-vis; U.S. dollar; debt; oil price; broad money; private sector; current account; monetary policy; Oil prices; Budget planning and preparation; Oil
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KEY ISSUES Context. Nigeria has a large and diverse economy that has achieved a decade of strong growth, averaging 6.8 percent a year. However, Nigeria still lags peers in critical infrastructure and has high rates of poverty and income inequality. The sharp decline in oil prices in the second half of 2014 underscores the challenging but compelling need to address remaining development challenges. Outlook and Risks. In 2015, oil exports are projected to decline by 6 percentage points (ppts) of GDP and oil revenue by 2.4 ppts of GDP from 2014 levels, with a reduction in the current account balance and loss in international reserves. A sharp contraction in public investment and domestic demand is projected to reduce growth to 4¾ percent, with inflation increasing to 11½ percent from the effects of exchange rate depreciation. These developments also increase risks to the banking sector, given its significant exposure to the oil industry and the potential for capital outflows. The outlook is subject to significant risks, both external (changes in oil market developments and investor sentiment) and domestic (uncertainty from the election outcome and security situation). Managing adjustment. The authorities adopted bold policy actions in November 2014— an adjustment in the official foreign exchange rate and band, tightening of monetary policy rates, and spending cuts totaling 1.7 ppts of GDP in the proposed 2015 budget. As the oil price fall appears more permanent than temporary, additional policies will be needed, including greater flexibility in the exchange rate and further fiscal adjustment, particularly in state and local governments. It will be essential to ensure that fiscal adjustment is achieved without endangering the delivery of critical public services. Boosting inclusive growth. The authorities have a comprehensive economic transformation agenda, designed to boost growth, create new job opportunities, and reduce poverty. With recent oil market developments, however, non-oil revenue mobilization (including an increase in VAT rate) is more urgent than ever and is critical for creating the fiscal space necessary to implement the transformation agenda. Further, the national infrastructure investment plan needs careful prioritization, as financing the entire plan would be a challenge, even with more supportive financial conditions and good progress in financial inclusion.

Abstract

KEY ISSUES Context. Nigeria has a large and diverse economy that has achieved a decade of strong growth, averaging 6.8 percent a year. However, Nigeria still lags peers in critical infrastructure and has high rates of poverty and income inequality. The sharp decline in oil prices in the second half of 2014 underscores the challenging but compelling need to address remaining development challenges. Outlook and Risks. In 2015, oil exports are projected to decline by 6 percentage points (ppts) of GDP and oil revenue by 2.4 ppts of GDP from 2014 levels, with a reduction in the current account balance and loss in international reserves. A sharp contraction in public investment and domestic demand is projected to reduce growth to 4¾ percent, with inflation increasing to 11½ percent from the effects of exchange rate depreciation. These developments also increase risks to the banking sector, given its significant exposure to the oil industry and the potential for capital outflows. The outlook is subject to significant risks, both external (changes in oil market developments and investor sentiment) and domestic (uncertainty from the election outcome and security situation). Managing adjustment. The authorities adopted bold policy actions in November 2014— an adjustment in the official foreign exchange rate and band, tightening of monetary policy rates, and spending cuts totaling 1.7 ppts of GDP in the proposed 2015 budget. As the oil price fall appears more permanent than temporary, additional policies will be needed, including greater flexibility in the exchange rate and further fiscal adjustment, particularly in state and local governments. It will be essential to ensure that fiscal adjustment is achieved without endangering the delivery of critical public services. Boosting inclusive growth. The authorities have a comprehensive economic transformation agenda, designed to boost growth, create new job opportunities, and reduce poverty. With recent oil market developments, however, non-oil revenue mobilization (including an increase in VAT rate) is more urgent than ever and is critical for creating the fiscal space necessary to implement the transformation agenda. Further, the national infrastructure investment plan needs careful prioritization, as financing the entire plan would be a challenge, even with more supportive financial conditions and good progress in financial inclusion.

Context

1. Nigeria has achieved a decade of strong growth from a large and diverse economy. Economic growth averaged 6.8 percent a year over the past decade, with the economy accounting for 35 percent of the GDP for Sub-Saharan Africa. While the economy is diverse, with services accounting for over 50 percent and oil only 13 percent of GDP in 2013, the oil sector remains a critical source for fiscal revenues and foreign exchange (Figures 1 and 2). Growth has been driven by the non-oil-sector and private consumption, but Nigeria still lags peers in critical infrastructure (Figures 3 and 4), has high rates of poverty (33 percent in 2012/13) and income inequality, and faces development challenges (Annex 1).

Figure 1.
Figure 1.

GDP by Sector, 2013

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: National Bureau of Statistics.
Figure 2.
Figure 2.

Consumption-led Growth, 2011-13

(Percent)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: National Bureau of Statistics.
Figure 3.
Figure 3.

Investment to GDP Ratio, 2013

(Percent)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: IMF.
Figure 4.
Figure 4.

Public Investment Effectiveness Index

(Units. Higher values reflect better performance)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: Dabla-Norris et al. (2011).

2. The sharp decline in oil prices in the second half of 2014 underscores the challenging but compelling need to address remaining development challenges. Sharply lower oil revenues to each tier of government will strain efforts to address social and economic disparities. In addition, the international environment is less accommodating, with uncertainty about the future of oil prices and the implications of the election (in March 2015) outcome increasing investors’ risk aversion.

3. The authorities continue to advance their policy agenda, drawing on past discussions with staff (Annex 2). Public financial management systems have been strengthened by expanding the coverage of the Treasury Single Account (TSA) and information management systems to most Ministries, Departments, and Agencies (MDAs). Financial sector supervision has advanced through the implementation of Basel II/III, adoption of the International Financial Reporting Standards (IFRS), implementation of the framework for consolidated supervision, strengthening of cross-border supervision (e.g., the use of memoranda of understanding (MOUs), joint inspections, and participation in various Colleges of Supervisors), and enhancements in macroprudential oversight. The legacy debt overhang in the power sector was solved, paving the way for investment to increase gas production; the seed and fertilizer program helped improve food security to rural farm households (including women farmers); and institutions and instruments have been established to boost affordable housing, promote skills acquisition and entrepreneurship training, and improve access to finance for small- and medium-sized enterprises.

Recent Economic Developments

4. Recent macroeconomic performance has been strong.

  • Real GDP grew by 6.1 percent in Q3 2014 (y-o-y): the non-oil sector (crop production, textiles and footwear, telecommunications, and real estate) remained robust (up 7.3 percent), but the oil sector declined by 3.6 percent, mostly driven by an increase in intermediate costs.

  • Inflation remained within the Central Bank of Nigeria’s (CBN) 6-9 percent target range, declining to 8 percent at end-2014. (Figure 5).

  • Key banking system financial soundness indicators remain above prudential norms and CBN stress tests indicate overall resilience. This is despite slight declines in overall capital adequacy, liquidity, and profitability, and a small increase in non-performing loans in the first half of 2014 (Figures 6, 7 and 8, Annex 3). Earnings have been affected by the commencement of banks’ annual payments (of 0.5 percent of total assets) into the Banking Sector Resolution Cost Fund. Banking sector performance has varied by institution-size (Figures 6 and 7), with medium and small banks underperforming larger banks, and two smaller banks requiring some recapitalization in the second half of 2014 after falling below the 10 percent minimum capital adequacy ratio. The risk profile of banks has also evolved, with increased foreign currency exposures, both on the lending and funding sides, though the net open foreign exchange position remains small (about 6 percent of total capital) (Annex 3).

  • Credit to the private sector grew 28½ percent in 2014, compared with 24 percent in 2013. Lending to the oil and gas, construction, and power and energy sectors have grown particularly fast, though exposures to the construction and power and energy sectors remain relatively small (at 5 percent and 4 percent of total loans respectively) (Figure 9).

  • The spread between prime and maximum lending rates widened to 9.5 percentage points. (Figure 10).

  • The trade surplus, $43.8 billion (or 8.4 percent of GDP) for 2013, is about 23 percent lower (2014 Q1-Q3), from lower oil exports and continued strong growth in imports. Remittances and income outflows (mostly oil profit repatriation) have been steady, with fluctuations in capital flows (including errors and omissions) driving reserve movements (Figures 11 and 12).

  • The risk of debt distress remains low (Debt Sustainability Analysis). Total debt is 12.4 percent of GDP, with external debt only 1.7 percent of GDP and mostly from International Financial Institutions (IFIs) on concessional terms. However, about 30-40 percent of Federal Government (FG) domestic debt was held by non-residents at end-2013. Moreover, FG debt service on total public debt is nearly 9 percent of general government revenue, a high ratio compared to an average of 5.5 percent in developing and emerging economies.

Figure 5.
Figure 5.

CPI Inflation

(Percent)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: CBN.
Figure 6.
Figure 6.

Capital Adequacy Ratio (by bank type)

(Percent)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Note the minimum prudential requirement for banks with an international banking license is 15 percent and 10 percent otherwise.Source: CBN
Figure 7.
Figure 7.

Liquidity Ratio (by bank type)

(Percent)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Note the minimum prudential ratio is 30 percent.Source: CBN
Figure 8.
Figure 8.

Profitability of Large Nigerian Banks

(Percent)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Note based on the reported financial statements of the seven largest banks in Nigeria.Source: Bloomberg
Figure 9
Figure 9

Lending by Sector, 2013-14

(Naira billions)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Sources: CBN
Figure 10.
Figure 10.

Interest Rates

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: CBN.
Figure 11.
Figure 11.

Balance of Payments

(Billion U.S. dollars)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: CBN.
Figure 12.
Figure 12.

Capital and Financial Accounts

(Billion U.S. dollars)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: CBN.

5. The authorities have taken bold policy actions to manage near-term vulnerabilities, but challenges remain.

  • With oil production below the budget target of 2.38 million barrels per day (bpd) (Figure 13) and the sharp fall in the oil price (Figure 14) the 2014 FG deficit is projected to increase by 0.2 percentage points of GDP above its target of 1 percent of GDP. The Excess Crude Account (ECA) reached $2.0 billion by end-2014—well below the $6.3 billion required to cover a one-half standard deviation shock to oil receipts. The fiscal authorities responded swiftly to the oil price developments by submitting a revised 2015 Medium Term Expenditure Framework (MTEF) in December, with a benchmark oil price of $65 per barrel (pb) compared to the $78 pb in the original MTEF (submitted in October).

  • The November 24-25 Monetary Policy Committee (MPC) adjusted the exchange rate and tightened the monetary policy stance. The midpoint of the official retail Dutch Auction System (rDAS) rate was adjusted from N155 to N168 per U.S. dollar (a 8 percent adjustment), and the band widened from ± 3 to ± 5 percent, bringing the rDAS rate more in line with the interbank foreign exchange market (IFEM) rate. In parallel, to maintain market confidence, the central bank also raised the monetary policy rate (MPR) from 12 percent to 13 percent and the cash reserve requirement on private sector deposits from 15 percent to 20 percent. Initial market reaction was positive, but pressures re-emerged as oil prices fell further.

Figure 13.
Figure 13.

Oil Production

(Million barrels per day)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Sources: Nigerian authorities, Bloomberg L.P.
Figure 14.
Figure 14.

Oil Price

(U.S. dollar per barrel)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: IMF

6. The equity market also declined sharply in 2014 as oil price continued to decline (Figure 15).

Figure 15.
Figure 15.

Selected Markets: MSCI Index. 2012–15

(Units)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: Datastream, Reuters.

7. Gross international reserves (GIRs) stood at $34.25 billion at end-2014, a decline of $8.5 billion from end-2013 (Figure 16). After stabilizing in the middle of the year, reserves declined in the fourth quarter as the CBN intervened to support the exchange rate in the face of falling oil prices and increased capital outflows.

Figure 16.
Figure 16.

Contributions to Reserve Adequacy Metric

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: IMF.

8. Exchange rate. The foreign exchange market remains segmented, with the IFEM and Bureau de Change (BDC) rates trading at premia over the rDAS rate (Figure 17), creating market distortions. Although the wedge narrowed on the November MPC decision, pressures persist and the IFEM continues to trade outside the 5 percent official band; the spread between the period average IFEM and rDAS rates reached 12 percent in January. In effective terms, the value of the naira changed by less in 2014, as the year-end adjustment offset an earlier appreciation, in line with the dollar (Figure 18). For regional trade, movements in naira per euro (to which CFA francs are pegged) matters more.1

Figure 17.
Figure 17.

Exchange Rates and CBN Forex Sales 2013–15

(Naira per U.S. dollars; billion dollars)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: CBN.
Figure 18.
Figure 18.

IFEM Exchange Rates vis-à-vis $,Euro

(Units, Jan 2013 = 100)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: Reuters Datastream.

Outlook, Risks, and Spillovers

9. The outlook is for growth to moderate as the economy adjusts to permanently lower oil prices. In 2015, oil exports are projected to be $52 billion (down from $88 billion in 2014), a reduction of 6 percentage points of GDP, which is projected to reduce the external current account balance and international reserves. Fiscal oil revenues are projected at 3.4 percent of GDP (down from 5.8 percent in 2014), limiting fiscal spending. Staff projects that these aggregate demand shocks could lower growth by about 1½ percentage point from 2014 to 4¾ percent in 2015—the overall impact on non-oil sector GDP will come from cuts in public investment and a reduction in real purchasing power of oil receipts (see Selected Issues Paper (SIP)2 for a more complete discussion). The depreciation of the exchange rate will add to inflation, reflecting the pass-through of higher domestic prices for imports, but the effect is likely to be contained, in part due to lower food prices from increased local production of staple food crops. The outlook is compromised by low fiscal and external buffers, which have reduced the capacity to absorb shocks relative to the experience of the 2008-09 financial crisis.

Authorities’ views: The authorities reiterated their determination to implement appropriate measures to manage risks. They agreed that the oil price shock is significant and, at least in part, permanent, but saw a smaller effect on economic activity than staff, owing to measures targeted at sectors critical for growth (agriculture, power, small enterprises) and the impact of remittances. They noted that rising food self-sufficiency would limit the pass-through to inflation and activity in housing construction would continue.

10. Risks are on the downside (Risk Assessment Matrix, Box 1).

  • External. Investor sentiment could deteriorate rapidly depending on a further decline in oil prices, and developments in the region and the rest of the world (e.g., outlook for AEs and EMs). Any of these could trigger capital outflows, putting pressure on the exchange rate and GIRs.

  • Domestic. Security risks could increase owing to election-related violence, as well as an intensification of the insurgency. Election results if disputed could lead to a prolonged period of uncertainty, disrupting reform efforts, and in turn adversely affect the investor sentiment.

Risk Assessment Matrix (RAM)1

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1 The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 percent and 30 percent, and “high” a probability between 30 percent and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

11. Inward and outward spillovers through trade channels can amplify risks.

  • The source of inward trade spillovers is shifting from traditional (EU and USA) trading partners to Asian countries, in particular China and India, reflecting the evolution of global energy markets (Figure 19).

  • Although small, Nigeria’s exports to Economic Community of West African States (ECOWAS) countries have been increasing, from $1 billion in 1990 to about $6 billion in 2013. The implementation in January 2015 of the Common External Tariffs (CET) for ECOWAS member countries is expected to reduce incentives for informal trade and simplify customs procedures, potentially increasing recorded trade volumes (SIP: Promoting Economic Transformation).

  • Moreover, the slowdown in Nigeria will adversely affect informal exports to Nigeria. Anecdotal evidence indicates that goods that are subject to import restrictions in Nigeria (e.g., rice) have become key export goods for neighboring countries. Those informal exports to Nigeria are important sources of income for some neighboring countries and outward spillovers may be nontrivial.

Figure 19.
Figure 19.

Exports

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: IMF Direction of Trade Statistics.

12. Growing cross-border activity of Nigerian-based banks has increased the scope for spillovers through financial channels, along with regulatory and supervisory challenges. Nine banks have a significant presence in Benin, the Gambia, Ghana, Liberia, and Sierra Leone. For example, United Bank of Africa has a meaningful market share (assets between 3 percent and 7 percent of GDP) in Liberia, Benin, and Burkina Faso, while Guaranty Trust Bank is systemically important (assets greater than 7 percent of GDP) for the Gambia. The effectiveness of cross-border supervisory cooperation was recently demonstrated when two subsidiaries operating in the Gambia were subject to regulatory action in May with minimal spillovers.

Policies

13. Discussions focused on policies and reforms to support the authorities’ strategic objectives of preserving macroeconomic stability, sustaining inclusive growth, and reducing poverty and inequality. Staff sees the need to balance monetary, fiscal, and financial sector policies in the short term to address increased vulnerabilities, while implementing broad structural reforms to foster higher and more inclusive growth. In particular, opening up fiscal space to allow for investment in productivity-enhancing infrastructure, especially in power and transportation, would facilitate the transition from consumption-led growth to private-investment led growth.

A. Addressing Near-Term Vulnerabilities

Monetary and Exchange Rate Policies

14. Recent developments have highlighted the challenges facing the monetary authorities, and risks to the current monetary and exchange rate policy framework. Monetary policy is driven by the CBN’s commitment to maintain a stable official exchange rate. Thus, international reserves have to adjust to balance supply and demand in the foreign exchange market, and the CBN has less room to manage its inflation target via monetary expansion or contraction. Moreover, the increased use of administrative measures in the money market, liquidity injections through intervention schemes that have contributed to increases in private sector credit, and the maintenance of a tight monetary policy stance can send mixed signals to market participants. Further, structural liquidity cycles have added to volatility in financial markets, resulting in sharp spikes in overnight rates.3 Staff sees clear tensions in the current operation of the monetary and exchange rate policy framework that attempts to maintain a peg against a strongly appreciating U.S. dollar while the economy attempts to adjust to a large adverse terms-of-trade shock. Staff sees the appropriate focus as allowing greater flexibility in the exchange rate to facilitate the adjustment to external shocks. In this context, a further tightening may be needed to avoid a disorderly adjustment of the exchange rate.

Authorities’ views: The authorities view exchange rate stability as a key plank in maintaining macroeconomic stability, and consider that a stable naira is not incompatible with managing inflation through open market operations and other monetary instruments.

15. The 2014 period average exchange rate was moderately overvalued (Annex 4, Text Table 1). The official exchange rate did depreciate in November, but the widening gap with the interbank market rate along with a further fall in the oil price suggest a continued misalignment. Reserves are six months of prospective imports, but slightly below the lower-end of the 100-150 percent of the emerging market reserve adequacy metric, in large part owing to the fall in reserves in 2014 and the buildup of liabilities to non-residents in recent years.

Text Table 1.

Nigeria: Assessment of Real Exchange Rate

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Source: IMF staff estimates.

Based on External Balance Assessment Methodology (IMF Working Paper 13/272).

Current account norm is adjusted upward for errors and omissions.

Positive numbers indicate overvaluation. Elasticity of current account to real exchange rate gap is 0.12.

16. Further liberalization of the foreign exchange market would facilitate macroeconomic adjustment. Staff welcomes the authorities’ intention to gradually move toward greater flexibility in the exchange rate, while noting that the stable naira policy has helped underpin market confidence. Staff encourages measures to minimize the wedge across or unify the segments of the foreign exchange market, rather than through administrative measures taken in recent months, and to develop market-based hedging instruments. Nigeria continues to avail itself of the transitional arrangements of Article XIV, although it no longer maintains any restrictions under Article XIV. Staff encourages the authorities to accept the obligations under Article VIII, noting the enhanced integration with international markets.

Authorities’ views: The authorities consider the current level of the official exchange rate to be close to its equilibrium value. Further, strong growth prospects suggest that Nigeria would remain an attractive prospect for foreign investors, implying continued capital inflows. The authorities monitor closely the various segments of the forex market and indicated their commitment to pursue intervention and prudential measures to preserve the smooth functioning of the market.

17. Financial stability has been maintained, but challenges to asset quality are emerging (Annex 3). Loan portfolios are vulnerable to the decline in oil prices given their concentration in the oil sector (24 percent of total loans as of 2014 Q2) and a significant proportion of total loans are denominated in foreign currency (21 percent as of 2013 Q4), only some of which will be mitigated by natural hedges. Consequently, movements in the exchange rate can impact credit quality. Large banks have strengthened their capital, providing greater capacity to absorb losses, but medium and smaller banks may be more vulnerable to an increase in NPLs. Staff welcomes the new prudential guidelines to limit foreign currency exposure, increased capital weighting on concentrated exposures, and efforts to enforce compliance with the existing provisions controlling SLG access to credit. Staff recommends continued vigilance, including through stress testing of individual banks’ balance sheets, and enhanced supervisory oversight of those banks that are relatively weaker. Also, to mitigate potential foreign currency liquidity risks, staff sees merit in considering a reserve requirement on foreign currency deposits, which now represent about 20 percent of total deposits.

Authorities’ views: The authorities agreed that continued vigilance is needed, noting that they remain fully committed to sustaining financial stability and that their recent prudential actions highlight their readiness to introduce “speed bumps” where systemic vulnerabilities are emerging.

Fiscal Policies

18. Given limited buffers, the draft budget appropriately tightens the fiscal stance. Relative to 2014, staff projects that oil revenue will drop by 2.4 percentage points of GDP. The MTEF envisages a gradual increase in non-oil revenues (0.1 percent of GDP in 2015), with a reduction in expenditure of 1.7 percent of GDP (1 percent from lower fuel subsidies, 0.2 from lower capital spending, and 0.5 from adjustment by SLGs). The projected overall impact is an increase of 0.3 percentage points of GDP in the consolidated government deficit. However, fiscal buffers remain weak and, absent additional fiscal adjustments, staff projects that the ECA could be depleted by end-2015 (SIP: Oil Sector Developments). In addition, with FG capital spending envisaged at 0.4 percent of GDP, the ability to delay capital spending as an informal buffer, as has happened in previous years, is limited. Staff welcomes the announced steps to increase revenue through enhanced revenue administration and excise taxes and fees on luxury goods and services. Nevertheless, staff sees the need to identify additional contingency measures to contain recurrent expenditures and boost non-oil revenues in 2015—such as accelerating potential reforms to VAT and CIT (¶20)—to prevent the ECA from being fully depleted.

Authorities’ views: The authorities noted they would take measures to preserve the ECA at least at $1billion in 2015, highlighting that they contained ECA withdrawals in 2014, a pre-election year. Also, they indicated they have identified measures for curtailing recurrent expenditure.

19. State and local governments face a challenging adjustment. Staff estimates that the existing revenue sharing formulas imply that SLG revenues fall by about a quarter billion dollars for each $1 drop in oil prices. In addition, given the low levels of the ECA, SLGs may not have recourse to augmentation or special distributions (equivalent to an average of 9 percent of their revenue over 2011-2013) to fund their expenditures. With limited room for financing and, absent increases in independently generated revenue, the revised MTEF implies an adjustment in SLG expenditure of about 15 percent in real terms relative to 2014. Achieving such a rationalization without impeding delivery of critical public services or the accumulation of arrears will require careful prioritization, especially in capital projects (45 percent of SLG expenditures), and better monitoring of the evolution of SLG accounts payable. Staff encourages the authorities to further improve public financial management across all levels of government, including through improved coordination and capacity-enhancement activities. In the long-term, it could be important to review the fiscal federalism arrangements—minimizing the duplication of programs (and taxes) and enhancing accountability—to help address more efficiently the socio-economic disparities across states (SIP: Promoting Economic Transformation).

Authorities’ views: The authorities have started to engage subnational governments on the need for budget adjustment. Following the budget price adjustments, the Federal authorities have informed the states of the much lower oil revenue expected for 2015 and the need to prioritize spending. The authorities acknowledge the benefits of a state-by-state approach, recognizing that the states with lower capacity are likely the ones with little internally generated revenue. The authorities aim to build capacity at the SLG level, including through collaboration with the State Commissioners of Finance and workshops with international experts.

20. There are near-term refinancing uncertainties. The government faces significant refinancing needs in the first four months of 2015, including a benchmark bond (about N500 billion) falling due in April, but financing costs have risen significantly—the spread between the Nigeria 2023 Eurobond and the reference U.S. Treasury was 442 basis points at end-December, over 220 basis points wider than the low for 2014 (Annex 5). Staff noted that active engagement with investors and preserving cash buffers can help mitigate refinancing risk.

Authorities’ views: The authorities are monitoring market developments closely and noted that they are projecting financing costs to increase in 2015. However, they remain confident that demand from domestic investors, especially pension funds, would ensure sufficient demand for new bonds and facilitate a smooth refinancing.

B. Medium- to Long-Term Growth Agenda

21. Non-oil revenue mobilization is a key fiscal priority. Non-oil revenue is just 4½ percent of non-oil GDP—compared to an average of 10-15 percent of non-oil GDP for other oil producers—providing inadequate financing for infrastructure and social needs, and leaving the budget vulnerable to oil shocks. A feasible target could be to raise non-oil revenue by 1½ percentage points of GDP by 2017, to achieve a sustainable non-oil primary balance (Text Table 2). This will require continued efforts for enhancing revenue administration and policy adjustments consistent with Nigeria’s well-diversified economy:

  • Administration: On-going reforms are gradually bearing fruit—CIT collections, for example, improved by 0.2 percent of non-oil GDP in 2014 after being stagnant during 2010-13. To ensure the durability of these reforms it will be important to establish qualitative benchmarks, such as the average length of the audit cycle, share of tax filings submitted before due date, and amounts recovered out of tax debt outstanding.

  • Policy: The authorities’ ongoing initiatives to modernize and simplify tax laws provide an opportunity to enhance tax policy. For VAT, the existing 5 percent rate is among the lowest in the world. Reforms should aim to maintain a single rate, keep exemptions to a minimum, and could allow input credits for capital goods and services. For CIT, the priority would be to limit the renewal of exemptions, in particular those derived from pioneer status, to broaden the tax base.

Text Table 2.

Nigeria: Fiscal Scenario

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Note: The sustainable non-oil primary balance is based on the permanent income hypothesis, which provides a long-term benchmark for fiscal sustainability in an oil-rich country.

Authorities’ views: The authorities agreed that non-oil revenue effort was low and that revenue mobilization was essential to meet capital investment and social expenditure. In this context, they shared the achievements to date of the tax administration reforms and planned improvements in registration, auditing, and communications, which are expected to yield an additional $0.5-1.0 billion in 2015. They acknowledged the low VAT rate and pointed to the potential importance of higher VAT collections for the SLGs—85 percent of VAT receipts are distributed to subnational governments. The authorities reiterated the importance they attach to further enhancing tax administration and increasing remittances from revenue-generating agencies, but considered broad tax reform, including VAT and CIT reforms as essential to their medium-term fiscal strategy.

22. Ensuring efficiency of public spending is critical. The absolute level of consolidated government expenditure, at 12 percent of GDP in 2014, is low by international standards: an average of 20 percent for low income, 31 for the emerging, and 41 for the advanced economies. Infrastructure gaps and social needs suggest scope for scaling and composition tilting, subject to resource availability. With projected revenue tightening further in 2015, it will be important to ensure that available resources are used efficiently to meet government’s priorities. Key actions include the implementation of ongoing efforts to prioritize the limited capital expenditure budget and control of recurrent expenditure via Public Financial Management (PFM) reforms (including expanding TSA, the Integrated Personnel and Payroll Management System (IPPIS) and the Government Integrated Financial Management System (GIFMIS) to all MDAs). Staff noted that enhancing the efficiency of expenditure is crucial to muster support for envisaged tax reforms. Staff encourages the authorities to conduct a selective review of expenditure to identify durable efficiency enhancing reforms. Ideally, this review, together with the ongoing prioritization of capital projects, should become a part of the budget preparation process. Staff welcomes the discussion of contingent liabilities in the MTEF and encourages the full and transparent disclosure of all current and future budgetary costs and fiscal risks related to Public-Private Partnerships (PPP)s, which are likely to gain prominence in the years to come as Nigeria attempts to close the infrastructure gap.

Authorities’ views: The authorities aim to remain fiscally prudent. Although the level of spending is relatively low, the authorities still see scope to curtail further current spending in the short term while protecting key programs in priority areas, including health, education, infrastructure, and security. They aim also to reprioritize capital projects to improve efficiency. In the medium term, any expansion of the spending envelope should be supported by additional non-oil revenue. On PPPs, the authorities agreed on the need for a careful approach, but indicated that these risks are minimal at present—strict selection criteria are being observed and only a handful of PPPs have been approved, with very little government exposure. The authorities agree with the need for disclosure, but questioned whether the MTEF is the right vehicle.

23. Financing the infrastructure investment plan will be a challenge. The National Infrastructure Investment Plan (NIIP) has identified new investment needs of about $30-50 billion a year. With domestic savings sufficient to finance about a third of the NIIP, this risks crowding out private sector investment (SIP: Promoting Economic Transformation), especially in the event of reduced foreign portfolio inflows. Consequently, external financing may be needed to fill the gap. (Annex 5). Staff recommends that to minimize risks to debt sustainability, especially given the deterioration in financing conditions, implementation of the NIIP should be carefully prioritized and program objectives adjusted as needed.

Authorities’ views: The authorities agreed that implementation of the NIIP would need to be scaled to resource availability, including through careful prioritization. In that context, they consider that implementation of the new manual on project selection will prove very effective. They indicated, however, that they do not see external market borrowing as a solution and that new external borrowing will be focused on available concessional sources.

24. Lower oil prices provide an opportunity to phase out fuel subsidies. The recent drop in crude oil prices (and lower petrol and kerosene prices) could facilitate the completion of the subsidy reform, which started in 2012. Staff recommends introducing an independent price-setting mechanism to smoothly pass through international price changes to domestic prices and gradually eliminate fuel subsidies. This could generate fiscal savings of about 0.5 percent of GDP per year in the medium term. Staff encourages the authorities to review possible mitigating measures to protect the most vulnerable, including boosting targeted cash transfers through the Subsidy Reinvestment and Empowerment Program (SURE-P), and to transparently communicate the government’s strategy in this regard.

Authorities’ views: The authorities expressed their commitment to subsidy reform, and indicated they were considering options, timing, and modalities of implementing these reforms in light of the decline in oil prices.

25. There is scope to improve budget preparation and reporting. Oil revenue projections have been inaccurate, assuming higher revenue-to-market value of oil production than actually realized. As a result, realized oil revenue is only slightly higher than projected in the budget even when market oil prices are substantially higher than the budget oil price. In addition, reporting of implicit oil subsidies could be enhanced. Staff encourages the authorities to review oil revenue forecasting, and recommends expanding fiscal reports from the Office of the Accountant General of the Federation (OAGF) to show gross and net oil revenues and implicit subsidies.

Authorities’ views: The authorities noted that improved revenue forecasting would be helpful and information on subsidies could be reported better, but cautioned about potential delays in reporting given that source data are preliminary and often subject to revisions.

26. Significant progress has been made in strengthening the supervisory and regulatory framework of the banking system, based on the recommendations of the 2012 FSAP. In addition to the implementation of IFRS and Pillars I and II of Basel II/III, the authorities have implemented a framework for the enhanced supervision of systemically important banks (DSIBs). Work continues on strengthening cross-border supervision, and collaboration with host regulators continues to deepen (Annex 3). These trends are also reflected in other domestic supervisory counterparts (e.g., the Securities and Exchange Commission, National Insurance Commission), with the Financial Supervision and Regulation Coordinating Committee (FSRCC) helping to deepen internal supervisory collaboration, contributing to enhanced oversight of holding companies, the implementation of the framework for consolidated supervision, and preliminary work on systemic risk monitoring. Staff welcomed the progress and encouraged the authorities to sustain their focus on these issues. In particular, staff looks forward to the implementation of the new framework for oversight of holding companies; the completion of the ongoing work on recovery and resolution planning; and further efforts to address weaknesses in banking sector corporate governance, and strengthen cross-border and consolidated supervision.

Authorities’ views: The authorities reiterated their commitment to ensuring the stability and integrity of the financial system.

27. Enhancing financial inclusion will promote inclusive growth. Financial inclusion is low (only a third of the adult population has a deposit at a financial institution). Initiatives are underway that could significantly increase the penetration of formal financial services. These initiatives, some organically grown and others public sector led, are found in the banking, pension fund, and insurance sectors, with many seeking to leverage mobile payments platforms and agents networks (SIP: Promoting Economic Transformation). Some mobile payment services are also considering expanding to quasi-deposit-taking services, complementing traditional/informal group savings clubs. Staff stressed the importance of ensuring the stability and integrity of the financial system to build confidence and ensure meaningful financial inclusion. In particular, the authorities should remain watchful that gaps in regulatory oversight do not emerge given the multiplicity of parties involved in delivery (agents, payments systems, financial institution). For instance, protection of quasi-deposits held in e-wallets should be reviewed and mobile payment systems should also be subject to the Anti-Money Laundering (AML)/Combating the Financing of Terrorism (CFT) requirements in line with international best practices.

Authorities’ views: The authorities acknowledge that the regulatory framework will need to evolve as new products emerge. The effectiveness of these efforts will be supported by the in-house expertise of CBN staff employed from the industry and engagement with stakeholders through the National Payment Systems Board.

28. Private sector-led growth would benefit from competitiveness-enhancing improvements to the business climate and reforms to facilitate trade. Staff noted that accelerating the power and oil sector reforms, including the passage of a sound Petroleum Industry Bill, could lead to a significant reduction in the cost of electricity, a key constraint for many businesses. Further, coordinating the enforcement of the tax regime amongst the federal government and the state and local governments could relieve a significant cost of doing business. Staff encourages a review of tariff policy (removal of import bans and levies on imports) to maximize the benefits of trade agreements such as the Economic Community of West African States (ECOWAS)’s Common External Tariff and to continue to work on agreements that would facilitate trade.

Authorities’ views: The authorities view power as a priority sector and key to promoting growth. They noted that funding issues associated with legacy debt of the newly privatized power generation companies have been addressed by the CBN providing funding through the Power and Aviation Intervention Fund. They noted the need for a unified market for gas to complement reforms in transmission and distribution in the power sector. The authorities acknowledge the need to continue to enhance the business climate, including in terms of coordination with tax authorities at the state level to address tax duplication issues. They indicated that the terms of the Economic Partnership Agreement (EPA) with the European Union (EU) remain under discussion, including on ensuring appropriate market access for Nigerian exports to the EU (SIP: Promoting Economic Transformation).

29. Efforts are underway to make growth more inclusive and generate additional jobs. A skills mismatch and the gap between the rate of job creation in the formal sector versus the number of youth entering the job market are resulting in youth unemployment and underemployment, which could become more acute as the economy slows. Ongoing initiatives include expanded vocational training, grants to foster entrepreneurial talent, and job creation via YouWin and the Graduate Transient Job Creation program funded by SURE-P. Staff noted the importance of protecting funding for these programs, as well as other programs aimed to improve maternal health, keep children in school, and promote higher female participation and gender equality in the workplace. Standardization of application processes, post-program evaluations (as in the case of SURE-P), and clear exit strategies could also help ensure the cost effectiveness of these programs.

Authorities’ views: The authorities stressed the importance of achieving the Millennium Development Goals (MDGs) and their commitment to protect associated social programs, such as the budget for polio vaccinations, Malaria, and HIV, education, security, and core infrastructure (power, critical road transportation and agriculture). With World Bank assistance, the authorities also plan to continue building the social safety net, including developing a conditional cash transfer scheme to promote primary and secondary education and improve maternal and child care.

30. Special financing schemes for private sector growth need to be carefully evaluated. Such schemes constitute quasi-fiscal activities, implying the spending of public resources (Box 2 and SIP: Promoting Economic Transformation). While there is some evidence of a positive impact on capacity and employment, the relative effectiveness and costs of each scheme (or the totality of the schemes) has not been assessed and the implicit subsidies can have distortive effects on resource allocation. Staff recommends that interventions should be carefully targeted with a clear exit strategy, and with a clear assessment of how the results of each program contribute to the sustainability of funding. In addition, staff emphasized the broader benefits of focusing resources on improving the enabling environment for business through infrastructure investment and improved administrative efficiency.

Authorities’ views: The authorities are committed to ensuring interventions are well-targeted and transparent. However, they see these as an appropriate policy focus and in line with the unconventional monetary policy actions taken in other jurisdictions.

Quasi-Fiscal Activities—Subsidized Credit from Public Financial Institutions

The Central Bank of Nigeria (CBN) and other public financial institutions (PFIs) play a role as agents of fiscal policy in Nigeria. These activities affect the overall public sector balance without affecting the FGN budget deficit. The implicit subsidies associated with subsidized lending (or on-lending)—calculated as the maximum lending rate minus subsidized interest rate times the credit extended since inception—through the CBN is estimated at about N140 billion in 2014, about 17 percent of FG capital expenditure.

Key schemes are: the commercial agriculture credit scheme (CACS); the agricultural credit support scheme (ACSS); the refinancing and rediscounting scheme (RRF) operated by the Bank of Industry (BOI) to restructure banks’ existing loan portfolios to manufacturers; and the power and aviation intervention fund (PAIF) also operated by the BOI.

Implicit Interest Subsidies

(Billion naira)

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Sources: CBN and Staff estimates.

31. Ongoing efforts to enhance transparency and monitoring of oil sector transactions could help reduce oil theft/deferred production. Oil production losses fell to about 150 thousand bpd in 2014, reflecting less frequent pipeline shutdowns, but theft and vandalism continue. Staff welcomed the authorities’ development of a strategic analysis, including trends and typologies, of the financing of terrorism within the AML/ CFT framework. It supported plans to undertake and publish in 2015 a similar analysis of oil theft, and require financial and non-financial sector supervisors to use risk-based approaches in controlling oil theft/money-laundering and report all suspicious activities to the relevant authorities. Staff supports the on-going efforts for the automation of oil-related data collections by Nigerian Extractive Industry Transparency Initiatives (NEITI) to improve the timeliness of data reconciliation and urged the publication of the PriceWaterhouseCoopers audit report of Nigerian National Petroleum Corporation (NNPC).

32. Data have improved significantly, but more needs to be done. Nigeria has come far (e.g., the rebasing of the national accounts, a new General Household Survey, and regular publication of FSIs). Continued efforts are needed in: (i) BOP—large errors and omissions, large other investment flows, and greater use of survey data; (ii) refining the CPI and PPI; and (iii) completing censuses of business and agriculture, and the Household Living Conditions Survey to improve the basis for compiling macroeconomic data, including the next rebasing (2015) of the national accounts (Box 3, Annex 5, and SIP: Promoting Economic Transformation).

Improving External Sector Data

Nigeria has been improving external sector data, with the support of the IMF and other partners (Informational Annex). The quality of current account data has improved: for example, the size of discrepancies between Nigeria’s imports from the world and the world exports to Nigeria has narrowed significantly, with the size now in line with that of other countries.

On the financial account, there have been improvements in capturing inflows. For example, the Certificate of Capital Importation (CCI) data provides a detailed monthly series.

Challenges remain in capturing capital outflows, in particular in other investment outflows where sizeable net outflows are reported relative to peers. Such a scale of outflows is not necessarily reflected in the change in net loans positions of BIS reporting banks (BIS Locational Banking Statistics). The authorities are also working to better capture inter-company transfers, particularly of International Oil Companies (IOCs).

However, errors and omissions remain very large.

A01ufig1

Selected Economies: Other Investment Net Inflows, 2008-131

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: IMF BOP Database.
A01ufig2

Selected Economies: Errors and Omissions

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A001

Source: BOP Database, IMF.

Staff Appraisal

33. Nigeria has achieved several years of strong growth, gradually diversifying the economy away from oil, but challenges remain. Growth has been driven by the non-oil sector and private consumption, but is yet to reduce poverty and income inequality has widened. Infrastructure gaps and weak institutions constrain growth prospects.

34. The adjustment to a lower level of oil prices will slow growth and create difficult policy choices. The oil price collapse, which is expected to be at least partially permanent, has significantly impacted the economy. The initial policy response—tightening of fiscal policy, gradual exchange rate depreciation, use of some of the reserve buffer—has been appropriate, but further adjustment will be needed in 2015. To this end, achieving the proposed fiscal consolidation in 2015 will require determined efforts to improve the efficiency and prioritization of spending, ensuring essential public services are not impaired and the implementation of the capital budget is carefully scrutinized. As much of the burden of adjustment falls on the state and local governments, it will be critical to provide appropriate support to these administrations to ensure effective budgeting.

35. Mobilizing additional non-oil revenues will be critical to expanding fiscal space and public service provision over the medium-term. Non-oil revenues are substantially below the levels of other commodity-based economies. Ongoing initiatives to strengthen tax administration have produced welcome improvements in collections, but determined efforts to rein in exemptions would help to broaden the tax net, while tax rates should also be kept under review. Improving oil revenue management, while scaling back fuel subsidies, would also provide additional fiscal space and enable a shift in the composition of expenditures towards pressing social and development needs. In the long term, it might be appropriate to review the revenue sharing arrangements to help address the socio-economic regional disparities.

36. The effectiveness of the monetary and exchange rate policy framework can be improved, including by allowing greater flexibility in the rDAS exchange rate. It is important for the CBN to maintain its focus on inflation. While exchange rate stability helps contain inflationary pressure given the high dependency on imports, exchange rate adjustment can play a key role in enabling the economy to adjust to a large external shock, whereas the rigidity in the rDAS had given rise to a situation where the current level of exchange rate is considered moderately overvalued with respect to the level implied by Nigeria’s fundamentals and reserves are low relative to EM metrics. The wedge between the rDAS and IFEM exchange rates perpetuate distortions and should be eliminated, preferably by unifying the market rather than through administrative measures.

37. Vulnerabilities remain high. With both fiscal and external buffers lowered further in 2014, prolonged uncertainty about future oil prices and domestic political and security developments could adversely impact investor sentiment and the overall assessment of the economy. Financial sector data and stress tests show resilience, but the concentration of risks and foreign currency exposures need to be monitored carefully. Recent progress in strengthening supervision/regulation both for DSIBs and cross-border should be continued and it is important to advance work on deepening financial market development, including for introducing hedging instruments. Moreover, communication is especially critical in helping sustain foreign investor confidence and mitigate the risk of capital flight and disorderly markets.

38. Data are broadly adequate for surveillance, but there are some areas for improvement. Progress has been made in strengthening national accounts data and new household survey, but additional efforts are needed on BOP data, in particular on capital outflows.

39. The longer-term challenge is to successfully position the economy on a path to lower oil-dependency and a diversified and competitive non-oil sector. The on-going transformation agenda establishes a clear strategic direction, but greater prioritization would be helpful to ensure rapid progress on key reforms and the efficient use of available resources. Further development of core infrastructure, reducing business environment costs, encouraging high value-chain sectors, improving access to finance, promoting employment of youth and female populations, and advancing human capital development are all key steps for not only raising growth, but also making it more inclusive.

40. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

Table 1.

Nigeria: Millennium Development Goals, 1990–2012

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Source: World Bank’s World Development Indicators.
Table 2.

Nigeria: Selected Economic and Financial Indicators, 2012–19

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Sources: Nigerian authorities; and IMF staff estimates and projections.

The budget oil price is US$72 a barrel for 2012, US$79 for 2013, $77.5 for 2014, and $65 for 2015 and thereafter.

For 2012, includes one-off payment of about 1 percent of GDP to settle arrears accrued in 2011.

Table 3.

Nigeria: Balance of Payments, 2012–17

(Billions of U.S. dollars, unless otherwise specified)

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Sources: Nigerian authorities; and IMF staff estimates and projections.

Nominal public sector short- and long-term debt, end of period. Guaranteed external debt is not included.

Table 4a.

Nigeria: Federal Government Operations, 2012–17

(Billions of Naira)

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Sources: Nigerian authorities; and IMF staff estimates and projections.

Includes earmarked spending for National Judicial Council, Universal Basic Education, Niger Delta Development Corporation, and Multi-Year Tariff Order subsidy.

Includes proceeds from privatization and sales of government properties.

Projections for 2015–17 are based on a constant oil price of $65 for the period of MTEF.

Table 4b.

Nigeria: Consolidated Government, 2012–17

(Billions of Naira)

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Sources: Nigerian authorities; and IMF staff estimates and projections.

Includes spending of customs levies and education tax; transfers to FIRS and NCS; spending from the ecology, stabilization, development of natural resources accounts; and FCT spending.

Includes projects not included in the FGN budget, even though funds are on lent by FGN.

Equal to the change in net claims on the consolidated government in the monetary survey, minus the change in state and local government deposits that are part of broad money.