Nigeria: Staff Report for the 2014 Article IV Consultation—Debt Sustainability Analysis
Author:
International Monetary Fund. African Dept.
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Publication Date:
30 Mar 2015
eISBN:
9781484306307
Language:
English
Keywords:
ISCR; CR; exchange rate; band vis-à-vis; U.S. dollar; debt; non-oil primary deficit; service-to-revenue ratio; debt-to-revenue ratio; debt stock; nominal interest rate; Fiscal stance; Public and publicly-guaranteed external debt; sustainability Framework
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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.

A. Background

1. At end-September 2014, external debt of the federal and state governments is $9.5 billion (1.7 percent of GDP), comprised by:3

Nigeria’s External Debt Stock, End-September 2014

(Millions of U.S. dollars)

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B. Macroeconomic Assumptions

2. The assumptions used in the baseline scenario for 2014–34 are:

  • GDP grows as in the staff report baseline through 2020 before accelerating in the medium term as structural reforms take hold, averaging 6.1 percent in 2014–34 (below the average of 6.8 percent assumed for the 2013–33 analysis, and below the 6.8 percent historical average).

  • Consistent with the recent decline in oil prices and their expected path in the medium term (based on the January 2015 World Economic Outlook (WEO) projections), the analysis assumes a Nigerian oil price of $100 per barrel in 2014, falling to $52.8 per barrel in 2015, recovering moderately by 2020 to $73.7 dollars per barrel, remaining constant in real terms thereafter.4

  • The non-oil primary deficit (NOPD) of the general government is expected to decline from 8.1 percent of non-oil GDP in 2014 to about 4.7 percent of non-oil GDP in 2020. In the baseline scenario, given Nigeria’s current low levels of government expenditure, this is implemented as keeping primary expenditure-to-GDP relatively flat at its planned 2015 level and increasing non-oil revenue.5 This takes into account the consolidation plans embedded in the 2015–17 Medium-Term Expenditure Framework, including policies to raise non-oil revenue and control operating expenses. On that basis, the Excess Crude Account accumulates gradually, reaching about 1 percent of GDP by 2020. With the importance of oil revenue to the economy and fiscal accounts expected to decline over time, the NOPD would continue to adjust, arriving at a deficit of about 2.5 percent of GDP in 2034.

  • Given the expected behavior of oil prices and production volumes that are projected to be flat, exports are assumed to grow less rapidly than the rest of the economy notwithstanding the projected continuation of the recent rapid growth in non-oil exports.6 Imports are projected to grow in line with the non-oil economy. Consequently, the current account surplus declines to 0.2 percent of GDP by 2020, and turns into a deficit of ½ percent of GDP by 2034.

  • N400 billion of contingent liabilities from the Asset Management Company of Nigeria (AMCON) bonds are assumed to materialize as ultimate fiscal cost for the federal government in 2023 (equivalent to 0.16 percent of GDP in 2023).7

C. External Sustainability

Baseline

3. In the baseline scenario (Table 1 and Figure 1), the nominal gross external debt burden is projected to gradually increase. The external debt-to-GDP ratio would rise from 1.7 percent in 2013 to 5.5 percent in 2034. The debt service-to-exports and the debt service-to-revenue ratios also rise gradually during the projection period. All debt and debt service indicators remain well below their respective threshold levels throughout the projection period.

Table 1.

Nigeria: External Debt Sustainability Framework, Baseline Scenario, 2011-34

(In percent of GDP, unless otherwise indicated)

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Source: Country authorities; and staff estimates projections.

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

Includes exceptional finding (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation in 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 device 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 governments and through new borrowing (difference between the face value and the PV of new debt).

Figure 1.
Figure 1.

Nigeria: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2014-341

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2024. In figure b. it corresponds to a one-time depreciation shock; in c. to a lending terms shock; in d. to a one-time depreciation shock; in e. to a exports shock and in figure f. to a exports shock.

Stress Tests

4. Standardized stress tests were carried out (Table 2 and Figure 1). The scenario shocking export values was run for 2016-17, since the baseline for 2015 already incorporates a large decline due to the fall in oil prices. 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.

Table 2.

Nigeria: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2014–34

(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 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Incorporates the 2015 oil price shock plus additional shocks in 2016-2017. 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 assuming 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.

D. Fiscal Sustainability

Baseline

5. Gross debt of the federal and state governments is estimated at 13.4 percent of GDP at end-2014, up from less than 10 percent of GDP through 2010, and is projected to rise modestly during the forecast horizon (Table 3). Debt service and debt-to-revenue ratios are also projected to increase relative to recent history and previous forecasts, as a result of the rising level of debt and the recent decline in oil prices and oil price futures. This illustrates Nigeria’s reliance on oil revenue in government funding, and underscores the importance of mobilizing non-oil revenue to reduce its exposure to fluctuations in oil prices. The current structure of domestic debt is favorable, with all debt carrying a fixed interest rate and the average maturity at 4.5 years. Similarly, external debt is largely on concessional terms other than the Eurobonds, and is contracted at long maturities. The forecast assumes an increase in the share of external debt contracted at commercial terms, with the grant element of external disbursements falling to less than 10 percent during the projection period. Oil and gas revenue is projected to decline as a share of GDP due to the recent drop in prices and flat production volumes going forward. It is assumed that the authorities will reduce expenditure or raise non-oil revenue in the medium term to offset this decline. Thus, these findings are highly sensitive to the resolute implementation of fiscal consolidation.

Table 3.

Nigeria: Public Sector Debt Sustainability Framework, Baseline Scenario, 2011-34

(In percent of GDP, unless otherwise indicated)

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Source: Country authorities; and staff estimates and projections.

Gross debt of the federal government and gross external debt of state governments.

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.

Revernues excluding grants.

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

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

Alternative Scenarios and Stress Tests

6. The stress tests underscore the need for fiscal policy to adjust to the economic environment. In particular, the present value of debt in 2034 would increase to 40 percent of GDP if the primary balance is kept unchanged at its 2014 level (Table 4 and Figure 2). Public debt dynamics could also become adverse if growth is permanently lower than in the baseline, with gross public debt rising to 33 percent of GDP in 2034. In such adverse scenarios, the debt service-to-revenue ratio would increase substantially from current levels and fiscal policy would need to adjust accordingly. Temporary shocks would be unlikely to significantly alter the conclusion that the risk of debt distress is low, as the other macroeconomic shocks considered do not bring about significant changes in the projected debt ratio.8 However, in the presence of shocks to either the primary balance or to other debt-creating flows (contingent liabilities), debt service-to-revenue ratios would increase, illustrating the importance of rebuilding fiscal buffers over the medium term. 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, risks to debt sustainability would be higher.

Table 4.

Nigeria: Sensitivity Analysis for Key Indicators of Public Debt 2014-34

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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 2.
Figure 2.

Nigeria: Indicators of Public Debt Under Alternative Scenarios, 2014–341

Citation: IMF Staff Country Reports 2015, 084; 10.5089/9781484306307.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2024.2/ Revenues are defined inclusive of grants.

E. Authorities’ views

7. The authorities concurred that both external and overall public debt risks were low provided that their fiscal consolidation plans are implemented as intended. They agreed, however, that timely policy responses would be necessary in the event of a prolonged economic growth shock or further substantial decline in oil prices.

1

The LIC debt sustainability framework (DSF) provides a methodology for assessing external debt sustainability which 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 of 40 percent, a PV of external debt to exports of 150 percent, and an external debt service to exports ratio of 20 percent.

2

For instance, errors and omissions averaged -4.4 percent of GDP from 2009-2013.

3

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

4

The Nigerian oil price is projected by holding constant the margin between the prices for Bonny Light oil and Brent oil.

5

See “Raising Non-Oil Revenue” in Nigeria: Selected Issues for a discussion of options.

6

Oil exports account for over 90 percent of exports and through 2013 about 70 percent of government revenue.

7

The Sinking Fund is estimated to be worth N6.1 trillion at the end of 2023 based on annual contributions of 0.5 percent of total assets by Deposit Money Banks (DMBs) (about N24 trillion at end-2013) and N50 billion annual contributions by the CBN, all accruing a 10 percent nominal return. The fund will be used to pay net interest expenses on its bonds and to fill the gap in AMCON’s balance sheet (assets and liabilities were about N2.5 trillion and N6.0 trillion, respectively, as of end-2013).

8

The shock to the primary balance is performed for 2016-2017, with half the shock coming from lower revenues. This scenario illustrates the impact from oil prices remaining at about current levels over that period.

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Cover IMF Staff Country Reports
Nigeria: Staff Report for the 2014 Article IV Consultation
Author:
International Monetary Fund. African Dept.
Volume/Issue:
Volume 2015: Issue 084
Publisher:
International Monetary Fund
ISBN:
9781484306307
ISSN:
1934-7685
Pages:
92
DOI:
https://doi.org/10.5089/9781484306307.002