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.
This supplement provides information that has become available since the issuance of the staff report on February 17, 2015. The information does not alter the thrust of the staff appraisal.
1. Political and Economic Developments.
On Saturday, February 7, the Independent National Electoral Commission announced that it was postponing general elections by six weeks—Presidential and parliamentary elections are now scheduled for March 28, and state elections for April 11. The postponement was based on the advice of the security forces that they could not guarantee the peaceful conduct of elections given the launch of a major offensive against Boko Haram.
Financial markets continue to weaken and remain volatile. In the week following the postponement of the elections, the Nigeria Stock Exchange lost 6 percent, bond yields widened 100 basis points, and sovereign spreads by almost 40 basis points, and in the interbank foreign exchange market (IFEM), the naira depreciated by 4½ percent with the spread between the rates in the IFEM and the retail Dutch Auction System (rDAS) window exceeding 20 percent.
Reflecting ongoing intervention in the IFEM, gross international reserves (30-day moving average), which ended 2014 at $34.5 billion, have further declined to $32.3 billion as of February 19.
2. Policy Development.
On February 18, the Central Bank of Nigeria (CBN) closed the rDAS window at which it had been providing foreign exchange for a specific list of activities at a rate of N168 per U.S. dollar with a band of ±5 percent. All foreign exchange demand is now to be met in the IFEM, with the CBN committing to intervene in the IFEM to meet legitimate demands for foreign exchange. The Naira has been trading in the IFEM at about N198 per U.S. dollar, so that the move implies an 18 percent devaluation in the official exchange rate.
The Medium Term Expenditure Framework, which sets the 2015 budget, passed the second reading in the National Assembly and was sent to the Joint Committee on Finance for deliberation whilst the National Assembly went on recess ahead of the February 14 scheduled election. The authorities are continuing discussions and anticipate submitting soon a revised set of budget assumptions to the National Assembly.
3. Implications.
The closure of the rDAS window is in line with staff advice and removes a major economic distortion. However, as the CBN remains the largest single supplier of foreign exchange, it will be important for the CBN to intermediate this supply in a transparent and efficient manner, while facilitating price discovery.
The impact of this change on growth, inflation, and the balance of payments is likely to be modest as the bulk of transactions were already at the IFEM rate. Market reaction to the change has been broadly positive and rates have stabilized; however, liquidity in the market is reportedly thin.
The recent recovery in oil prices—the Brent futures average price for 2015 has recovered from $53/barrel on January 20 to $61/barrel on February 20—together with a possible revision to the 2015 budget, suggest that the fiscal position might improve relative to what is projected in the Staff Report.
In view of the closure of the rDAS window, the description of the “Exchange Rate Arrangement” contained in the Informational Annex should be amended to:
Exchange Rate Arrangement
The de jure exchange rate arrangement is other managed arrangement. The Central Bank of Nigeria (CBN) explicitly aims to maintain an exchange rate fundamentally driven by market forces, but intervenes to reduce volatility and to counteract speculative attacks on the national currency. In recent years it has maintained an exchange rate band vis-à-vis the U.S. dollar (the band was increased from ±3 percent to ±5 percent in November, 2014) and has allowed adjustment of the band’s midpoint in response to market forces (the last adjustment in November 2014). On February 18, 2015, the CBN announced the closure of its Dutch Auction System (DAS) window and requested all foreign exchange transactions to be effected through the interbank market. The de facto exchange rate arrangement remains other managed arrangement. In spite of some stability of the Naira-U.S. dollar exchange rate, the nominal effective exchange rate has fluctuated considerably in recent years. Nigeria is a signatory to the W-ERM II of the WAMZ, which requires that the spot exchange rate between the naira and the U.S. dollar be maintained within ±15 percent around the central rate. The foreign exchange market comprises the interbank and bureau de change segments.