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.
In spite of the severe negative oil price shock since the second half of 2014, the Nigerian economy has maintained its decade long strong performance amidst enormous but manageable developmental challenges. This was made possible by the adoption of contingency policy measures to deal with the oil shock and at the same time implementing the reform agenda which is aimed at placing the economy on a more diversified, sustainable, and inclusive growth trajectory. While the authorities recognize the negative effect of the oil shock on the economy, they expect that the impact would be less than envisaged by staff on account of measures put in place. They are equally aware of the various concerns raised by staff in the report including revenue redistribution mechanism for dealing with regional disparity and poverty reduction. They are focused on addressing these issues within the provision of the law and subsisting political arrangements some of which were achieved after complex compromises. Overall, the authorities are grateful to staff for the fruitful discussions during the mission and the Executive Board for the support.
Macroeconomic developments and outlook
Economic performance in 2014 was good with real GDP growth estimated at about 6.23 percent compared to 5.49 percent in 2013 and 5.94 in the fourth quarter of 2014. Growth was generally driven by the non-oil sector. Headline inflation moderated to 8.0 percent y-o-y in December 2014 pretty much within the 6-9 percent Central Bank of Nigeria (CBN) target band on account of discreet monetary policy stance and improved domestic food production.
Fiscal management, particularly in the last quarter of the year, was challenging due to oil revenue underperformance occasioned by lower international oil prices and domestic production. This notwithstanding, fiscal deficit is projected to remain within the target one percent of GDP and the overall public debt, particularly public external debt, is at low risk of distress. In addition, the pressure on the external sector increased with the current account deficit projected to worsen on account of the oil shock. The exchange rate was broadly stable until the recent speculative attack and international reserves, though declining, were still adequate to cover at least six months of imports.
Uncertainties surrounding oil price movements, global economic growth and domestic political and security environments pose significant downside risks to the economy. With the measures currently being implemented to contain these risks, the macroeconomic outlook is expected to remain favorable.
Fiscal policy
The authorities’ focus is on addressing the emerging fiscal risk, particularly oil revenue shortfall with the overall objective of achieving fiscal and debt sustainability in the medium-term. Accordingly, serious attention would continue to be given to non-oil revenue mobilization, including tax reforms (VAT and CIT), broadening of the tax revenue base, and improvement in tax administration. In this regard, significant actions to boost revenue have already been outlined in the 2015 budget and further measures are expected to be taken as warranted. Efforts are also underway to enhance transparency of fiscal operations of all public institutions that collect revenues, including ensuring that excess funds are deposited into the Government Consolidated Revenue Fund.
Public spending would continue to be oriented towards social and productive sectors, including transportation and energy infrastructure. In doing this, steps would be taken to consistently align expenditures to expected revenues and ensure that the near-term fiscal deficit target is met. This would involve prioritization of projects and greater involvement of private investors in the execution of those projects considered critical to growth. Moreover, the authorities do not intend to close the financing gap under the National Infrastructure Investment Plan through external borrowing.
The authorities have continued to improve public financial management through the use of the right technologies such as biometrics and digitizing government payments. Discussions are going on regarding how to extend this to subnational level. Oil subsidy reform remains a key priority of the government. However, in view of the highly sensitive nature of the exercise, the timing has to be appropriate to avoid social and political consequences as witnessed in January 2012. The various options, timing and modalities for implementation of the reform are under consideration by the various stakeholders.
Monetary and exchange rate policies
Monetary policy would continue to support the broader macroeconomic policy objectives of government, including maintaining low and stable inflation, exchange rate stability, and enhancing access to banking services for the under-banked. In the past years, a cautious monetary policy stance helped keep inflation within single digit. This monetary policy stance is expected to continue in the near-to-medium term with adjustments to contain any emerging vulnerabilities.
On exchange rate, government’s intention is to allow market forces to drive its movement with exchange rate flexibility remaining the first line of defense in the presence of external shocks. Intervention in the foreign exchange market would be limited to smoothening excessive volatility of the exchange rate and liquidity management in response to disorderly market conditions. This has been demonstrated by the recent closure by the CBN of its Dutch Auction System (retail and wholesale) foreign exchange window in order to avert the emergence of a multiple exchange rate regime occasioned by the widening margin between the rates at the interbank and retail Dutch Auction System window. This action marks a significant move towards a unified foreign exchange market (the interbank foreign exchange market) where there is basically only one exchange rate determined largely by market forces. Going forward, the authorities will continue to monitor closely developments in the interbank foreign exchange market and take intervention and prudential measures that would ensure the smooth functioning of the market.
Financial sector policies
The financial system remains stable, adequately capitalized, profitable and liquid. It is also resilient to significant shocks to credit, interest and exchange rates. This has been made possible by the strengthening of the regulatory and supervisory framework for the banking and non-bank financial institutions including their foreign subsidiaries. Moreover, collaboration among the regulatory authorities of the financial system has been enhanced through the Financial Supervision and Regulation Coordinating Committee. Going forward, the authorities would continue to work towards ensuring financial sector resilient through improvement of the corporate governance framework, recovery and resolution framework, oversight of holding companies, as well as consolidated and cross-border supervision.
The implementation of the financial inclusion policy under the 2012 National Financial Inclusion Strategy is progressing as planned. The aim is to reduce the percentage of Nigerian adults that are excluded from financial services from 46.3 percent in 2010 to 20 percent in 2020. As at 2014, the exclusion rate has reduced to 39.5 percent. Some progress has also been made in usage of financial services (payments, savings, credit, insurance, and pensions), and access channels. Notwithstanding this progress, the authorities are mindful of the regulatory/supervisory challenges which may emerge in the process. Accordingly, they are working to strengthen internal capacity within the CBN and improve engagement with stakeholders through the National Payment Systems Board.
Structural policies
The authorities’ are implementing bold and comprehensive structural reform measures to raise potential growth, diversify the economy and improve competitiveness and the business climate. The overall strategy is to create a private sector driven economy supported by appropriate government policies and incentives. In this regard, priority attention has been given to sectors considered as growth drivers and enhancers including power, roads, agriculture, manufacturing, oil and gas, creative industries, housing, and information and communication technology. There are also targeted special financing schemes for the private sector including small and medium scale enterprises (SMEs).
The authorities are also intensifying job creation efforts through several initiatives targeted at youths and women which combine training with financial assistance that will enable beneficiaries set up their businesses. The authorities are equally working closely with the World Bank to build social safety nets that would include conditional cash transfer for the promotion of primary and secondary education and improvement of maternal and child care.
Conclusion
2014 was a particularly difficult year as revenue shortfall occasioned by the oil price shock affected economic performance. The fiscal outlook for the medium-term is likely to be equally challenging unless there is a significant rebound in the oil price. Whichever direction the oil price goes, there is obviously no alternative to a resilient, diversified, and more inclusive non-oil economy. It is in this regard that the authorities are focused on deepening and widening the diversification drive through the implementation of the various reform measures. These measures are expected to accelerate the pace of decline in poverty and reduce income inequality and regional disparity in the medium-to-long term.