Nigeria: Selected Issues

Abstract

Nigeria: Selected Issues

Subnational Governments: Vulnerabilities and Challenges1

This chapter reviews subnational fiscal performance and vulnerabilities2, discusses policy initiatives taken by the government, and explores options to improve the subnational fiscal framework to cope with future shocks. It documents the heavy dependence on oil receipts; mounting debt and financing pressures; and the fast buildup of arrears. Going forward, bold reforms and revenue diversification will be essential.

A. Fiscal Federalism arrangements

1. Nigerian fiscal federalism3 is based on a constitutional revenue-sharing mechanism to support expenditure-devolution assignments. Oil and non-oil revenues are pooled in and shared from the Federation Account (FAAC allocation) according to allocation formulas. These formulas are set by the National Assembly, and can be updated every five years following the recommendations of the Revenue Mobilization Allocation and Fiscal Commission (RMAFC). With the recent decline in oil revenues, from lower oil prices and production disruptions, SLGs’ public finances have come under severe strain and potential contingent liabilities for the federation are substantial. The implications are significant, as SLGs account for about half of the Consolidated Government, both in terms of revenue and expenditure (Figure 1).

Figure 1.
Figure 1.

Nigeria: Revenue and Expenditure Trends, 2011–16 I

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A005

Note: Central gov.: Federal Government; SLG: State and Local Governments; and EBF: Extra-Budgetary Funds.

2. Sharing formulas vary according to the type of resources collected (Figure 2). For oil receipts, the revenue-sharing is done at the agreed budgeted oil price set through negotiations between the Executive and Legislative branches. Depending on the realization of the oil price, the windfall (shortfall) is transferred (withdrawn) to (from) the Excess Crude Account (ECA), a stabilization fund. The Constitution mandates (a derivation principle) that no less than 13 percent of the oil revenue is to be allocated to the states endowed with oil.4 The remaining 87 percent is allocated among the FG (48.5 percent), EBFs (4.2 percent), and SLGs (47.3 percent). For the subnational component, the revenue-sharing mechanism allows for 40 percent of allocations to be distributed equally among the states and the remaining 60 percent to be allocated according to equity considerations (population, land mass, internal revenue generation, school enrollment, hospital beds, and rainfall). Corporate Income Tax (CIT) and Customs fees follow a similar sharing principle, with collection fees (7 percent for Customs fees and 4 percent for CIT) deducted before distributions. Value Added Tax (VAT) is allocated 85 percent to SLGs, 14 percent to the FG, and 1 percent to EBFs. Besides these statutory allocations, SLGs can impose specific taxes (Internally Generated Revenue (IGR))—so far, these include property taxes, Pay-As-You-Earn (PAYE), direct assessment, and road taxes.

Figure 2.
Figure 2.

Nigeria: Sharing Mechanisms of the Federation Revenue

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A005

3. SLGs are constitutionally responsible for financing basic public services. The constitution sets an exclusive list for the FG (including national interest, defense, international affairs, elections, roads and railways), a joint list for the FG and the states (including electricity, industry, commerce and agriculture, research, statistics, higher education, health, and social welfare), a joint list for SLGs (including primary, adult, and vocational education, health care, agricultural, and non-mineral natural resources), and an exclusive list for local governments (roads, streets, public facilities, sewage).

B. Recent fiscal performance

4. SLGs are heavily dependent on statutory allocations, mostly oil revenue. In 2015, more than half of the distributable revenues went to SLGs (Figure 3a). In the distributable part, oil receipts remain the largest source of financing of SLGs—averaging about 66 percent of total revenue during 2011–13, before the collapse in oil price in 2014. SLGs’ revenue-to-GDP ratio fell from 8.6 percent in 2011 to 2.7 percent in 2016, primarily from lower oil revenue that dropped by 5 percentage points following the large decline in oil price and production (Figure 3b). Accordingly, the share of oil revenue declined significantly from 70 percent in 2011 to 26 percent in 2016, while non-oil revenue (excluding IGR) proved relatively resilient at around 1.6 percent of GDP in 2016 (and represented 59.2 percent of total SLG revenue in 2016). IGR performance was stable, but unsatisfactory, remaining at 0.4 percent of GDP—except Lagos State, where IGR topped 60 percent of total revenue in 2016, IGR across states averaged about 20 percent of revenue in 2016.

5. With lower revenue, SLGs’ expenditure adjusted (Figure 3c). SLG expenditures declined from 7.4 percent of GDP in 2011 to 4.5 percent of GDP in 2016, with the ratio of capital expenditure to total expenditure remaining broadly the same (about 41 percent). However, revenues fell more than proportionately to expenditures, and the SLGs’ overall deficit widened to 1.7 percent of GDP in 2016 (from a surplus of 1.2 percent in 2011) (Figure 3d).

Figure 3.
Figure 3.

Nigeria: Stylized Facts on Subnational Revenue, Expenditure, and Deficits

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A005

6. The fiscal deficits in 2015-16 increased SLGs’ debt-to-GDP ratio by 3 percentage points, from 2 percent of GDP in 2011 to 5 percent of GDP in 2016 (Figure 4a). The increase is mostly attributed to:

  • External debt (Figure 4a). Over the 2011-15 period, external debt rose steadily, with the increase mostly associated with debts accrued by Lagos State, which makes up over 36 percent of SLG’s total external debt.

  • Domestic debt (Figure 4b). By 2015, domestic debt represented 75 percent of total SLG debt, mostly fueled by salary and pension arrears (10 percent), contractors’ arrears (28 percent), commercial bank loans, and other liabilities. Financing pressures also pushed more SLGs to tap the domestic bonds market (see Appendix B),5 with about 15 states issuing bonds in the last five years. In 2015, seven states raised funds from the capital market, with a total face value of N61 billion, compared to N15 billion recorded in 2014 for Bauchi State only. Increased borrowing activities have led to wider divergence between gross and net federation revenues available to states, owing to rising debt servicing costs deducted from FG allocations through irreversible standing payment orders (ISPOs) and other service payments.

Figure 4.
Figure 4.

Nigeria: Stylized Facts on Subnational Debt Trends and Composition

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A005

7. To ease financing pressures, the FG provided bailouts and restructuring facilities. In 2015, the FG addressed salary arrears of SLGs through a partial bailout and facilitated the restructuring (longer maturities and lower rates) of N576 billion in commercial bank loans to 23 states (about ½ percent of GDP). The FG provided a further ½ percent of GDP financial assistance plan for 2016–17, conditional on states providing a plan for implementing a comprehensive 22-point Fiscal Sustainability Program (see below). Further contingent liabilities from SLGs could be substantial, but have not all been quantified.

C. Subnational Challenges

The vulnerabilities highlighted above reflect the immediate effect of the oil shock, but also the consequences of macro-fiscal and structural challenges.

Macro-fiscal challenges

8. The fiscal federalism framework—and its dependence on oil revenue and economic activity—does not provide enough incentives to improve spending efficiency and discipline. Formula-based transfers of oil revenues depend on the budgeted oil price, which is not rooted in legislation and does not necessarily allow for macroeconomic stabilization. This helps augment SLGs’ spending envelopes in good times, reducing incentives to exert expenditure control or raise independent revenue. Moreover, guaranteed transfers to SLGs raise questions on the quality of expenditure and governance. Revenue-sharing formulas do not account for expenditure capacity. For example, an increase in VAT rates would result in higher revenue for SLGs, potentially leading to inefficient expenditure, particularly in the absence of strong governance structures.

9. Under the current fiscal framework, IGR collection is intrinsically low (Figures 5a and 5b). In 2015, IGR represented on average about 19 percent of total revenue (Figure 5a). This is mostly explained by the lack of collection capacity, the importance of a rural-based economy, and limited subnational incentives to improve IGR performance. So far, the PAYE outturn has been the main source of revenue of SLGs (Figure 5a), with the best outturns concentrated in a few rich and urban centers. For instance, in 2015, Lagos bucked the trend and recorded an IGR share of recurrent revenue over 50 percent, while 23 states performed below the sub-national average of 12 percent (Figure 5b).

Figure 5.
Figure 5.

Nigeria: Subnational Internally Generated Revenue, Budget Implementation, and Regional Disparities

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A005

10. Budget execution at the SLGs level is weak, with capital projects being adjusted according to available financing. Budget implementation has been consistently below 80 percent (Figure 5c). As for the FG, the implementation of the budget at the SLGs level is skewed towards recurrent spending, particularly spending on salaries and wages, and overheads. The average budget implementation performance for the 36 states shows that actual recurrent spending has remained high compared to capital spending. Between 2010 and 2013, budget implementation for recurrent spending across the 36 states averaged nearly 100 percent, compared to 58 percent for capital spending.

11. Idiosyncratic risk pooling is absent in the current framework. In theory, an optimal federal tax and transfer scheme should have the benefit of diversification. In the face of idiosyncratic economic fluctuations across different regions, stabilization should be achieved in a Federal system through interstate transfers. In other words, spending at the SLGs levels should be disconnected from the revenue collected if risks are perfectly pooled. For Nigeria, we estimate the relationship between various categories of expenditure and both shared and independent revenues over 201115 and find no evidence of risk pooling among subnational governments. Expenditure is heavily determined by all revenues and in particular by independently collected revenues (Table 1). With limited borrowing capacity and little effort in mobilizing internally generated revenue, many SLGs rely almost entirely on allocated revenues to finance their budgets.

Table 1.

Nigeria: Extent of Risk-Sharing Among SLGs, 2011–15

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Standard errors in parentheses*** p<0.01, ** p<0.05, * p<0.1

12. Poor policy coordination among all tiers of government hinders the adjustment to shocks. Fiscal federalism in Nigeria has not been accompanied by strong inter-governmental coordination, amplifying the effects of fiscal shocks. For example, the recent large shock to oil revenue resulted in lower distributable revenues leading to adjustments across different tiers of government. Without effective coordinating mechanisms, these adjustments might lead to duplication or lack of provision of certain services or types of expenditure (capital investment) with adverse macroeconomic impacts.

Structural challenges

13. Disparities across states are not fully addressed. The Nigerian Federal system endows SLGs with considerable political and fiscal autonomy. Regional socioeconomic differences, in turn, have left SLGs with different needs and fiscal capacities (Figure 5d). In addition, the revenue-sharing formulas are not based on a definition of a minimum set of public services per capita, irrespective of the state of residence. This limits the ability of the current fiscal framework to address large disparities across states (for example, most of the North Eastern States have substantially higher than average absolute poverty rates). A large variation in allocation of revenue across states is observed both in terms of revenues (distributable and internally generated) and expenditures (Figures 5e and 5f).

14. Data weaknesses prevent a reliable fiscal assessment of SLGs. Only limited statistical information is available for the SLGs posing challenges for macro-policy formulation. For instance, in 2015, only 10 states have disclosed information on an approved budget and no state has published an actual outturn report. Currently, only limited statistical information is available for the SLGs, posing challenges for macro-policy formulation and reliable fiscal assessment of SLGs

D. Options and Strategies to Cope with Future Shocks

Homegrown Actions

15. Nigeria has developed a homegrown plan to strengthen fiscal discipline and the accountability framework of SLGs. In 2016, the FG launched a contract-based 22-point plan (Fiscal Sustainability Plan—FSP) to help ease SLGs’ financial strains. Access to the facility is conditional on States submitting an action plan for implementing the FSP’s objectives to rationalize public expenditure, increase government revenue, improve accountability and transparency, debt management, and the overall public financial management system. The FSP is a positive step towards reducing SLG vulnerabilities that should be implemented by all states. However, while the 2015–17 restructuring and bailouts may have provided relief to SLGs, they also entailed significant moral hazard risks.

16. A contractual system—as is the case with the FSP—could help enforce the coordination between the FG and SLGs. Contracts (fiscal programs) have helped achieve subnational fiscal consolidation and facilitate fiscal coordination in several federations (e.g., Brazil, Spain). The contracts create an institutional framework that ensures fiscal targets covering the entire federation public sector can be met. In practice, they enable the FG to supervise subnational fiscal policies while working together with state governments in: (i) the definition of fiscal programs, including primary surplus and revenue targets, (ii) limits on spending (e.g., wages, investment) and (iii) debt issuances, and ensuring minimum reporting of budget execution and debt levels. Usually, the contracts stipulate numerical limits, annual fiscal targets, and sanctions in case of noncompliance. A key challenge, however, relates to implementation.

17. In line with actions already initiated by the authorities and within constitutional guidelines, Nigeria’s fiscal framework at the SLGs level could be strengthened through: efforts to depoliticize the oil price, increase non-oil revenues, and strengthen coordination and transparency—including through improved monitoring, better reporting, strengthened public financial management, and capacity building.

Depoliticizing Oil Prices

18. Depoliticizing the budget oil price is key to help build comfortable buffers. As discussed above, the budgeted oil price is highly volatile and subject to political negotiation. As a result, SLGs are left with limited buffers during adverse shocks as evidenced during this ongoing downturn. In previous work, Staff showed that a price rule could limit the effect of oil price volatility and political tension on the benchmark.7 A budget rule using a combination of the past 5-year average oil price, the current year oil price, and forward-looking 5-year average oil-price, together with a structural primary surplus target in percent of non-oil GDP (to be tailored at the time of adoption), is one option (subject to pre-announced exceptions) that could provide a basis for long-term sustainability and the preservation of oil wealth. .

Increasing Non-Oil Revenues

19. Comprehensive tax policy reforms are necessary to ease SLGs’ fiscal strains. With 85 percent of VAT receipts allocated to SLGs, reforming the VAT system and raising its rate could provide sufficient resources to fulfill subnational spending mandates. Reforming the VAT system to broaden the base (allow tax credits for all inputs including capital goods, increase the registration threshold with a simplified presumptive tax regime for SMEs, and rationalize exemptions) and progressively increasing the VAT rate from 5 to 15 percent over the medium term—will increase non-oil revenues by at least 4 percent of GDP for SLGs in the medium term. In a similar vein, reforms to Personal Income Tax (PIT) and Corporate Income Tax (CIT) (including a review of the existing rate structure, rationalizing tax expenditures, reviewing incentives, and phasing out income tax holidays) would help reduce the reliance on oil revenue since close to half of the collected revenue falls to SLGs.

20. Encouraging the collection of independent revenue is essential to diversify SLGs’ finances. According to the constitution, tax revenue sources assigned to SLGs are limited. However, reforming the income tax (PAYE) and introducing a property tax could help augment internally generated revenue of states, by about 0.5 percent of GDP. Improving tax administration is also essential. For instance, states’ ability to achieve development goals can be buttressed by strengthening capacity of the Joint Tax Board (JTB) to disseminate best practices and enabling systems; establish and enforce minimum standards; and monitor the quality of state PIT administration.8

Strengthening Coordination Mechanism

21. Looking forward, it will be important to further develop coordination mechanisms across different tiers of government. In Federal economies, coordination across tiers of government is critical for successful (durable) fiscal consolidation. It will be important to start discussions on a coordination mechanism that will ensure a coherence of fiscal objectives, help fiscal management over the business cycle, and further strengthen policy credibility. For instance, using medium-term targets for debt (e.g., commitment to achieve a certain level of debt-to-GDP over the next 4–5 years) would give a stronger signal regarding the long-term commitment to fiscal sustainability, while providing annual flexibility. Under the medium-term target, the annual target could be changed in response to large unexpected shocks, while maintaining the commitment to medium-term targets. This would operationalize the government’s commitment to contain subnational fiscal imbalances.

22. The fiscal responsibility law (FRL) should be adapted to SLGs. Despite the passage of the FRL9 at the Federal level and across some states, fiscal sustainability has remained weak for most sub-national governments. States are at different levels of adopting a Fiscal Responsibility Law. For some, the law has been passed but not implemented yet. Others require additional consensus building efforts to ensure the support of local stakeholders. An FRL, in addition to the Public Procurement Act, is essential for providing the required rules and procedures relating to three important budget processes: accountability, transparency, and stability. It is thus important to introduce an enforcement mechanism of the FRL through an effective and periodic comparative analysis of budgeting procedures at the sub-national level. Further, peer reviews can be used effectively for learning and monitoring of outcomes and compliance.

Improving Transparency

23. Improving the quality, coverage, and timeliness of fiscal reports. To help provide the full picture of public spending and facilitate fiscal coordination between Federal and sub-national levels, the fiscal reports should capture all off-budget revenues and spending and consolidate general government revenue, expenditure, and financing. The authorities have already made plans to implement international accounting standards to produce consolidated fiscal reports covering all three tiers of government.

Strengthening Public Financial Management

24. Extending a Treasury Single Account (TSA) to States along the lines implemented by the FG could help improve expenditure controls. TSA implementation requires careful phasing, taking into account the specifics of individual States. There should be a comprehensive plan, describing all stages of implementation and the required changes to be made to the existing financial regulations, IT-based financial management information systems (FMIS), and accounting arrangements or procedures. In that regard, the Kaduna State TSA Implementation Manual (2016) can serve as a useful guide. Also, it is important to develop cash flow forecasting and management tools to leverage the benefits of TSA implementation.

Capacity Building

25. Building capacity at the SLG level will be key to support the adequate implementation of the proposed measures. This includes capacity in undertaking long-term revenue forecasts, establishing a medium-term orientation of the budget, implementing quality public investment projects, and managing stabilization funds. More specifically, in the near term, SLGs need to strengthen budget preparation process to transition from the incremental line item approach towards a programmatic approach. This will help facilitate policy costing and more effective setting of expenditure ceilings. Moreover, there is a need to capture all committed (multiannual) liabilities in the fiscal framework. It will help identify forward spending pressures (particularly from the existing capital projects contracts) and available fiscal space for new spending initiatives.

E. Conclusion

26. The recent oil shock brought to the fore vulnerabilities of subnational governments. As oil prices collapsed and economic activity weakened, SLG deficits widened, increasing recourse to debt while adjustment was insufficient. To address these vulnerabilities and structural challenges present in the current framework, strong and bold reforms are needed. Some of these have been initiated through the government’s FSP. Additional reforms would include: depoliticizing the budgeted oil price, initiating comprehensive tax policy reforms, better reporting of fiscal outcomes and risks, and stronger coordination between the different levels of government. Finally, capacity building at the SLGs level is key.

Appendix I. Data, Bond Issuance by States, and Fiscal Sustainability Plan

Data

This section sheds some light on the public finance of the state governments by utilizing data from Central Bank of Nigeria’s survey returns from 36 states.

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Bond Issuance by States

Table: Subnational Bond Issuances (NGN’ Billion), 2011 – 2015

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Data Source: Securities and Exchange Commission (2016)
Fiscal Sustainability Plan
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Source: Governors’ Forum Secretariat.

References

  • Governors’ forum, 2016, “Inception Report for Fiscal Sustainability Study”, unpublished document.

  • CBN documentations, 2011-15, Central Bank of Nigeria Annual Economic Reports.

  • 2016 Selected Issues PaperOptions and Strategies for a Fiscal Rule for Nigeria’s Oil Wealth Management

1

Prepared by Sampawende Jules Tapsoba and Marwa Ibrahim.

2

We focus on 2011-16, with 2016 data based on all IMF estimates.

3

The Federation comprises a Federal Government (FG), 36 states, and 774 local authorities, labelled States and Local Governments (SLGs). The Constitution allocates responsibilities for public service delivery across different levels of government, with expenditure assignments supported by revenue-sharing agreements. Some of the federation’s responsibilities are carried through extra-budgetary funds (EBFs).

4

For other FAAC revenues (CIT and customs) a collection fees are deducted before the FAAC and transferred to revenue and customs authorities.

5

Options available to SLGs for domestic borrowing are threefold: (i) domestic on-lending from the FG (or loans guaranteed by the FG); (ii) borrowing from the capital market; and (iii) borrowing from commercial banks.

7

2016 Selected Issues Paper “Options and Strategies for a Fiscal Rule for Nigeria’s Oil Wealth Management”.

8

The Joint Tax Board meets on a quarterly basis to appraise the performance of its members (including the Internal Revenue Boards of the 36 states and the Federal Inland Revenue Service) and to deliberate on tax issues of national importance.

9

In Nigeria, a procedural FRL was enacted in 2007. The objective is to provide for prudent fiscal management by ensuring long-term macro-economic stability, and by securing greater accountability and transparency in fiscal operations within a medium-term fiscal policy framework. The FRL recommends the creation of an independent fiscal responsibility commission, consisting of representatives (appointed for a single term of 5 years) of the private sector, Civil Society, Federal Ministry of Finance, and members of the six geopolitical zones (North-Central, North-East, North-West, South-East, South-West and South-South). The Commission has the power to monitor progress in meeting the FRL objectives, as well as disseminate practices for greater efficiency and transparency in public financial management (expenditure execution, revenue collection, and debt control).

Nigeria: Selected Issues
Author: International Monetary Fund. African Dept.
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    Nigeria: Revenue and Expenditure Trends, 2011–16 I

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    Nigeria: Sharing Mechanisms of the Federation Revenue

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    Nigeria: Stylized Facts on Subnational Revenue, Expenditure, and Deficits

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    Nigeria: Stylized Facts on Subnational Debt Trends and Composition

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    Nigeria: Subnational Internally Generated Revenue, Budget Implementation, and Regional Disparities