Public Information Notice No. 05/110

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Nigeria

August 10, 2005

On July 18, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Nigeria.¹

Background

Macroeconomic performance in 2004 was commendable. Preliminary official data suggest that GDP benefited from the improved macroeconomic environment. Real GDP is estimated to have increased by about 6 percent, stemming largely from higher growth in the non-oil economy, in particular agriculture, and some areas within manufacturing and services.

The consolidated government's fiscal stance was prudent in 2004, despite the large increase in oil revenue, and the fiscal position strengthened significantly. Oil revenue rose as a result of higher oil prices and production and the removal of the price subsidy on domestic crude oil sales to the Nigerian National Petroleum Corporation (NNPC). All three tiers of government adhered to a conservative oil price based fiscal rule, thereby achieving fiscal discipline. Public spending was kept in check and a windfall oil revenue of about US$6 billion was set aside.

The Central Bank of Nigeria (CBN) tightened its monetary policy to achieve the disinflation objective and the CBN met its monetary policy targets. Monetary tightening and the strengthening of the naira helped lower inflation. The 12-month inflation rate decelerated to 16 percent in March 2005, from 24 percent at end-2003. Certain reforms helped improve the effectiveness of monetary policy, including the CBN's withdrawal as a buyer from the primary market for government securities.

Prudent macroeconomic policies also resulted in exchange rate stability, and the spreads between the Dutch auction official rate, the interbank market, and the parallel market remained low. The exchange rate appreciated moderately in real terms in 2004. International reserves rose considerably to US$23 billion at end-May 2005.

The gross external public debt declined in 2004 relative to GDP and exports. However, arrears continued to accumulate. The government serviced its commercial and multilateral external debt obligations, but paid US$1 billion (about half of its obligations) to Paris Club creditors, while maintaining a dialogue with them.

Since the 2004 Article IV consultation, Nigeria has made good progress in implementing its structural reform agenda. The authorities took measures to tackle public sector corruption, improve the transparency of public policies, advance the civil service reform and the Extractive Industries Transparency Initiative (EITI), and strengthen budgetary procedures. They have also largely withstood pressure to reverse the liberalization of the downstream petroleum sector. The overall pace of privatization was, however, disappointing. To reenergize the privatization process, the top management of the Bureau of Public Enterprises (BPE) was replaced in March 2005.

In July 2004, the CBN announced a major bank restructuring reform built around a large increase in the minimum capital requirement to force bank consolidation. Some banks are in talks for mergers and acquisition, while others have offered shares to the public in order to raise sufficient capital. The CBN also announced reforms to address major weaknesses in bank and non-bank financial institution supervision.

Executive Board Assessment

Executive Directors commended the authorities for Nigeria's strong economic performance in 2004 under the homegrown reform program, as articulated in the National Economic Empowerment and Development Strategy (NEEDS). A number of key priorities of the program have been achieved, including enhanced predictability and transparency of policies, growth in the non-oil economy including the agricultural sector, and reduced vulnerability to oil price shocks. Moreover, fiscal restraint allowed much of the oil windfall to be saved in 2004, resulting in lower inflation and a sharp increase in international reserves.

Directors cautioned that, despite the recent progress, Nigeria's economic transformation continues to face formidable challenges, owing to weak institutions, administrative and technical capacity constraints, resistance from entrenched interests, and the legacy of decades of economic mismanagement. They encouraged the authorities to persevere in their efforts, building on the progress made in 2004 and broadening the reform agenda.

Directors observed that a prudent fiscal policy in 2004 had contributed importantly to the macroeconomic stabilization effort. From that perspective, they expressed concern about the expansionary fiscal policy stance in 2005 and consequent larger non-oil deficit, which could complicate the management of monetary policy, lead to spending inefficiencies, and crowd out export activities and private investment. Directors considered that these potential consequences of the planned loosening of the fiscal stance made it all the more important to strengthen public expenditure management to ensure that public spending helps achieve the NEEDS objectives and the Millennium Development Goals. In this light, they welcomed the establishment of a virtual poverty fund to track poverty-reducing spending, and the creation of a cost-benefit analysis unit in the Ministry of Finance to examine large investment projects. They called on the authorities to further improve the government's budget classification systems to enable adequate monitoring of the pro-poor and growth-supporting aspects of the budget. Directors welcomed the provisions of the Fiscal Responsibility Bill, which, if passed, will enhance fiscal transparency and accountability at all levels of government, introduce formal fiscal rules into the budget process, and lay the foundations for medium-term fiscal sustainability. They took note of the authorities' efforts to garner broad support for the Bill in the National Assembly.

Directors emphasized that, in the light of the fiscal expansion, more of the burden of controlling inflation would fall on the Central Bank of Nigeria (CBN). Given the sharp increase in monetary aggregates in early 2005, Directors supported the recent actions of the CBN to limit broad money growth. They welcomed progress in relying more on indirect instruments of monetary management, and urged the authorities to allow short-term interest rates and the exchange rate to adjust as needed to meet the monetary targets. Directors concurred with the authorities' intention to continue with money targeting as the operational framework for anchoring inflationary expectations. Several Directors recommended that the authorities consider moving to an inflation targeting regime in the shortest possible time after appropriate preparations and contingent upon a strengthening of the financial sector.

Directors regretted the deterioration in the financial condition of some banks in 2004, and noted that major challenges remain for promoting a healthy and vital financial sector. At the same time, they welcomed the measures taken by the authorities in this area, including the capitalization program and the recent establishment of a high-level steering committee to guide the bank restructuring and consolidation program. They urged the CBN to develop a strategic plan to deal with banks that will not meet the minimum capital requirement at end-2005, strengthen its legal powers to close insolvent banks, and enhance banking supervision. They called on the authorities to ensure that sound accounting standards are applied in valuing banks' assets, and to advance the legal processes for establishing asset management companies to minimize the budgetary costs associated with liquidation of some banks. Directors supported the authorities' request for Fund technical assistance on the banking reform program. They welcomed the progress made in strengthening the anti-money laundering framework with the establishment of a Financial Intelligence Unit in the Economic and Financial Crimes Commission.

Directors called for steps toward reform of Nigeria's foreign exchange markets, which remain segmented and a source of distortions. In this vein, they welcomed the CBN's commitment to introduce a wholesale auction for foreign exchange in early 2006, which should unify the exchange system. The CBN should expedite work to put in place the necessary infrastructure and regulations for the auction. Directors urged the authorities to further streamline current foreign exchange regulations and to take the steps necessary for accepting the obligations of Article VIII of the Fund's Articles of Agreement.

Directors considered that the authorities' ambitious structural reform agenda is focused appropriately on strengthening governance and transparency, enhancing public service delivery, streamlining the role of government in the economy, and improving the business environment. They welcomed the revamping of the Bureau of Public Enterprises (BPE) and encouraged the authorities to expedite the overall pace of privatization, bearing in mind the need to rally public support for it. They also welcomed the authorities' emphasis on broad-based participation in advancing the country's commitment to improve transparency in the oil and gas sector under the Extractive Industries Transparency Initiative (EITI).

Directors supported the authorities' tariff reform program, as lower tariffs will benefit Nigeria's international competitiveness. They commended the authorities' intention to phase out all import bans by end-2006 and fully adopt the ECOWAS Common External Tariff by end-2007, but recommended that the timetable for implementing these reforms be accelerated.

Directors were encouraged by the readiness of Nigeria's external creditors to negotiate a comprehensive debt relief agreement with the country.

Directors stressed the importance of improving the reliability and timeliness of economic statistics to better support the formulation and monitoring of macroeconomic and social policies. To this end, they welcomed the recent merging of the Federal Office of Statistics with the National Data Bank to create the National Bureau of Statistics.

All Directors welcomed a continuing close dialogue of the Fund with Nigeria on policy formulation and implementation, in the most appropriate and effective form, including in the context of a possible non-borrowing relationship.