Kristalina Georgieva, Managing Director, International Monetary Fund (IMF). Image Credit: IMF
Notwithstanding higher oil prices, the economy is expanding at slightly above the population growth rate. The double-digit increases in Nigeria’s terms of trade and significant improvement in the trade balance created an opportunity to build fiscal space and foreign exchange (FX) reserves, but that opportunity was not harnessed. Inflation is elevated and fuel subsidies remain a formidable drain on fiscal revenues. Ensuring macroeconomic stability requires tightening across all policy levers, and stronger revenue mobilization and exchange rate reforms. In addition to consistent macroeconomic policies, a more robust growth trajectory would require measures to decisively tackle governance weaknesses and implement trade and agricultural reforms.
1. Economic recovery continues on the back of agriculture and services sectors . Output growth at 3.4 percent (y/y) in 2022Q2 marked the seventh consecutive quarter of growth driven by various services sectors, especially information technology, trade, and finance. Oil production has been on the decline since mid-2020, reflecting low investment and significant leakages associated with poor maintenance and theft. Despite Nigeria’s limited direct exposures, the war in Ukraine has permeated through higher domestic food prices with headline inflation reaching its 17-year high in October 2022 of 21.1 percent (y/y). High food insecurity is compounding the pandemic’s scarring effects on the vulnerable.
2. Output growth is expected to moderate in 2022 to 3 percent and improve slightly next year. The slowdown in growth reflects year-to-date weaknesses in oil production and the adverse effects of recent flooding. Supported by the authorities’ measures to curb ongoing oil theft and considering new production coming on stream, a protracted recovery in the oil sector is projected beginning late this year. Headline inflation is expected to moderate at end-2022 as the start of the harvest season more than counters the projected increase in rice prices caused by recent flooding.
3. The near-term outlook faces downside risks, with some upside risks over the medium term . The effects of recent flooding and high fertilizer prices could become more entrenched impacting negatively both agricultural production and food prices in 2023. Similarly, further volatility in the parallel market exchange rate and continued dependence on central bank financing of the budget deficit could exacerbate price pressures. In the medium term, there are downside risks to the oil sector from possible price and production volatility, while climate-related natural disasters pose downside risks to agriculture. There are also upside risks from a stronger rebound in oil production, investment in the gas sector and Dangote refinery coming on stream with a large production capacity.
Fiscal policy: Undertake Bolder Fiscal Reforms to Create Policy Space
4. Public finance is under stress with elevated fiscal deficits, high debt servicing costs and public debt projected to increase over the medium term . Despite higher non-oil revenues relative to 2021, the general government (GG) fiscal deficit is projected to widen to 6.2 percent of GDP in 2022, mainly due to fuel subsidy costs. Without bolder revenue mobilization efforts, costly fuel subsidies and rising debt servicing costs will keep overall fiscal deficits above 6 percent of GDP in the medium term raising public debt to about 43 percent of GDP by 2027. While still deemed sustainable, such a level of debt is projected to take up nearly half of GG revenues in interest payments making the fiscal position highly vulnerable to real interest rate shocks. It also leaves little fiscal room for vital social spending on education and health, where Nigeria fares poorly compared to peer countries in sub-Saharan Africa (SSA).
5. Urgent revenue mobilization and fuel subsidy reforms are critical to create much needed fiscal space. Successful revenue mobilization episodes in SSA highlight the need for comprehensive fiscal reforms supported by high-level political commitment. The mission recommended the following package of measures, which are estimated to create fiscal savings of close to 6 percentage points of GDP during 2023-27 while also making room for higher social spending.
- Remove fuel subsidies and address oil theft. As a near-term priority, the mission highlighted the urgent need to remove fuel subsidies fully and permanently, which disproportionately benefit the well-off, by mid-2023 as planned. The government should also prioritize addressing oil thefts and governance issues in the oil sector to restore production to pre-pandemic levels.
· Step up implementation of tax administration reforms. The mission welcomed the steady implementation of the tax automation system (TaxPro Max) and recommended stepping up efforts to further expand coverage under a well-designed roadmap and strengthen taxpayer segmentation centering on the Large Taxpayer Offices (LTOs). In the medium-term, the authorities should develop a compliance improvement program and comprehensive customs modernization program, improve the effectiveness of the State Internal Revenue Service’s administration of the Pay-As-You-Earn (PAYE) system, and strengthen inter-agency coordination and data sharing.
- Adopt tax policy reforms. The mission advised the authorities to consider adjusting tax rates to levels comparable to the average in Economic Community of West African States (ECOWAS) as compliance improves. This includes further increasing the VAT rate to 15 percent by 2027 in steps while streamlining numerous VAT exemptions based on systemic reviews, increasing excise rates on alcoholic and tobacco products while broadening the base, and rationalizing tax incentives by streamlining tax expenditures based on comprehensive periodic reviews.
- Increase well-targeted social assistance . To mitigate food insecurity and cushion the impact of high inflation and fuel subsidy removal on the poor, the mission recommended increasing social spending by up to 1.7 percentage points of GDP during 2023-27 in well-targeted programs in coordination with the World Bank and other development partners.
6. Fiscal transparency is critical for a sound fiscal policy. Notwithstanding recent improvements, some gaps remain. While the authorities have published the annual financial reports of the state-owned Nigerian National Petroleum Company (NNPC) since 2019, uncertainties remain regarding the nature of tax write offs and fuel consumption volumes. The mission recommended a closer look at the nature of NNPC’s financial commitments to the government and the costing details of the fuel subsidy, including through a financial audit. Stronger cash management and better coordination among key public institutions is needed to increase the realism of budgetary forecasts and reduce reliance on central bank overdrafts.
Monetary and Exchange Rate Policies: Head off Inflation Drifts and Address BOP Pressures.
7. Monetary conditions are accommodative despite tightening measures undertaken by the CBN. The mission welcomed measures taken by the Central Bank of Nigeria (CBN) to tighten liquidity and curb inflationary pressures through increasing the monetary policy rate (MPR) by a cumulative 400 basis points and raising the cash reserve ratio (CRR). However, overall conditions remain accommodative— the MPR is below inflation, and financing provided to the budget and the CBN’s directed lending schemes continue to drive strong monetary expansion.
8. Decisive and effective monetary policy tightening is a priority to prevent risks of de-anchoring of inflation expectations . Given the multiplicity of monetary policy tools, market segmentation and weak interest rate transmission, the mission recommended the following measures to effectively tighten the monetary policy stance: (i) fully sterilize the impact of CBN’s financing of fiscal deficits on money supply; (ii) stand ready to further increase the MPR to send a tightening signal; and (iii) continue phasing out CBN’s credit intervention programs, which expanded rapidly during the pandemic to support the economy. The mission welcomed progress in the securitization of the CBN’s existing stock of overdrafts and recommended speedy finalization. Going forward, it would be important to limit reliance on CBN overdrafts for fiscal financing to the statutory limit of 5 percent of previous year’s revenues by pursuing fiscal consolidation, better budgetary planning and resorting to supplementary budgets in case of financing shortfalls. The mission also reiterated its previous recommendations to modernize the 2007 CBN ACT to establish price stability as its primary objective. It also recommended to enhance transparency through timely publishing of audited financial statements.
9. Despite improvement in the current account, the external sector continues to face pressures. Rising oil prices drove export revenues in 2022, generating a merchandise trade surplus. The current account is also improving despite higher profit repatriation by foreign companies. However, large net private outflows by domestic banks and nonbanks in the form of offshore deposits surpassed net inflows by foreign investors putting downward pressure on gross international reserves. Against this backdrop, Nigeria’s external position is preliminarily assessed to be moderately weaker than implied by economic fundamentals.
10. A unified and market-clearing exchange rate remains critical to enhancing confidence. Continued FX shortages, a stabilized exchange rate regime, rising inflation, limited debt servicing capacity, and administrative restrictions on current transactions fuel devaluation speculations. These factors hinder much needed capital inflows, encourage outflows and constrain private sector investment. The mission reiterated its past recommendations to move towards a unified and market-clearing exchange rate by dismantling the various exchange rate windows at the CBN accompanied by clarity on exchange rate policy and supportive fiscal and monetary policies. In the medium term, the CBN should step back from its role as main FX intermediator, limiting interventions to smoothing market volatility and allowing banks to freely determine FX buy-sell rates.
Banking Sector: Prudently Navigate the Credit Cycle
11. The banking sector is profitable and liquid, while regulatory measures are being adopted. Profitability and banking sector liquidity have remained roughly stable while NPL ratio has dropped to near 5 percent. The share of questionable loans rebounded after the CBN announced the expiration of pandemic-related forbearance in loan classification by end-2023; however, the authorities’ stress tests indicate that the banking system remains resilient to a potential significant rise in NPLs. The mission welcomed the implementation of Basel III regulation and recommended monitoring risks from less-regulated digital lenders, ongoing FX shortages faced by the corporate sector, and possible crowding out from the strong sovereign-bank nexus, which has increased in recent years. The mission also advised to resolve weak smaller banks and proceed with the winding down of the public asset management company (AMCON) by end-2023.
12. Macro-financial linkages warrant close monitoring. Significant retail credit growth, while partly reflecting financial deepening, may be further propelled by a forthcoming regulation allowing households to tap into their pension savings for mortgage down payments. The mission recommended increased vigilance and adoption of selected macroprudential policy instruments to handle possible retail credit risks.
13. The authorities are making slow but steady inroads into financial inclusion. Nigeria continues to fall short of its inclusion targets, particularly in access to financial products. The share of population with financial access has increased benefiting from non-banking and informal financial services, but financial exclusion rate at 36 percent remains high relative to peers in SSA. The mission welcomed further expansion of the agent network, the rising uptake of mobile money and electronic payments, and granting of payment service bank licenses to large mobile operators. The authorities have also recently launched promising initiatives to improve financial literacy and promote access to finance for women. The mission welcomed the imminent launch of CBN’s regulatory sandbox for fintech and encouraged the authorities to increase the number of banking agents in underserved regions, provide more targeted training in using financial products, and extend the eNaira further to the unbanked population.
14. The authorities’ recent actions in response to the 2021 GIABA Mutual Evaluation Report have lessened the risk a public listing by the Financial Action Task Force (FATF) . They updated and passed new laws and took regulatory and transparency measures. Sustained actions to address any remaining deficiencies would be important to avoid the risk of FATF grey listing.
Structural policies: Strengthen Agricultural Productivity and Address Corruption
15. Strengthening the performance of the agricultural sector is key to job creation, food security, and social cohesion. Over the next decade, an estimated 25 million additional jobs will be needed to employ the new labor market entrants. For agriculture to continue playing a strong role in employment and ensure food security, boosting production and yields through improved input usage, especially through affordable fertilizers and higher quality seeds, better storage facilities and a more coordinated policy support across government agencies are recommended.
16. Addressing corruption remains critical to stimulating investment. The mission welcomed recent measures to fight corruption and promote the rule of law and accountability through the passage of the Proceeds of Crimes and Whistleblower’s Act, and efforts to increase the rate of asset declarations by the Code of Conduct Bureau. However, Nigeria is still assessed to have widespread governance weaknesses and the mission was not able to assess progress in audits of the COVID-19 related emergency spending. The government should redouble its efforts to implement key aspects of the National Anti-Corruption Strategy (NACS), including measures to reduce bribery, improve prosecution and conviction rates for corruption cases, as well as the confiscation of related proceeds of crime.
17. Trade-enabling reforms are essential to promote economic diversification. The reopening of land borders earlier this year is a welcome move to facilitate trade. To speed-up compliance with rules on non-tariff barriers agreed under the African Continental Free Trade Agreement, the mission recommended making operational the already deployed scanners, which would limit tedious physical ports inspection processes and contain customs delays.
The IMF mission would like to thank the authorities and other counterparts for the frank and thoughtful discussions and kind cooperation.
