Staff Concluding Statement of the 2022 Article IV Mission

Nigeria: Staff Concluding Statement of the 2022 Article IV Mission

November 18, 2022

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.