On August 6, 2001, the International Monetary Fund (IMF) published the full details of its Staff Report on consultations held with Nigerian officials during the IMF Staff visit to Lagos and Abuja from March 8-20 , 2001 and Nigerian official visit to the IMF in April. The Staff Report was completed on June 14. IMF issued a Staff Statement on June 29, updating information provided in the Staff Report. Finally, the IMF issued a Public Information Notice (PIN), which summerizes the view expressed by the Executive Board of the IMF during its June 29 discussion of the staff report. Below are excerpts from the Staff Report along with the full texts of the Staff Statement and Views of the Executive Board.

Executive Summary

Serious macroeconomic imbalances have emerged in Nigeria over the last year. Inflation has accelerated to double-digit levels, and instability bas prevailed in the foreign cxchange market. Although there has also been a rebound in economic activity, this is likely to prove temporary in the wake of the imbalances. Against the backdrop of pressures to deliver a "democracy dividend," spending surged, absorbing the large oil windfall gains. In 2000, large wage overrun led to much higher levels of government spending than anticipated . The 2001 budget envisages sharply higher spending, which also raises concerns about the quality of spending. Monetary tightening has come too late and been too gradual to forestall inflationary pressures. Moreover, the Central Bank of Nigeria (CBN) has reverted to a system of selling foreign exchange at a predeterrnined price, and the differential between the CBN's rate and the parallel market rate has widened substantially. Structural reforms and measures to improve governance were both delayed.

Tensions between the government and the National Assembly, ethnic and religious conflicts, and the absence of requisite technical capacity in the civil service have all hampercd progress. Moreover, the 1999 constitution, which gives state and local governments full and automatic rights to their share of oil revenues, and their insistence on spending them, have made prudent management of oil windfall gains diflicult. Nevertheless, a series of useful, if modest, achievements has been made over the last two years. The government has decided to restrain spending to preserve macroeconornic stability. Monetary policy has been tightened, with signs of calm retuming to the foreign cxchange market. The privatization process has gained momentum and several actions have been taken to lay the groundwork for improving transparency and accountability in the use of public funds. These achievements offer a modest basis to build on as market-based reforms and the restoration of macroeconomic stability are pursued. Above all, it is critical that for 2001 the federal government adhere to its intention to restrain spending. The quality of spending also needs to be ensured through strict compliance with due process. Further tightening of monetary policy may be needed to bring inflation down to single digits and substantially narrow the differential between the CBN and parallel market rates.

Maintaining the momentum of privatization will be essential to laying the foundation for a private sector-driven improvement of medium-term growth prospects. Thc government's anticorruption measures will have to be particularly strong to tackle deep-rooted problems and make a dent in firmly entrenched pcrceptions in the private sector. Moreover, the capacity to implement economic reforms is inadequatc, particularly in relation to the budget process. In this context, donors need to enhance and coordinate their assistance.

Even with a determined pursuit of economic reforms, Nigeria will need concessional assistance from the international comrnunity. Steadfast implementation of these reforms should help Nigeria garner the support of the international community in seeking to reduce its debt burden. If the authorities implement the actions necessary to reinvigorate their economic programme, the staff would recommend that the Board complete the first review under the current Stand-By Arrancement and extend the arrangement by six months. The authorities intend to seek a successor three-year arrangement. The broad support of state and local governments, National Assembly, and civil society will be important for the success of the economic reform and poverty reduction strategy.

INTRODUCTION

The last Article IV consultation was concluded on December 8, 1999. At that time, Directors noted that an exceptional window of opportunity existed for Nigeria to undertake ambitious and wide-ranging reforms to lay the basis for a renewal of confidence and sustained economic development. They considered that a tightening of the fiscal stance was needed, and cautioned that the delegation of fiscal responsibilities to lower levels of government should be consistent with their institutional capacity. They viewed the decisive implementation of the privatization programme as a key element of the reform agenda and emphasized the importance of transparency, good governance, a strong judiciary, and institution building for sustained economic recovery.

Since then, the Executive Board met on Nigeria, formally or informally, on a number of occasions, including on August 4, 2000 when a 12-month precautionary Stand-By Arrangement in the amount of SDR 788.94 million (45 percent of quota) was approved in support of a programme for July 2000 - June 2001. The first review under the Arrangement was to have been completed by end-December 2000, but it has been delayed in view of deviations from programme targets. In the informal discussion of February 7, Directors expressed their disappointment with Nigeria's performance under the Stand-By Arrangement. They endorsed the staff's plan to bring the first review, together with the Article IV consultation, to the Executive Board for its consideration in May, following the completion of actions to bring the programme back on track and an agreement on the economic programme for January-June 2000. In the event, the Nigerian authorities were unable to complete some of the key prior actions. Notwithstanding this disappointing performance, the Nigerian authorities strongly wish to complete the current Stand-By Arrangement-albeit with a delay-and, then, enter into a successor, three-year arrangement. The latter would help provide continuity in economic policy implementation into the next administration (which will take office after the next general elections scheduled for February 2003), and assist the authorities in tackling widespread poverty. Under the circumstances, the staff would recommend that the Executive Board consider, in early August 2001, the authorities' request for completion of the first review and an extension of the current arrangement by six months to February 4, 2002, if (a) certain measures are taken by the end of June as reported in this paper; and (b) a satisfactory understanding is reached on the economic programme for the second half of the year.

Summaries of Nigeria's relations with the Fund and with the World Bank Group are presented in Appendices I and II, respectively. A discussion of statistical issues is contained in Appendix III, while selected social and demographic indicators are provided in Appendix IV. The performance under the Stand-By Arrangement is summarized in Appendix V. Medium-term growth prospects are described in Appendix VI, while a debt sustainability analysis is found in Appendix Vll. Appendix VIII reviews Fund technical assistance since 1999 and the Technical Cooperation Plan (TCAP). A tentative work programme is presented in Appendix. Selected economic and financial indicators are provided in Table 1.

Background

The present administration took office in May 1999, following 20 years of military rule, mismanagement, and the destruction of civil institutions. It pledged to fight corruption; ease the infrastructure bottlenecks, particularly for power and petrol; improve education, health, and other basic public services; accelerate privatization; and reestablish government institutions that serve the public. Its aims were to promote private investment, revive the economy, and reduce unemployment, while restoring macroeconomic stability. The new administration declared its intention to work closely with the international community to help deliver a "democracy dividend" to the Nigerian public.

Several factors have, however, hampered progress. First, for much of 2000, the government was involved in a bitter political battle with the National Assembly-in essence, to delineate the boundaries of their respective authorities under the new democracy. At stake, among other issues, was the responsibility of the executive vis-a-vis the legislature in the formulation, implementation, and monitoring of the federal government budget. Second, strong ethnic and religious tensions surfaced with the cessation of military rule which have claimed many lives and, at times, threatened national unity. While such tensions appear to have eased, the undercurrent of these conflicts continues to constrain economic policy decisions. Third, under democracy, labour unions have emergcd as an effective force in challenging certain of the govemment's policy measures. Massive protests, organized by the labour unions, forced the governrnent to roll back its decision to remove the petroleum subsidy and deregulate the downstream petroleum sectors. Fourth, the absence of the requisite technical capacity in the civil service, coupled with opposition from parts of the government, meant that reform measures could not be pushed through as swiftly as wished.

In addition, the new constitution, which gives state and local governments full and automatic right to their shares of the oil revenues, has severely constrained the management of oil windfall gains. The 2000 oil windfall, defined as oil revenue in excess of US$20 per barrel (so-called excess proceeds), amounted to US$4 billion, or 10 percent of GDP. About one-half of this accrued to subfederal governments, which was distributed equally in the last quarter of 2000 and the first quarter of 200 l . Reflecting in part the latter, spending by state and local governments is expected to increase in 2001 by about 4 percent of GDP.

Moreover, the sharp contrast between the democracy dividend promised by the democratic government and the lack of discernible unprovements in living standards- symbolized by the continued power outages and gasoline shortages-fueled pressures on the federal government to revert to the old-and failed-paradigm of employment and income creation through big public spending. Thus, the federal government more than doubled public service wages in May 2000 (which the authorities felt necessary to compensate for the substantial erosion of real wages and to reduce petty corruption). After a prolonged dispute, the federal government agreed in July to support the 2000 budget, which envisaged a sharp increase in consolidated govemment spending to 43 percent of GDP, nearly all of which was eventually spent. The federal government then proposed, and the National Assembly approved, the 2001 budget that provided for a further increase of the consolidated government spending to 53 percent of GDP.

With inflation negative in early 2000, the Central Bank of Nigeria (CBN) pursued a policy of low interest rates to help reflate the economy. The minimum rediscount rate was reduced in three steps from 18 percent in December 1999 to 14 percent in December 2000, and the cash reserve requirement was reduced in two steps from 12 percent to 10 percent during the same period. Moreover, the CBN transferred in December to the federal govemment the proceeds of the earlier sale of N100 billion worth of treasury bills (3 8 percent of end- 1999 reserve money), which fully offset the sterilization it had undertaken earlier in the year. To ensure a reserve build-up of US$4 billion-the amount of excess oil proceeds in 2000-the CBN did not sterilize the liquidity injection from the fiscal operations with increased sales of foreign exchange. Thus, reserve money expanded by 40 percent in 2000 with much of the growth having occurred in December. As inflation picked up, the interest rate turned negative in real terms. The CBN began to shift its monetary policy stance in early 2001, but reserve money continued to expand at a rapid pace.

The large government spending, together with the buoyant oil sector, appears to have given a temporary boost to the economy (real GDP grew by an estimated 3.8 percent in 2000, but macroeconomic stability has come under serious threat. Inflation, as measured by the 12-month increase in the consumer price index, rose from 0.2 percent in December 1999 to 18 percent in March 2001. Moreover, excessive fiscal spending spilled into the foreign exchange market. With the CBN reverting to the pre-reform system of selling foreign exchange in the interbank foreign exchange market (IFEM) at a predetermined rate, the interbank market split into the IFEM and the open inter-bank market- where banks trade among themselves at freely negotiated exchange rates (the NIFEX.) The parallel rate depreciated by 30 percent between December 1999 and May 2001, and the differential with the IFEM rate widened to 20 percent. A foreign exchange market crisis emerged in April 2001, when the CBN made a small adjustment of the IFEM rate before it had effectively mopped up the excess liquidity. Very large amounts of foreign exchange were sold to deal with the crisis, and foreign reserves have increased only modestly during the first five months of 2001 despite the continued high oil price.

These macroeconomic developments and policies were substantively at variance with the programme supported by the Stand-By Arrangement. Inflation exceeded the programme target by a substantial margin. The federal govemment borrowed substantially compared with the programme target of zero borrowing, and used a larger portion of the excess oil proceeds than envisaged under the programme which together resulted in spending greatly exceeding the programme target. Also, the CBN's liquidity absorption operations were more limited than targeted. While the end-2000 target for net international reserves was met, the CBN's foreign exchange management included some administrative measures, which gave rise to a multiple currency practice. ln addition, structural reforms fell behind schedule.

Why did the programme go off track even within a few months after approval? The legal, institutional, and political constraints were much stronger than the authorities had expected. One of the fundarnental premises of the programme was to contain the wage bill within the budgeted outlay. However, large wage overruns occurred because the government, under strong pressure from the civil service establishment, rolled back in October 2000 its earlier decision to pay wages in accordance with the estimates of the Accountant General of the Federation (AGF) rather than those requested by the line ministries. Second, political pressures to "implement the approved budget"-in particular to alleviate the severe power outages-intensified as oil prices continued to rise and the next general elections approached. Third, the programme assumed that, in line with past practice, no excess oil proceeds would be distributed beyond the levels approved in the budget. The state and local governments successfully claimed-against the opposition of the federal government-that the federation could not withhold their shares of all oil procccds as the constitution stipulated that these proceeds accrued to them directly.

MEDIUM-TERM ECONOMIC PROSPECTS

The Nigerian authorities have stressed that it is their highest priority to reduce poverty as rapidly as possible, sufficient at least to meet the United Nation's target of halving absolute poverty by 2015. Given the projected growth of the population (nearly 3 percent per year), attaining this objective would require overall economic growth of at least 6-7 percent per annum. The authorities have emphasized that it is feasible to achieve such growth rates, pointing to the country's abundant natural resources, in particular natural gas (whose proven reserves are larger in value than those of crude oil) and agriculture. Moreover, Nigeria's labour force is large and skilled, and its relatively large domestic market makes it an attractive location for foreign and local investors.

While the authorities' growth targets were laudable, the staff advised caution in raising expectations. It would likely be difficult to elicit in such a short period the private sector response that would be needed to achieve growth as high as 6 percent to 7 percent. Even the attainment of a modest growth rate-of, say, 4 percent to 4.5 percent in the medium term-would require prudent fiscal policy, the steadfast implementation of structural reforms, governance-improving measures, and the rebuilding of public institutions so as to create an attractive environment for private investment. These actions would need to be supplemented with generous levels of concessional external financing under the staff's projections based on a medium-term oil price of US$20 per barrel.

Prudent fiscal policy-one that safeguards macroeconomic stability and preserves competitiveness while also cushioning the economy against a future downturn in oil prices-will be central to facilitate private sector investment. This would require the federal government in 2001 to save excess oil proceeds and keep spending below budgeted levels. For 2002, it would require a sharp reduction in spending by state and local governments as the oil price is projected to fall to US$22.5 per barrel from high levels in 2001, which may be difficult to sustain politically. Beyond 2002, it would require all levels of government to contribute to macroeconomic stability. It would, therefore, be imperative for Nigeria to create a workable intergovernmental structure for smoothening revenue flows that ensures sound macroeconomic management at all levels of government.

In view of the depth of the challenges that the Nigerian authorities must address, it may be only realistic to assume that improvements would be gradual, and that it might take some time before Nigeria is put on a growth trajectory of 6-7 percent. The staff therefore projects, as a central scenario, that non-oil growth could increase from 2.8 percent in 1999-2000 to about 5 percent by 2004, sufficient for real GDP growth to increase from 2.4 percent to 4.5 percent over the same period. Macroeconomic stability could be maintained, while bringing end-period inflation down to 9 percent in 2001 and 5 percent over the medium term. Gross international reserves could rise and remain close to US$10.3 billion (6 months of imports) over the medium term.

Even with such a fiscal adjustment, Nigeria's external payments situation will likely remain difficult. From a projected deficit of 2 percent of GDP in 2001, the current account deficit is expected to widen to average about 7 percent of GDP in the outer years. The capital account is projected to register small but rising surpluses over the medium term, reflecting disbursements from IDA and other agencies as well as a gradual rise in private capital inflows. Nevertheless, a financing gap averaging US$1.5-US$2 billion per year is envisaged through 2005. These estimates take account of the Paris Club rescheduling agreement of December 13, 2000.

REPORT ON THE DISCUSSIONS

Against this background, the discussions focused on measures to safeguard macroeconomic stability and the quality of public spending, as well as those that would lay the foundations for sustainable economic growth and poverty reduction. Specifically, the discussions focused on (a) fiscal policy and issues relating to the management of oil windfall gains; (b) the challenges posed by fiscal federalism; (c) monetary policy in the wake of expansionary fiscal policy; (d) measures to promote good governance, privatization, trade liberalization, and regional integration, as well as policies to improve the investment climate; and (e) capacity building and priority technical assistance needs. Progress in developing a poverty reduction strategy and views on debt sustainability were also discussed. During these discussions, the staff reached understandings on the prior actions that would be necessary for the staff to recommend completion of the first review under the Stand-By Arrangement.

Fiscal Policies

Nigeria experienced a positive terms of trade shock in 2000 and 2001, with oil prices rising from US$17 per barrel in 1999 to US$28 per barrel in 2000, and a projected US$25.5 per barrel in 2001. The income gains from the terms of trade improvement accrue almost exclusively to the government in the form of additional revenue. In addition, about US$ 1billion, or 2.5 percent of GDP of foreign exchange receipts (from nonresidents) is expected from the privatization programme and sales of oil field exploration rights.

What would be an optimal policy response to these terms of trade gains? The staff argued that such a policy would be for the government to spend only part of the windfall and save tbe rest, thus enabling Nigeria to safeguard fiscal sustainability against a likely fall in the oil price. The staff projections showed that if vigorous efforts to reduce the wage bill, contain federal capital expenditures, and enhance domestic taxation (including removal of petroleum subsidy) were pursued, a sizable primary balance could be achieved and, hence, fiscal sustainability assured. However, there were substantial downside risks of the oil price falling below the current projection of about (US$20 per barrel. If, for example, the oil price fell to US$ 15 per barrel in 2002 and 2003, government revenue would be lower by about 10 percent of GDP annually. As it would be difficult to reduce government expenditures substantially from the levels currently assumed, the primary deficit could decline to 4-5 percent of GDP and foreign exchange reserves to below US$2 billion, equivalent to about one month of imports. Recognizing this risk, the authorities initially intended to base the 2000 budget on the oil price of US$20 per barrel, and save oil revenues in excess of this level. The staff was in agreement with this approach, and proposed a fiscal policy rule to save oil proceeds in excess of US$20 per barrel. This rule would provide for savings of "windfall gains" of US$ 4 billion or 10 percent of GDP in 2000, and US$3.7 billion or 9.6 percent of GDP in 2001.

Several other considerations supported the staff's fiscal rule. First, in view of the time that would be required to improve the quality of expenditure and enhance governance, there would be little assurance that higher-than-proposed levels of spending would contribute effectively to poverty reduction and non-oil growth. Second, the economy had limited capacity to absorb sharply higher levels of government spending, given the severe bottlenecks in infrastructure. Third, unduly large spending financed from oil revenues would lead to an appreciation of the real exchange rate and undermine prospects for the non-oil sector ("Dutch disease" effects).

While agreeing in principle that it svould be desirable to save the oil windfalls, the authorities considered that, in the current circumstances, the states rule was too stringent to adhere to in practice. Specifically, given the current extreme poverty and the devastation of basic infrastructure, using the windfall to allow higher current spending would be justified even if it meant foregoing spending in the future. In their view, the key therefore was the quality of spending-including cost- effectiveness, poverty focus, and transparent implementation-which they were committed to achieving through strict observance of due process. To this end, the government had adopted a set of "due process tests" (in line with World Bank recommendations), and introduced a system of checks and balances so that no capital expenditures would

Monetary and Exchange Rate Policy

As a result of the substantial terms of trade gains and the deviation from the expenditure restraint proposed by the staff, fiscal operations have given rise to a large liquidity injection in 2000 and 2001. This injection was equivalent to l 03 percent of the opening reserve money stock in 2000. The resulting surge in inflationary pressures and consequent appreciation of the interbank exchange rate (13 percent in real terms) could weaken prospects for medium-term growth based on a revival of the non-oil economy.

In the wake of such an expansionary fiscal policy, how should monetary policy respond in 2001? The first priority should be to reduce the rate of inflation to single digits as soon as possible. This would require substantial and rapid absorption of liquidity. In the staff's view, a preferred method for liquidity absorption would be central bank sales of government securities, and limiting sales of foreign exchange to ensure an adequate build-up of reserves. However, in view of the enormous size of liquidity that would need to be absorbed, large foreign exchange sales by the CBN would have to be accepted in order to limit reserve money growth consistent with the aim of reducing inflation substantially. It had to be recognized, however, that tight monetary policy was a second-best response in the face of expansionary fiscal policy, and could not be expected to mitigate the impact of the latter on the real exchange rate, except in the short run.

The Nigerian representatives explained that the CBN had come to a view, late last year, that, as economic activity had begun to pick up in response to the fiscal stimulus and signs of rising inflationary pressures had become clearer, the balance between facilitating non-oil activity and forestalling macroeconomic instability had shifted toward the latter. The CBN thus changed its policy direction in December, but judged that monetary tightening would have to be gradual in order to minimize the political opposition and pressure on the banking system. Accordingly, over the subsequent five-month period, (a) the minimum rediscount rate (MRR) was raised in three steps, by 2.5 percentage points to 16.5 percent (treasury bill interest rates were raised correspondingly to 17 percent); (b) the interest rate on 360-day CBN certificates was raised to 21.5 percent; (c) the cash reserve requirement was raised in two steps by 2.5 percentage points to 12.5 percent; and (d) the ]iquid asset ratio was increased from 35 percent to 40 percent.

TheNigerian representatives noted that, by late April, these measures, togetber with the restraint on Federal Government spending, had brought about a considerable tightening of monetary conditions, with interest rates in the interbank market rising from 17-20 percent throughout most of 2000 to 30-40 percent in April 2001. There were nascent signs that this tightening was strengthening the currency as the parallel market rate appreciated from over N140 per U.S. dollar in early April 2001 to about N 135 per U.S. dollar in mid-May. Correspondingly, the differential between the parallel and the IFEM rates narrowed from 23 percent to about l9 percent.

While acknowledging that these measures were significant, the staff stressed that a threat of major macroeconomic instability remained. The liquidity injection from fiscal operations would continue to be large during the remainder of the year, stoking further inflationary pressures. Further, inflationary expectations had been aggravated by the extremcly large government spending provided for in the 2001 budget and the attendant anticipation of a future depreciation (based, in part, on the unsustainably large differential between the official and parallel exchange rates).

The staff regards it as important that lasting stability in the foreign exchange market be restored quickly, and that reforms toward developing a fully market determined exchange system be expeditiously resumed. After the successful introduction of the interbank market in the third quarter of l999, where the CBN and commercial banks traded foreign exchange on the basis of two-way quotes, the CBN prohibited in 2000 the transfer between banks of foreign exchange purchased from tbe CBN. This action, together with administrative measures which limited access to the IFEM, led to the segmentation of the interbank market with two distinct exchange rates, and gave rise to a multiple currency practice subject to Article VIII. Transferability was re-introduced in mid-December 2000, but was barred again in early-February 2001. The staff recommended that (a) the IFEM and the open inter-bank market be merged, thus eliminating the multiple currency practice; and (b) the differential between the IFEM and the parallel market rates be narrowed to less than 10 percent, all by the end of May 2001. The staff was also in the process of determining whether exchange restrictions had been introduccd.

The staff thus recommended that, as part of the prior actions for completing the first review, the CBN adopt a monetary programme for 2001 that aims at bringing about lasting stability in the foreign exchange market and restoring price stability. Specifically, the CBN would (a) sell a large amount of treasury bills and CBN certificates in May and June that would reduce net domestic assets of the CBN by N22 billion for the year as a whole; (b) limit its sales of foreign exchange, sufficient to achieve at least a small increase in intemational reserves in 2001; and (c) limit the increase in reserve money to 8.3 percent, consistent with the target of reducing inflation to less than 10 percent by the end of 2001.

The Nigerian representatives agreed with the staff's recommendations on the monetary programme but cautioned that it would not be easy to achieve these objectives. First, the exchange rate differential reflected to a large extent a premium that purchasers of foreign exchange were willing to pay to falsify import documents so that they could evade customs duties, or to make transfers that were otherwise restricted (e.g., capital flight) or illicit (e.g., money laundering.) The recent widening of the differential also reflected stricter controls on "round-tripping" (i.e., purchases of foreign exchange for resale in the parallel market) and tighter enforcement of capital controls. Thus, while the differential should narrow, the exact magnitude of the differential may be beyond the control of the CBN. Second, an increase in international reserves in 2001 would be possible only if federal government spending could be limited as currently envisaged. Third, once currency went into circulation, it tended not to flow back into the banking system, making it difficult to control reserve money. Most Nigerians did not either save or settle transactions through the banks. Furthermore, in view of the poor quality of money and banking statistics, movements of reserve money ought to be interpreted with care. The staff further recommended that the vulnerability and soundness of the financial system be carefully assessed to ensure that weaknesses in the banking system did not unduly constrain the conduct of monetary policy. The last Article IV staff report described progress that had been made during the second half of the l 990s in addressing financial distress in commercial and merchant banks (SM199/276, Appendix Vl). There were indications that the health of the banking system had improved further during 2000. Banks reported strong earnings with profits before tax having increased by 36 percent to N63.3 billion (1.5 percent of GDP). In addition, and notwithstanding another year of strong growth of credit to the private sector, the ratio of non-performing loans to total loans had fallen by 4 percentage points to a stil1 high 21.5 percent. Nonetheless, problems remained. According to the World Bank study of May 2000, many banks were taking imprudently high foreign exchange risk, 14 banks (out of a total of 51) were classified as distressed, and 7 additional banks appeared to remain at risk. Moreover, while the frequency of on-site inspection of commercial and merchant banks had been gradually increased, not much progress had been made in addressing the inadequacy of supervision of the nonbank financial sector. There was still a need for enhancing the overall supervisory capacity, including through training and an increase in the number of bank supervisors. A Financial Sector Stability Assessment is to be conducted during 2001.

Good Governance

On governance issues, the staff representatives indicated that, notwithstanding a number of actions that had been taken to reduce corruption, including the dismissal or prosecution of some senior of ficials, there appeared to be a sense of disappointment among the Nigerian public and in the internaffonal community that corrupt practices continued to be widespread throughout public institutions in Nigeria. In part, this may be a reflection of the high hopes held by the public that corruption would be reduced substantlally and rapidly under the democratic government. The preliminary interim reports of the value-for-money audit of government expenditures in 2000 showed frequent neglect of the established procedures governing the use of public resources. The delays in (a) the start-up of the Anti-Corruption Commission; (b) the submission to the National Assembly of the statutory audit of the 1999 government accounts; (c) the adoption of strengthened procurcment procedures; and (d) the completion of the value-for-money audits and other programme measures were also sources of concern.

In response, the Nigerian representatives stressed that the government had now implemented most actions that had been programmed for completion by end-December 2000, and suggested that, if the public's perceptions were negative, as reported by the staff, it might be because they were not fully informed of the measures the government bad taken. The oft-cited Transparency International's corruption index, which ranks Nigeria at the bottom, was bascd on a survey taken before the present administration took of fice. The Anti-Corruption Commission had received initial funding to commence operations and was now investigating about one dozen major cases. The government had not hesitated at all in dismissing and prosecuting high of ficials whenever a clear case of abuse had been presented (there have been 11 such cases since this administration took office). Moreover, the Attorney General had made it clear that the government would follow up on the results of the value-for-money audits and the civil service audit, and would prosccute where there was evidence of wrongdoing.

The staff urged the authorities to redouble their efforts to improve transparency and accountability in the use of public resources. The authorities indicated that thc government would ensure that budget implementation did not give rise to abuses of contracting and other procedures to the detriment of the quality and effectiveness of spending. The establishment of additional checks to ensure full compliance with due processes was central to these efforts. To this end, the government would publish the newly established due process tests, and the role of the Budget Monitoring and Price Intelligence (BMPI) unit in the presidency in this regard. It would also continue with the value-for-money audits; the results of the audit of projects undertaken in the first quarter of 2001 were expected to be published by end- June 2001. New procurement procedures, which are in line with World Bank recommendations, will come into effect in June 2001.

The Nigerian representatives also indicated that they placed a high priority on ensuring that anti- money laundering legislation met international standards. The government was reviewing the 1995 Anti-Money Laundering Act to ascertain whether it conformed to international standards. The government would then adopt the Forty Recommendations on Anti-Money Laundering developed by the Organization for Economic Cooperation and Development (OECD)'s Financial Action Task Force.

Privatization and Deregulation

The Nigerian representatives reiterated that privatization remained the centerpiece of their structural reforms and noted that, although progress had been slower than initially hoped for, there was now a momentum to move forward rapidly. Phase I of the privatization programme, which involved the sale of the government's shareholdings in a dozen commercially viable enterprises, such as banks and petroleum marketing, cement, and insurance companies, had now been largely completed. Important progress had also been made toward the privatization of the telecommunications sector, a key item in phase II. Three GSM licenscs were successfully auctioned in February 2001, for a license fee of US$285 million each (i.e., for a total of US$855 million). Expressions of interest from strategic investors in the Nigeria Telecommunications Company (NITEL) had been sought; it was expected that a majority shareholding in NITEL would be sold by the end of 2001. In preparation for this sale, it was now expected that the regulatory framework and law in the telecommunications sector would be approved by the cabinet and submitted to the National Assembly by end-June. Moreover, the government had reached agreement on a Privatization Support Credit with the World Bank that would enable the Bank to intensify its support for privatization in this and other sectors.

The Nigerian representatives also informed the staff that they had made major strides in gaining public support for the deregulation of the downstream petroleum sector and the associated removal of the petroleurn subsidy. Following the almost complete rolling back of the 50 percent hike of retail prices of petroleum prices in luly 2000, the government constituted a committee, consisting of all major stakeholders, to advise on whether and how to proceed with deregulation of this sector. In January 2001, the committee had supported the government's policy (with representatives of the labour unions dissenting) and recommended that the petroleum subsidy be removed in two stages over a nine-month period, beginning the third quarter of 2001. The government was firmly committed to implementing these recommendations and is seeking the consent of the labour unions through a further consultative process. A bill to establish an independent regulatory agency in the downstream petroleum sector, which would consolidate and develop existing laws, would be submitted by end-200 l to the National Assembly. Privatization of the first refinery is now envisaged in 2002.

The Nigerian public enterprise sector accounts for an estimated 50 percent of total GDP, 57 percent of investment, and two-thirds of forrnal sector employment. Underscoring the importance of privatization in Nigeria's econornic reforms-to remove structural bottlenecks to growth and improve allocation of budgetary resources-the staff representatives wondered whether a shift in strategy might not be needed to prevent further delays in reforming other key sectors. First, in the critical power sector, the government's approach had been to strengthen the Nigeria Electric Power Agency (NEPA) with a wholesale change in its top management, while continuing to entrust NEPA with the rehabilitation and upgrading of the existing generation facilities, transmission systems, and power distribution (pending the unbundling of the company expected in early 2002 and subsequent privatization); concurrently, generation capacity had been augmented through arrangements with private power suppliers. This approach apparently had little success as severe disruptions of power supplies have continued unabated. Second, the 2001 budget envisaged an injection of large amounts of public funds into a number of unviable, large public enterprises in the aluminum, fertilizer, steel, and other sectors, on the premise that additional investments for rehabilitation and/or completion of the projects would facilitate privatization. The World Bank had consistently maintained that such investments would be unwise, as the facilities were better sold "as is." Third, the 2001 budget also provided for the construction of grain silos and a national food security programme. According to the World Bank, such government intervention in agriculture would be inappropriate, given that it had failed in the past, both in Nigeria and elsewhere in Africa.

The Nigerian representatives were not in full agreement with these views of the Bank and Fund staff. However, they agreed not to put in public money, pending the completion of an ongoing technical audit of the Ajaokuta Steel complex, Delta Steel, and three inland rolling mills, which will look at options for privatization in the sector.

Trade Liberalization & RegionaL Integration

The discussions of trade policy took place against the background of the approaching expiry of the 1995-2001 customs and excise tariff, which had been amended with the adoption of the annual budgets. These amendments introduced a modest degree of trade liberalization, by reducing the average tariff, the dispersion and number of rates, and lowering some tariffs on consumer goods while increasing those on raw materials. Nigeria still has a complex structure of trade taxes, with at least seven taxes and with the customs duty varying from 0 percent to 100 percent.

The staff expressed disappointment that the full review of the tarriff structure contemplated for end- 2000 had not been completed. In the staff's view, Nigeria should give high priority to simplifying the structure of trade taxes by folding all trade taxes into one tax-the customs duty. Nigeria should aim to move gradually toward a structure of rates for the basic duty akin to that in the West African Economic and Monetary Union (WAEMU)-a zero rate could be applied to essential goods, raw materials, and capital goods, and a rate of 10 percent or 15 percent to all other goods. Such a structure would reduce the administrative burden and scope for rent seeking and provide some protection to domestic industry, while mitigating the anti-export bias by ensuring that exporters had access to inputs at world prices. At the same time, Nigeria should strive to eliminate remaining nontarriff barriers.

The authorities indicated that their intention was to move in the direction of a more liberalized and simplified tariff regime. However, decisions would be made only after the completion of the comprehensive review of the structure of trade tariffs and the level of effective protection which is now expected by September 2001, in time for a major revision of the current tariff code in the 2002 budget.

The staff also welcomed the decisions taken at the Economic Community of West African States (ECOWAS) Heads of State summit in December 2000 to establish an ECOWAS free trade zone and to harmonize ECOWAS and WAEMU programmes in the areas of common tariffs, convergence of macroeconomic policies, and implementaffon of sectoral policies. In particular, the staff called on the authorities to emulate the steps taken by the WAEMU countries to establish a common external tariff and to remove existing intratrade barriers within the community. It was essential to proceed with nonpreferential liberalization of the external tariff to minimize trade diversion that might stem from regional integration. The authorities noted that the agreement reached with Ghana in December 1999 to implement the programme of free movement of persons, goods, and services under a fasttrack approach was making progress, including the removal on April 1, 2000 of duties on bilateral trade between Nigeria and Ghana.

The staff also noted the decision taken by six non-WAEMU countries in April 2000 (the "Accra declaration") to create a second monetary zone in West Africa by 2003, with the ultimate objective of combining it with the WAEMU to establish a single, unified currency system in the region in 2004. While welcoming the long-run objective of closer integration, the staff cautioned that the quest for monetary union should not distract attention from resolving Nigeria's current problems, and the timing and modalities for achieving monetary union had to be carefully assessed. In particular, the staff stressed that appropriate macroeconomic discipline and structural policies would be prerequisites for successful monetary integration. While recognizing these concerns, the authorities indicated their resolve to proceed with plans for monetary union.

Debt Sustainability & Poverty Reduction Strategies

The staff presented the key findings of the debt sustainability analysis (DSA), taking into account the Paris Club agreement of December 2000. It noted that, before the full use of traditional Paris Club mechanisms, that is, a stock-of-debt operation with a 67 percent net present value (NPV) reduction on pre-cutoff-date and commercial debt, Nigeria's debt ratios could be brought close to or below the HIPC thresholds after three years of concessional flow rescheduling. However, notwithstanding this expected positive trend, actual debt-service payments were projected to increase significantly after the three-year flow rescheduling, averaging 17-20 percent of exports, which was higher than the corresponding ratios for the HIPC countries before they obtained relief. Thus, further debt relief may be necessary if this hike was to be prevented. Assuming strong macroeconomic policy performance, Nigeria would need continuing access to concessional resources even to achieve a modest growth target of 4 percent to 4.5 percent over the medium term.

The authorities expressed the concern that a succession of concessional flow reschedulings would not address Nigeria's large debt overhang, which was estimated at US$ 31 .9 billion at end-2000, or the equivalent of 80 percent of GDP. In particular, they pointed out that with a debt-to- export ratio projected at or above 150 percent (on an NPV basis) well into the decade, a sizable share of Nigeria's resources that could otherwise be invested in the economy or devoted to vital social services, such as health and education, would continue to be diverted. At a recent debt conference, the authorities, while disavowing the need for outright debt cancellation, forcefully argued that only a debt stock reduction operation on Naples terms would be satisfactory from their perspective. The mission encouraged the authorities to pursue discussions with creditors, noting that a solid track record of programme implementation and timely debt-service payments would enhance the prospects for eliciting creditors' support for any debt relief.

The authorities stressed that poverty reduction was important and noted that the increase in poverty since 1980 stemmed from the ineffective use of available resources, as well as the poor performance of the economy. The federal government had therefore restructured and streamlined its poverty alleviation agencies to avoid wasteful duplication and to improve their performance. The National Poverty Eradication Council, chaired by the President and with the membership of core ministries, is at the apex of this new structure, overseeing the implementation of the National Poverty Eradication Programme (NAPEP). The latter covers four schemes: the Youth Empowerment (YES), Rural Infrastructural Development (RIDS), Social Welfare Services (SOWESS), and Natural Resources Development and Conservation (NRDCS) schemes. A National Poverty Eradication Policy and a Blueprint for Poverty Eradication had been adopted, and a Poverty Reduction Plan prepared. During 2000, the Poverty Alleviation Programme (PAP) also provided jobs to about 250,000 people.

While welcoming efforts to improve coordination, the staff expressed concern that this approach had so far not been developed as part of a wider strategy for poverty reduction and was focused on the execution of speciflc projects. As such, the approach appeared to have been derived in a "top-down" manner. The staff therefore welcomed the govemment's intention to develop a interim poverty reduction strategy paper (I-PRSP), with broad-based participation, to consolidate the efforts so far undertaken. The authorities indicated that, following consultations with donors, including in the Consultative Group, the l-PRSP was expected be completed by the end of 2001.

Statistics and Capacity Building

The staff stressed that the reliability and timeliness of economic statistics needed to be improved to support the monitoring of macroeconomic developments and policy formulation. The capacity of Nigeria's statistical agencies to compile such statistics had been seriously impaired by inadequate funding, poor management, and a lack of coordination among statistical agencies with resulting deficiencies in all areas of macroeconomic statistics.

The authorities shared these concerns. They also agreed that technical assistance could play a vital role in improving statistics and implementation capacity and expressed some concern that the pace of delivery of technical assistance had, in some areas, been slower than planned. They recognized that the increased receptiveness of key government agencies would help to expedite the delivery of such assistance.

In this vein, the authorities agreed on steps to take to ensure the effective and timely use of available technical assistance, including the United Nations Development Prograrn (UNDP) IIMF technical assistance programme. This programme, with financial and technical support from the UNDP, Japan, the U.K. Department for International Development (DFID), and the IMF, is designed to strengthen the capacity of key institutions to formulate and implement appropriate macroeconomic policies in the fiscal and monetary areas, and to manage public finances more effectively and efficiently. Considerable assistance has been provided, including the placement of short-term advisors and technical assistance missions in the area of fiscal federalism and foreign exchange management, and numerous seminars and workshops. While the staff considered that the implementation of this ambitious and wideranging programme had not met initial expectations-owing in part to concerns about public perceptions of "Fund monitoring" of Nigeria's economic management-recent experience had been more encouraging.

To accelerate the use of these technical assistance resources, the government has designated the Director of Multilateral Institutions of the Federal Ministry of Finance as National Director of the UNDP/IMF programme, and, established, in consultation with staff of the Fund, the World Bank, UNDP, and other agencies, the following priorities for technical assistance for 2001. (a) establishing a Budget Office in the Federal Ministry of Finance headed by a Permanent Secretary responsible for overseeing all aspects of budget preparation and implementation; (b) establishing a Budget Monitoring and Price Intelligence Unit in the Of fice of the President to ensure that costs of major budget items are accurate and contracts are awarded only after due processes have been followed; (c) strengthening the management system and automation of the AGF's office as the first stage of the development of a government financial information system (GFMIS); and (d) strengthening the capacity of the CBN, the Federal Office of Statistics, and the Ministry of Finance to compile and disseminate accurate and timely economic statistics, with priority given to improving national accounts, monetary, and balance of payments, and government financial statistics.

STAFF APPRAISAL

Serious macroeconomic imbalances have become evident in Nigeria over the last year. Against the backdrop of pressures to deliver a democracy dividend, the government has now spent the windfall gains from higher oil prices in 2000. Unsurprisingly, the very sharp increase in government spending brought double-digit inflation and instability in the foreign exchange market. A rebound in economic activity fueled by higher spending is thus likely to prove temporary. Moreover, for most Nigerians, especially the poor, the erosion of living standards from higher inflation far outweighs any gains from increased public spending. The risks of a further acceleration of inflation and continuing instability in the exchange market remain.

The staff regrets this loss of macroeconomic stability, for it was foreseen and avoidable. The programme for 2000, supported by the Stand-By Arrangement, was based on the premise that the budget approved by the National Assembly was incompatible with macroeconomic stability and fiscal sustainability. However, the desired underspending of the budget did not materialize because of a wage overrun of over 3 percent of GDP-largely reflecting irregular payments. The 2001 budget, which contains many ill-prepared projects and does not target poverty reduction effectively, entails additional spending incompatible with macroeconomic stability and saving for a future downturn in oil prices. The government insisted that it could, if necessary, "put a brake" on spending to preserve economic stability. However, the key lesson of the current episode is that sound economic management requires carefully anticipating impending problems rather than reacting to them.

The staff recognizes that excessive government spending has put an undue burden on the Central Bank of Nigeria (CBN), but its policy responses were nevertheless disappointing. The shift toward monetary tightening came too late and, given this delay, was too gradual. The resulting large expansion in monetary aggregates has accommodated, if not fueled, inflation. Under pressure of the unsustainably large demand for foreign exchange, the central bank reverted to selling foreign exchange at a predetermined price. As a result, the official (IFEM) rate was held unchanged (except for two adjustments) and, in real terms, appreciated sharply. Moreover, the interbank market split into two, giving rise to a multiple currency practice, and the differential between the IFEM and parallel exchange rates widened to nearly 20 percent.

The staff understands that the authorities were driven by a desire to deliver positive results quickly. At the same time, the depth of the problems inherited from the military governments decaying infrastructure and public services, and the demoralized government institutions-was greater than the government and the staff had anticipated. The delicate ethnic and regional balances, the political tensions associated with the transition to democracy, and the weak civil service ravaged under many years of military rule all made it difficult for the government to accomplish many of the goals that it had set. Even with prudent macroeconomic management, it will take several years of steadfast implementation of structural reforms, improved governance, and the alleviation of bottlenecks in infrastructure before the full confidence of private investors can be reearned. Such investor confidence will be critical to decisively raise investment and attract savings, thereby helping achieve-and sustain-the required rates of economic growth. It was simply unrealistic to have expected to lowear poverty significantly, improve power and other essential public services substantially, and put the country on a higher growth path-all in such a short period.

Nevertheless, the staff is of the view that a series of useful achievements over the last two years offers a modest basis on which to build. On the political front, ethnic and religious tensions have eased somewhat, as have frictions between the executive and the National Assembly. Based on its own internal review of the capital budget, the government has decided to restrain spending to preserve macroeconomic stability. Monetary policy has recently been tightened, with signs of calm returning to the foreign exchange market. The privatization process has gained momentum with the successful sale of the GSM licenses and the imminent sale of the national telecommunications company. In addition, the commencement of operations of the Anti-Corruption Commission, the successful launch of value-for- money audits, and the adoption of strict due process tests have laid the groundwork for substantively improving transparency and accountability in the use of public funds.

The staff thus urges the government to rededicate itself to the pursuit of marketbased reforms, while accepting that an attempt at a quick fix through big public spending would only hurt prospects for sustained economic growth and poverty reduction over the medium and long term. To achieve sustained growth and poverty reduction, the government should attach the highest priority to avoiding the Nigerian bane of an oil price-related cycle of boom-and-bust.

The staff thus considers it most critical that the federal government adhere to its intention to restrain spending consistent with saving fully its share of windfall oil revenues and not borrowing from domestic sources. While the spending level now envisaged is still higher than desired, it may be unrealistic to expect any further cuts. In this regard, it is most important to ensure the quality of government expenditures, by complying strictly with due process and rejecting capital projects with an insufficient poverty focus. A public commitment to restrained spending would also help dampen inflationary expectations. The staff also calls on the authorities to rid the wage bill of ghost workers and other irregular payments, and launch comprehensive civil service reforrns, so that "living wages" could be paid to all employees without jeopardizing the sustainability of the federal budget.

State and local governments have an essential role to play in ensuring the Nigerian economy can maintain macroeconomic stability and effectively deliver essential public services in a cost-effective, transparent, and accountable manner. Since the state and local governments have been given full and automatic access to more than half of oil revenues, the implementation of prudent fiscal policies requires collaboration among all tiers of government. A pact among the federal and state governments that would acknowledge the common goal of economic stability and the shared responsibilities to achieve it would be very beneficial. The staff is of the view that, ideally, the availability of financial resources to state and local governments should be insulated from oil price fluctuations, and commensurate with the tasks that they are assigned to perform and their capacity to effectively spend such resources. The staff recognizes that issues of fiscal federalism are complex and involve sensitive constitutional considerations, but it urges the authorities to reconsider carefully the implications of the current arrangement for macroeconomic management, the delivery of basic public services, and the reduction of poverty.

In the meantime, the likely spending of oil windfall gains by the state and local governments should be taken into account in setting macroeconomic policy. Interest rates have risen to over 30 percent (against the current inflation rate of l 8 percent), but reserve money continues to expand at a rapid pace and a large premium persists in the parallel exchange market. The CBN believes that even higher interest rates would seriously strain the banking system. The staff believes, however, that a more effective approach to achieve lasting stability in the foreign exchange market and the banking system is to accept further increases in short-term interest rates for a brief period, and to narrow the differential between the interbank and parallel exchange rate quickly and substantially-if necessary, with a step adjustment of the interbank rate.

Even with the determined pursuit of economic reforms as outlined above, the staff is of the view that Nigeria will need concessional assistance from the international community over the medium term if it is to attain the objectives of higher growth and poverty reduction. The staff's analysis shows that, given the projected decline in the price of oil, and even with a more effective utilization of Nigeria's considerable resources, substantial financing gaps of up to US$ I.5-US$2 billion will remain over the medium term. Nigeria's oil resources are large, but, in per capita terms, its overall income, as well as its income derived from oil, is smaller than many countries that currently receive considerable international assistance. The successful implementation of the current Fund-supported programme and the adoption of policies that could be supported under a successor arrangement should help Nigeria garner the support of the international community in seeking to reduce the burden of its existing debt to a sustainable level.

The Nigerian authorities have undertaken to take decisive steps to move forward in their economic reforms, prior to requesting completion of the first review under the current Stand-By Arrangement. If these actions are fully implemented, the staff would recommend that the Board complete the review and extend the arrangement by six months. This could be followed by a successor three-year arrangement. In this context, the staff urges the authorities to develop expeditiously a medium-terrn poverty reduction strategy-that includes macroeconomic and structural reforrns-with the active participation of stakeholders. Support of the state and local governments, the national assembly, and the civil society will be important for the success of such a strategy.

The depth of Nigeria's economic problems, the useful if modest start made by the authorities in reversing decades of economic mismanagement, and the constructive role that can be played by the Fund and the international community in helping Nigeria steer through difficult times argue in favor of continuing Fund engagement. The staff would, however, underscore the enormous challenges that lie ahead and call upon Nigerians and the international community to recognize that the process of transforming the economy will be long and needs to be sustained by determined efforts.

It is proposed that the next Article IV consultation discussions with Nigeria be held on the standard 1 2-month cycle.

The 2001 Article IV Consultation

On June 29, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Nigeria. Under Article IV of the IMF's Articles of Agreement, the IMF holds bilatera1 discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developrnents and policies. On I return to headquarters, the staff prepares a report, which forms the basis for discussion by the / Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the June 29, 2001 Executive Board discussion based on the staff report.

Background

Nigeria experienced a rebound in economic activity in 2000, spurred by increased public spending of the windfall gains stemming from higher oil prices and by a buoyant oil sector. Real GDP is estimated to have grown by 3.8 percent in 2000. Notwithstanding a sharp pick-up in activity in the non-oil sector, overall growth is projected to slow to 3.0 percent in 2001 owing in part to a reduction in Nigeria's OPEC oil production quota by more than 9 percent during the first juarter of 2001. At the same time, increased public spending has stoked inflationary pressures. Inflation, measured by the 12-month increase in the consumer price index, rose to 18 percent in March 2001 from 0.2 percent in December 1999.

The inflationary impact of the expansionary fiscal policy led the official exchange rate of the Naira to appreciate in real effective terms by close to 13 percent in 2000. However, at the same time the premium in the parallel exchange market rose significantly. Aided by the increase in the price of oil by about 71 percent, the current account moved to a surplus of 5 percent of GDP in 2000 from a deficit of abouf 10 percent of GDP in 1999. As a result, gross intemational reserves increased to US$9.4 billion from US$5.4 billion over the same period.

Fiscal policy, and management of the windfall gains from the substantial oil price increases in particular, is playing a key role in economic developments in 2000 and 2001. These gains- defined as oil revenue in excess of US$20 per barrel (so-called excess proceeds")- amounted to US$4 billion (10 percent of GDP) in 2000 and are projected at US$3.7 billion (9.6 percent of GDP) in 2001. On account of the constitution adopted in 1999, that gives state and local governments full and automatic right to their shares of oil revenues, almost one half of the excess proceeds which accrued in 2000 was distributed to sub-federal governments in the second half of 2000, and the remainder in the first quarter of 2001.

Against the backdrop of the windfall gains, the 2000 budget envisaged a sharp increase in consolidated government spending to over 43 percent in 2000 from 38 percent of GDP in 1999. The sub-federal levels increased their expenditures by about 6.6 percentage points of GDP, while Federal government expenditures declined by about 1.3 percentage points. This outcome reflected a combination of the elimination of extra-budgetary outlays (3 percent of GDP in 1999) and a sharp increase in personnel costs of 2.4 percent of GDP, following a substantial increase in public service wages in May 2000. Actual spending levels in 2000 were about 6.5 percentage points of GDP greater than they would have been had the government saved all of the windfall gains.

The budget for 2001 envisages a further increase in consolidated government spending, which should rise to about 53 percent of GDP. Federal govemment capital expenditure accounts for about 40 percent of this increase and spending by sub-federal levels for the rest. In response to concerns that the size of the budget might threaten macroeconomic stability and also compromise the quality of spending, the authorities have decided to limit federal expenditure, thereby bringing projected consolidated govemment expenditure in 2001 to about 50 percent of GDP. Compliance with due process requirements, which is considered necessary to safeguard the quality of spending, is likely to result in lower levels of capital expenditure than budgeted. Had the government saved all the excess proceeds in 2001 and not distributed the carryover of excess proceeds from 2000, consolidated government spending would have been about 10 percentage points of GDP lower than currently envisaged.

Monetary policy has not offset the liquidity injected by the fiscal stance. On the contrary, the minimum rediscount rate (MRR) was reduced in three steps to 14 percent in December 2000 from 18 percent in December 1999 and the cash reserve requirement was reduced in two steps to 10 percent from 12 percent during the same period. This, in conjunction with the unsterilized increase in foreign reserves by US$ 4 billion-the amount of excess oil proceeds in 2000-resulted in reserve money growth of 40 percent.

Since early 2001, the CBN has tightened monetary policy stance. The MRR was raised in three steps by 2.5 percentage points to 16.5 percent (accompanied by increases in interest rates on treasury bills and CBN certificates), the cash reserve requirement was raised by 2.5 percentage points to 21.5 percent, and the liquid asset ratio increased to 40 percent from 35 percent. As a result of these measures, market interest rates rose to between 30 and 40 percent in late April and May from about 17-20 percent in early 2001.

In response to the pressures in the exchange market stemming from expansionary fiscal policy, the CBN reverted to the pre-refom (i.e. pre October 1999) system of selling foreign exchange in the Inter-bank Foreign Exchange Market (IFEM) at a fixed rate, except for step adjustments in mid- December 2000 and early-April 2001 that devalued the Naira by 10 percent. Consequently, the differential widened between the IFEM rate and the open interbank market-where banks trade among themselves at freely negotiated exchange rates- and with the parallel rate, and at the time of intensified pressures in April 2001 had reached 15 percent and 20 percent, respectively. In the parallel market, the Naira lost about 30 percent of its value between December 199 and May 2001. As very large amounts of foreign exchange were sold to deal with these pressures, foreign reserves have increased only modestly during the first five months of 2001, notwithstanding continued high foreign exchange inflows from oil.

On structural reforms, the government successfully sold four Global System for Mobile Communications (GSM) liconses and has brought to the point of sale NlTEL/M-Tel and several other public enterprises. However, progress on implementing the appropriate regulatory frameworks for telecommunications and power has been slower than originally envisaged. The Anti-Corruption Commission was inaugurated in September and investigations are now under way on some 20 cases. The Auditor General's report on the 1999 accounts was submitted to the National Assembly in February 2001 while the federal civil service audit was completed in December 2000.

Macroeconomic developments and policies in 2000 and early 2001 were at variance with the programme in support of which the Stand-By Arrangement had been approved. In particuiar, inflation and federal government spending exceeded the programme targets by a substantial margin and the CBN's liquidity absorption operations were more limited than expected. While the end-2000 target on net international reserves was met, the CBN's foreign exchange management included some administrative measures that gave rise to a multiple cunrency practice. In addition, structural reforms fell behind schedule. As a result, the first review under the Stand-By Arrangement could not be completed.

Executive Board Assessment

Executive Directors observed that major macroeconomic imbalances had emerged as a result of the sharp increase in government spending-particularly that of state and local governments-and expressed concern at the risks of a further acceleration of inflation and continuing instability in the exchange market. They regretted that the programme implementation had been inadequate during the second half of 2000 and that the Stand-by Arrangement review would not be completed on time, and attached great importance to getting the programme back on track as soon as possible. Directors understood the desire of the democratic government to deliver positive results quickly, but cautioned that for most Nigerians, especially the poor, the erosion of living standards from higher inflation could outweigh any gains from increased public spending. Directors stressed the urgent need for strong action by the government to restore macroeconomic stability by containing govemment spending, and to ensure its quality through implementation of the due process tests.

Directors recognized that the problems that the present government inherited from previous military governments were far greater than anticipated, and made it difficult to achieve rapid progress in economic reforms. They also agreed that effective policy making, especially under a democracy, required institution and consensus building which would take time and involve a process of learning by doing. Directors saw a role for donors and Nigeria's development partners to provide technical assistance in these areas.

Directors stressed that prudent fiscal policy would be critical to assure macroeconomic stability and the sustainability of the fiscal position over the medium term. Most important in this regard was to save the excess oil proceeds. Directors regretted that the objective of saving these excess oil proceeds in 2000 was not realized, and welcomed the intention of the federal government not to spend its share of excess oil proceeds in 2001. They also expressed concern at the failure of the federal government to control the wage bill in 2000, which was largely responsible for the major overruns in spending, and they welcomed the recent progress in reducing the wage bill. They recommended that the authorities work closely with the staff in formulating the 2002 budget, and endorsed the staff's efforts to maintain a dialogue with the National Assembly and officials at the national and sub-national level.

Directors underlined the risks to the economic outlook from rising oil prices. They stressed that it is imperative that state and local govemments, in addition to the federal govemment, contribute to the re- establishment of macroeconomic stability. They endorsed strongly the federal govemment's intention to reach an understanding with the sub-federal levels to save their share of excess oil proceeds and restrain spending, and to institute due process tests to ensure the quality of public spending. Efforts to strengthen legislation on the accountability of sub-federal levels would also be very helpful. Directors underlined the importance of providing for adequate spending on the priority areas of health and education.

Directors stressed the urgent need to fight inflation through monetary restraint. While recognizing that expansionary fiscal policy had burdened monetary policy, they considered that the shift toward monetary tightening had come too late and was too gradual, so that the resulting large expansion in monetary aggregates had accommodated the upsurge in inflation. They welcomed the recent tightening, but noted with concern that interest rates in the interbank market are now barely positive in real terms. Most Directors thus considered it necessary to maintain tighter monetary conditions for some time, to help re-establish macroeconomic stability while at the same time instituting appropriate measures to safeguard the stability of the banking system.

On exchange rate policy, Directors expressed concem at some recent measures-reverting to selling foreign exchange at a price set by the CBN, eliminating transferability between the official and open interbank markets, and limiting the freedom of banks in setting the price of foreign exchange in the open interbank market-that would impede the development of a market-based exchange system. They underscored the need for exchange rates to reflect market forces, and urged the CBN to reverse these measures, and to move quickly to unify the exchange markets.

Directors strongly recommended that the authorities build on the recent progress on structural reforms. The privatization process had received an impetus with the successful sale of the GSM licenses. They encouraged the authorities to accelerate the preparation of the regulatory frameworks in key infrastructure sectors and welcomed the Privatization Support Credit that had recently been approved by the World Bank. They supported the consultative process initiated by the govemment aimed at deregulating the petroleum sector. Directors were encouraged by the increasingly effective implementation of the due process tests that had contributed to restraint on capital expenditures. They hoped that this, in conjunction with the near-completion tof the value-for-money and civil service audits and the commencement of operations of the Anti-Corruption Commission, would contribute to improved transparency and accountability in the use of public funds.

While encouraged by the government's commitment to fight corruption, Directors observed that, given the deep-rooted problems and firmly entrenched perceptions in this area, the govemment's anti- corruption measures will need to be particularly strong. They urged appropriate follow-up action on the cases being pursued by the Anti-Corruption Commission. Fostering transparency would assist in improving govemance, and Directors encouraged the commission to report regularly on its activities. They noted that the Financial Action Task Force had recently added Nigeria to its list of non-cooperative countries in fighting money laundering, and called on the authorities to improve their anti-money laundering efforts, especially in the context of an FSAP. Directors recommended the speedy publication of the value-for-money and civil service audits and attached great importance to the Attorney General's undertaking to follow up on the results of these audits and to initiate actions where there was evidence of wrongdoing.

Directors underscored the critical importance of capacity building for the successful implementation of the government's economic reforms. They stressed that proper formulation, implemental on, and monitoring of economic reforms will require urgent capacity-building efforts for budget formulation and monitoring, as well as substantial improvement of the quality of all key economic statistics in Nigeria. They encouraged the authorities to make greater use of technical assistance, and donors to enhance and coordinate such assistance.

Directors noted the staff's intention to recommend the complete on of the first review and an extension of the current Stand-By Arrangement, provided that certain prior acts are met and a satisfactory programme for the second half of 2001 is presented. They thought that successful completion of the current arrangement and adoption of policies that could be supported by the Fund under a successor arrangement, would enhance the prospects for further assistance by the intemational community to reduce the burden of Nigeria's existing debt to a sustainable level. Directors considered it likely that, over the medium term, Nigeria will need concessional assistance from the intemational community in order to underpin its own efforts to attain the objectives of higher growth and poverty reduction. It will be equally important to attract private capital. To this end, some Directors noted that maintaining good relations with external creditors, including continued timely payments, is crucial.

In conclusion, Directors commended the government's efforts to lay the foundations for sound policy making, and were encouraged by the easing of ethnic and religious tensions as well as those between the National Assembly and the executive. However, the depth and complexity of Nigeria's economic problems means that the process of transforming the economy will take time, and Directors therefore cautioned against unrealistic expectations. The serious current macroeconomic imbalances make it urgent for the authorities to intensify their efforts to restore macroeconomic stability in the near future and to implement market-based reforms that lay the foundations for growth and poverty reduction in the medium term. Directors called on Nigeria to show continued commitment to pursuit of a strong economic programme that could be supported by the Fund.

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Nigeria: Debt Sustainability Analysis, By IMF
Last recent weeks saw several major developments on the debt front for Nigeria, beginning with the release of the International Monetary Fund 2001 Article IV agreement with the country. The next day an IMF staff paper suggested that the country's debt ramped from an innocent US$960 million in 1970 to a staggering US$32.5 billion in 2000 or a dizzying 2,899 per cent jump in 30 years. And when it began to look like the country had surrendered its battle for debt relief, following the lamentation of Ambassador Jubril Aminu in Washington that the technically-minded IMF and World Bank would not waive, President Olusegun Obasanjo made a surprising new call for debt cancellation. In the excepts from Article IV below, IMF Board assesses Nigeria's career in debt. - Editors

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