NIGERIA: ECONOMIC REFORMS PHASE TWO

UNCLAS SECTION 01 OF 03 ABUJA 001793 SIPDIS SIPDIS DEPARTMENT PASS TO USTR (AGAMA) E.O. 12598: N/A TAGS: ECON EINV EFIN NI SUBJECT: NIGERIA: ECONOMIC REFORMS PHASE TWO ¶1. Summary. Phase two of financial sector reforms in Nigeria continue with a new monetary policy (redenominating the naira by August 1, 2008); inflation fighting measures (targeting framework implementation by January 1, 2009),improved liquidity management (commencing September 2007, disbursement of portions of the fiscal revenue from the Federation Account to the different tiers of government in US dollars to deepen the foreign exchange market), Current Account liberalization and convertibility, and plans for accession to International Monetary Fund (IMF) Article VIII by January 1, 2009. The GON hopes these new measures will deepen ongoing reforms and make the naira the currency of reference in Africa. End Summary. . -------------- Time is Ripe for New Strategic Agenda -------------- . ¶2. On August 14, Chukwuma Charles Soludo, Governor of the Central Bank of Nigeria (CBN),announced the "Strategic Agenda for the Naira", which is phase two of the financial sector reforms and a compliment to the 13-point agenda of phase one that was launched on July 6, 2004. According to Soludo, the specific objectives of the Strategic Agenda were to make the naira the currency of reference in Africa, a strategic catalyst for achieving the goal of becoming an international financial center and promoting Nigeria's rapid economic development. The GON expects that the results achieved under phase one will be deepened and sustained. ¶3. Soludo commented that this was an excellent time to introduce the strategic agenda due to the GON's commitment, under President Umaru Musa Yar'adua, to sustaining macroeconomic reforms, Nigeria's robust external reserves, strengthened banking system and capital markets; single digit inflation, 6% GDP growth, exchange rate stability and the elimination of multiple currency practices. Strong capital inflows and growing non-oil exports were other major variables cited. ¶4. The Strategic Agenda focuses on the naira and is aimed at realigning its denominations, ensuring its stability, and increasing global integration. Components of the agenda include: -- Currency re-denomination; -- Adoption of an inflation-targeting framework for the conduct of monetary policy; -- Disbursing part of the federation account allocation in US Dollars to deepen the foreign exchange market and increase liquidity management; and -- Current account liberalization/convertibility with plans to accede to IMF Article VIII. . -------------- Currency Redenomination -------------- . ¶5. The currency redenomination intends to restructure the naira by dropping two zeros, which in effect moves two decimal points to the left, and issuing more coin denominations. This implies that all existing naira denominations will be phased out, all naira assets, prices and contracts will be redenominated by dropping two zeros or moving two decimal points to the left beginning August 1, 2008. From that date, the proposed currency structure that would come into effect for coins is - one kobo, two kobo, five kobo, 10 kobo, 20 kobo and for notes - 50 kobo, one naira, five naira, 10 naira, and 20 naira. . -------------- Federation Account Allocation in US Dollars -------------- . ¶6. Soludo informed the Monetary Policy Committee (MPC) that the CBN approved disbursing a part of the Federation Account allocation to federal and state governments in US dollars. Beginning September 2007, a portion of the Federation Account will be distributed in US dollars depending on foreign exchange market assessment and CBN liquidity management requirements. Officials would not be allowed to withdraw dollars from the Special Domiciliary Dollar Account which will be maintained by commercial banks, but rather access would be restricted to monetizing the balances into naira for withdrawal or utilizing the accounts for settlement of external obligations. The applied exchange rate in the monetization of the Federation Account and the Special Domiciliary Dollar Account will be the inter-bank rate on that day. . -------------- Inflation-Targeting Framework -------------- . ¶7. The CBN will adopt an inflation-targeting framework as the nominal anchor in monetary policy taking effect January 1, 2009. ABUJA 00001793 002 OF 003 The goal is to ensure monetary and price stability and also provide a more disciplined, consistent, transparent and credible framework to manage inflationary expectations. The CBN will also pay attention to other broader macroeconomic policy objectives such as output growth, employment, exchange rate, and balance of payments. The National Bureau of Statistics (NBS) and CBN would collaborate to improve the availability of high-frequency and reliable GDP data and robust price indices. . -------------- Current Account Liberalization -------------- . ¶8. Beginning January 1, 2009, the CBN will implement full current account liberalization/convertibility. The stated aim is to deepen the integration of Nigeria's financial system and economy into the global economy, eliminate all restrictions on current account transactions, and to pave the way for accession to IMF Article VIII. . -------------- West African Monetary Zone (WAMZ) -------------- . ¶9. When asked if the new policy is consistent with a single currency in West Africa, Soludo replied "yes" and said the Strategic Agenda conforms to the reforms spirit envisaged under the WAMZ convergence program. He contended that if the naira is properly re-aligned and becomes the "Reference Currency" a monetary union under the WAMZ would become a more credible and sustainable goal. . -------------- What Does It All Mean? -------------- . ¶10. The Strategic Agenda policy components will consolidate reforms, possibly lead to growth and stability of the Nigerian economy, promote the integration of Nigeria's financial system and economy into the global economy by eliminating restrictions on current account transactions, and strengthen the naira. Gains from the redenomination will put Nigeria in a better position to take advantage of the proposed West African Monetary Zone (WAMZ). The redenomination will likely drive down the volume of money in circulation while retaining its value, and reduce the strain on the payment system, especially automated teller machines. Another expected major policy advantage is a huge reduction in the cost of printing currencies. ¶11. Current Account liberalization and floating the naira would dismantle exchange rate controls and promote convertibility, effectively removing the CBN's influence over the exchange rate. Correspondingly it could lead to increased volatility and increase the potential damage of a run on investment funds at the slightest public sign of panic. . ¶12. A major challenge facing the GON in the implementation of the component policies is that Nigeria is a largely illiterate society and the masses are likely to not understand the benefits from redenomination. To them, it just appears that their money has shrunk over night. This will come into play most seriously in the large informal sector of the economy where prices are low, volatile and are largely fixed by macro-economic variables inspired by instability and the collapse of infrastructure, rather than by the logic of monetary policy. In this critical sector, participants may not understand, or be unwilling/unable to divide present prices by 100, which could trigger hyper-inflation and spell doom for the policy. This grave danger of "rural resistance" may make it difficult to secure political support, particularly from state governments, who are going to see the gross volume of naira revenue shrink. The CBN is considering a comprehensive public education campaign to combat cynicism, apathy and mythology from taking root. . -------------- Overall Assessment -------------- . ¶13. The Strategic Agenda should not be considered as a cure for all of Nigeria's currency and economic issues. The policies of redenomination, partial dollarization, and current account liberalization will trigger other significant economic repercussions. It might have been advisable for the CBN to focus on holding down inflation, enhancing the real value of the naira, creating a buoyant economy, and sustaining employment generation, rather than concentrating on the nominal value of the naira. The timing of the measures may be premature since the naira is not in any immediate jeopardy and redenomination might be better suited to take place at the end of economic reforms, rather than mid-way. ABUJA 00001793 003 OF 003 There is also speculation as to how long CBN Governor Soludu will remain in the CBN. His removal could seriously jeopardize full Strategic Agenda implementation. GRIBBIN