NIGERIA-IMF ARTICLE IV CONSULTATION, ECONOMIC DIAGNOSTIC AND ADVISORY DISCUSSION

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SENSITIVE

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E.O. 12958: N/A

TAGS: EFIN, ETRD, ECON, EPET, EAID, PINR, NI

SUBJECT:NIGERIA-IMF ARTICLE IV CONSULTATION, ECONOMIC DIAGNOSTIC AND

ADVISORY DISCUSSION



SENSITIVE BUT UNCLASSIFIED - HANDLE ACCORDINGLY



1. (SBU) Summary: During an IMF debrief in Abuja, David Nellor,

Senior Advisor in the Africa Department, commented that economic

progress and gains from reform have transformed the policy

environment, and created new major challenges to managing Nigeria's

oil revenues and savings to preserve macroeconomic stability. He

cautioned that large increases in domestic spending have the

potential to increase inflation and slow down growth over the

medium-term. The IMF team was pleased with Nigeria's macroeconomic

indicators and predicted growth will remain robust in the

medium-term and welcomed Nigeria's 2008-2010 Medium Term Fiscal

Strategy. The IMF suggested that monetary policy faces the

challenge of insulating the economy from large liquidity injections

expected from withdrawals from the Excess Crude Account (ECA) in

2008. The overall assessment was that Nigeria's financial system

remains stable but with inherent macroeconomic and financial sector

risks. End Summary.

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IMF Team Visits Nigeria

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2. (SBU) An IMF Mission led by David Nellor, Senior Advisor in the

African Department, visited Nigeria from November 7 to 20 for 2007

Article IV consultations - an annual economic diagnostic and

advisory discussion held with each IMF member country. The IMF

mission met with the Nigeria's Minister of Finance, Dr. Shamsudeen

Usman; the Nigerian Central Bank (CBN) Governor, Professor Chukwuma

Soludo; other members of the Economic Management Team; and senior

officials and representatives of the private sector.

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Positive Assessment

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3. (SBU) On November 20 Nellor briefed embassies and development

partners on the IMF's findings. The IMF team reported that Nigeria,

over the past five years, has achieved strong macroeconomic

performance supported by the introduction of broad-based economic

reform and prudent policies. It acknowledged Nigeria's successful

completion in October 2007 of the two-year Policy Support Instrument

(PSI) with the IMF as an important milestone. Economic progress and

gains from reform have transformed the policy environment, and

created new major challenges particularly managing Nigeria's oil

revenues and savings to preserve macroeconomic stability. Nigeria

received a positive assessment of its 2008-2010 medium-term fiscal

strategy. The IMF recommended the GON control spending, while

allowing for greater infrastructure investments, to preserve

macroeconomic stability, and cautioned that large increases in

domestic spending have the potential to increase inflation and slow

down growth over the medium-term.

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2008 Outlook

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4. (SBU) The team was optimistic regarding most macroeconomic

indicators and predicted growth will remain robust in the

medium-term with increased demand from both public and private

sectors contributing to growth. Noting a 60% increase in private

sector credit in 2007, the IMF projected that the GDP could grow at

9% in 2008; better than the 6% originally forecast.



5. (SBU) Nigeria's inflation has remained in line with the IMF

expectation. The team reported that implementation of Nigeria's

2008 budget within the proposed medium-term fiscal strategy would

ensure strong growth and single-digit inflation, but warned that a

stronger naira and poor agro-harvest due to reported cases of

drought in the north may fuel inflation in 2008.



6. (SBU) The team was complimentary of Nigeria's new road to

macroeconomic stability spelled out in the 2008-2010 Medium Term

Fiscal Strategy, but suggested complementary monetary policy

coordination responses to inflationary pressures as they emerge.

Due to rapid changes in Nigeria's financial sector including foreign

appetite for Nigerian assets, the team advised Nigerian authorities

to enhance regulatory capacity for surveillance of domestic

financial transactions, new products and instruments, and

developments in trans-border activities. Other areas highlighted

were instituting a robust framework for debt management, recent

progress made in enabling private sector activities, more action on

privatization, trade facilitation, corporate governance and



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legislation that spurs economic reforms.

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Financial Sector

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7. (SBU) The team commented that credit has expanded greatly in the

past few years with increased lending to the corporate sector and

retail markets affiliated with strong corporate clients. Increased

capital inflows into Nigerian banks via public offers, Eurobonds,

Global Depository Receipts (GDR) and private placements from abroad

are taking place. Bank trading capacity has increased significantly

when measured by foreign exchange trade and inter-bank trade

volumes; activities between banks and the CBN have also increased.

Generally, Nigeria's financial system remains stable; the banks are

well capitalized with a capital adequacy ratio of 18.6%; banks'

asset quality is very high; provisions for doubtful loans increased

commensurately; liquidity remains very high at about 61%; but

earning and profitability measured by return on assets (ROA) and

return on equity (ROE) have been falling.



8. (SBU) The IMF team noted two classes of risk inherent in

Nigeria's financial sector - macroeconomic and financial sector

risks. The macro-economic risks include fiscal shocks with

potential impacts on the interest rate, the naira exchange rate, and

inflation. The rather large linkage between the banking sector and

the stock exchange with sixty of the total market capitalizations in

the exchange from banks, and the potential for a negative trigger

from either side that could have a near-total collapse effect on the

other.



9. (SBU) The financial sector risks include increased cross-border

and cross-sector activities in Nigeria's financial system with banks

opening branches outside of Nigeria; and banks huge interest in

insurance, unit trusts, and pension funds management. The IMF urged

the CBN to improve its cross-border risk analysis and monitoring.

It also noted strategic operational risk in banks' lending huge

funds to high risk businesses in pursuit of high returns and worried

there has been very little lending to small and medium enterprises

in the real sector.

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New Landscape

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10. (SBU) Nellor said that Nigeria's economic progress and reform

gains have transformed the policy environment and created new

challenges. Although the Excess Crude Account has de-linked the GON

budget from volatility in the international price of oil, monetary

policy faces the challenge of insulating the economy from large

liquidity injections expected from ECA withdrawals in 2008. There

is a need to manage Nigeria's oil revenues, ensure that spending,

particularly on infrastructure investments, are at levels that can

be absorbed to reduce the risk of inflation and preserve

macroeconomic stability. The IMF recommended infrastructure

spending on items with high import content to manage domestic

macroeconomic risk if large spending must be made from the ECA. The

IMF team reported that it will work with the Ministry of Finance to

provide targeted technical support on the possible effects of sudden

and huge spending from the ECA.



11. (SBU) Nigeria's budgetary capital allocations have increased

300% over the past four years, and the IMF suggested that the GON

redefine its spending priorities and strengthen management of public

finance at all tiers of government to achieve better value for money

from public spending through improved project planning, costing, and

sequencing. Towards this end, the GON should improve budget

efficiency by improving methods of project selection, proper

cost-benefit analysis, and persuade the states to adopt the Fiscal

Responsibility Bill. The IMF noted that the fuel subsidy, estimated

to be $2.5 billion, was not reflected in Nigeria's 2008 budget. It

also advised Nigeria to improve on non-oil tax revenue component of

national budget and create an enabling environment for private

sector activity to hasten growth.



SANDERS