NIGERIA: NIGERIA SEEKS A SECOND PSI WITH IMF

UNCLAS SECTION 01 OF 02 ABUJA 001289 SENSITIVE SIPDIS DEPARTMENT PASS TO USTR AGAMA TREASURY FOR PETERS, RHALL DOC FOR 3317/ITA/OA/KBURRESS DOC FOR 3130/USFC/OIO/ANESA/DHARRIS E.O. 12958: N/A TAGS: EFIN ECON EINV PGOV NI SUBJECT: NIGERIA: NIGERIA SEEKS A SECOND PSI WITH IMF REF: A. ABUJA 1191 ¶B. ABUJA 1014 ¶C. 07 ABUJA 2589 ¶D. 07 ABUJA 1954 ¶E. 07 ABUJA 426 ¶F. 06 ABUJA 519 ¶G. 05 ABUJA 497 ¶1. (SBU) SUMMARY: On June 11, the IMF briefed Development Partners on a mid-May visit to Nigeria regarding discussions for a second Policy Support Instrument (PSI) between Nigeria and the IMF. The IMF mission commented that Nigeria's economic performance remained strong; output had grown, inflation was in the single digits and external and fiscal positions had strengthened significantly. The financial sector was growing and supporting private economic activity. The IMF expects Nigeria's economic outlook would remain favorable if appropriate GON policies were sustained; but expressed concern regarding the delayed 2008 budget passage, and rapid depletion of the Excess Crude Account (ECA) in the face of dwindling oil production. The IMF welcomed the GON intention to maintain a close policy dialogue in the context of a second PSI. If the IMF proceeds with a second PSI it would signify endorsement of President Yar'Adua's economic programs and policies at least in areas of broad macroeconomic management. END OF SUMMARY . PSI Primer -------------- . ¶2. (U) In May, an IMF mission spent several weeks in Nigeria discussing a new economic management program to be supported by its PSI. The visit was at the invitation of the GON. On June 11, the IMF Senior Resident Representative, Michael Bell, briefed Development Partners on the GON-IMF discussions, and noted that negotiations on a second PSI for Nigeria are still on-going. (NOTE: The IMF had in October 2005 approved a two-year PSI for Nigeria under its newly created PSI framework. The PSI supported Nigeria's economic reform efforts which commenced in 2004. The first PSI was based on Nigeria's National Economic Empowerment and Development Strategy (NEEDS) and Poverty Reduction Strategy, and focuses on rapid and sustainable non-oil growth and poverty reduction. (See reftels D, E, F & G. END NOTE.) . Current Macroeconomic Environment -------------- . ¶3. (U) The IMF observed that economic growth would continue at about 9%, driven by strong performance in agriculture and trade. Inflation has been kept at single digits, but food inflation remains volatile. Foreign reserves exceeded $59 billion as of end-May 2008 and were projected to hit $85 billion by December 2008. The remaining external debt of $3.3 billion at end-2007 is largely to multilateral creditors. The financial sector is stronger and expanding rapidly with bank branches and deposit accounts having grown significantly from 1.7 trillion naira ($14.17 billion) in 2004 to 2.23 trillion naira ($18.58 billion) by end of 2007. The IMF also noted that Nigerian banks have increased lending to the private sector particularly in oil and gas. Private sector credit as a percentage of GDP rose from 12% in January 2006 to 22% in January ¶2008. However, broad money grew from 18% in January 2006 to 60% in January 2008, potentially posing a serious threat to monetary management. ¶4. (U) Nigeria is also increasingly integrating into global financial markets; the volume of debt internationally traded grew from $3 billion in December 2006 to $9 billion at the end of 2007. Investment in naira assets has been spurred by improved macroeconomic conditions, robust external reserves, and global liquidity developments. . Emerging Challenges -------------- . ¶5. (U) The IMF team highlighted the challenge to past success in de-linking domestic spending from oil revenue flows. It is concerned with rapid depletion of oil revenue savings in the face of dwindling oil production. The IMF also noted caution that the changing composition of official spending complicates fiscal policy. Increased fiscal discipline at the federal level could be negated by larger expenditures by states and local governments driven by large releases from the ECA (reftel A). The team reiterated the need for the GON to secure agreement with states on a fiscal framework that would continue to de-link spending from oil revenue flows and protect macroeconomic stability ABUJA 00001289 002 OF 002 ¶6. (U) The IMF lamented that the oil sector has been negatively affected by continuing unrest in the Niger Delta, resulting in oil production disruptions. Non-oil growth is also constrained by poor infrastructure, especially the lack of electricity. The IMF cautioned that excessive spending could cause the prospects for non-oil growth to deteriorate. It encouraged the GON to address the infrastructure gap within a strengthened public financial management system (reftel G). ¶7. (U) According to the IMF, increased private credit has fuelled rising private demand, and a rapid rise in broad money. Local banks are offering new products found in other emerging markets, and are expanding into cross-border and cross-sector activities. The surging investment in naira assets and global integration underscore the increasing need to maintain good policies and adjustment to sustain macroeconomic stability. The IMF cautioned that growing money demand from the rapidly changing financial system and increased capital flows pose serious challenges to monetary management. . Moving Ahead -------------- . ¶8. (U) The IMF welcomed the GON intention to maintain a close policy dialogue in the context of a second PSI, however, it encouraged the GON to strengthen fiscal discipline, prioritize spending in line with absorptive capacity in addressing infrastructure needs to sustain non-oil growth, and synergy between fiscal and monetary policies. It urged that prudent fiscal policies -- in particular, the oil price based fiscal rule -- be sustained for macroeconomic stability. It stressed that the GON should secure agreement with the states on a fiscal framework to delink spending from oil revenue flows to protect macroeconomic stability, and called for the replication of economic reform legislations, such as the Public Procurement and Fiscal Responsibility, at the States level to widen and institutionalize reforms. On Nigeria's increasing integration into global financial markets and the growth opportunities it offers, the GON was advised to stay ahead of developments in the financial sector, and strengthen banking supervision. . Comment -------------- . ¶9. (SBU) Nigeria's major challenge remains maintaining an appropriate mix of the fiscal and monetary policies required to maintain low inflation and macroeconomic stability for robust economic growth. The recent trend of large extra-budgetary fund releases from the ECA does not indicate that the Yar'Adua administration could sustain fiscal discipline, particularly at the sub-national levels. The resulting fiscal expansion has placed the burden of controlling inflation solely on the Central Bank of Nigeria (CBN). In response, the CBN has recently used stronger measures to reduce money growth -- including increased sales of foreign exchange, more aggressive open market operations, and a further increase in monetary policy rate (MPR) and cash reserve requirements (CRR) (see reftel B). It also has required an increase to capitalization for stockbrokers. ¶10. (SBU) A second PSI for Nigeria would signify IMF endorsement of the administration's macroeconomic management under the Yr'Adua vision 20/20/20 (Nigeria being the 20th largest economy in 2020) and would be a positive signal to investors. The IMF is preparing a report for IMF Board approval on the visit, and when the Board approves will send the report and notify the GON of the IMF's willingness to continue PSI discussions. Following that, it will be up to the GON to formally notify the IMF that it intends to sign a second PSI. The IMF expects the discussions to end in 2008 and that a new PSI will be in place by January 2009. SANDERS