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Cablegate: Nigeria's Macroeconomic Picture -

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 05 ABUJA 001419

SIPDIS


STATE ALSO FOR USAID


E.O. 12958: N/A
TAGS: ECON EAID ENRG EFIN NI
SUBJECT: Nigeria's Macroeconomic Picture -
Where We Stand At Year Two of Democracy

Refs: (A) Abuja 1375, (B) Abuja 1374 (C) Abuja 1365
(D) Abuja 792, (E) Abuja 742, (F) Abuja 129,
(G) Abuja 127, (H) Abuja 30, (I) Abuja 004


-------
Summary
-------


1. Economic policy and performance in 2000 and so far
in 2001 have been mixed. Growth may have been
sufficient to produce a small "democracy dividend" and
privatization is moving ahead. The GON remains
committed to fuel deregulation. Nevertheless, the
2000 and even more the 2001 budgets have created
problems. No Stand-by Arrangement with the IMF has
been reached; inflation is up and interest rates are
rising; the Naira is under pressure. Over-dimensioned
and prestige projects and investments in state-owned
enterprises raise questions about the GON's commitment
to creating a private sector-led economy. Dialogue
with the GON on the budget is imperative, not only to
support IMF efforts to rein in excessive spending, but
also to encourage the GON to devote more funds to
poverty alleviation and growth. The threatened re-
introduction of fertilizer subsidies is a serious
issue in agricultural policy. Attempting to offset
these tendencies, the Mission is engaged in policy
advocacy across the board, including emphasis on
policy coordination, budget process reform, domestic
debt and interest rate issues, as well as
privatization. The U.S. must take a long-view and
work with Nigerians who share our vision of reform;
our expectations of instant results may have to be
dampened. Nevertheless, we should seek solid results
in the short-run, build capacity for the longer-term
and help our counterparts to develop an enabling
environment that fosters transparent, responsible and
democratic government. End Summary.


---------------------
The Political Economy
---------------------


2. Nigeria is beginning a third year of a very
difficult transition after 30 years of military
misrule. The new government faces an array of issues
that must be overcome if Nigeria is to make a
successful transition to a democratic market economy:


-- Pervasive poverty, unemployment and an attendant
lack of personal security coupled with the political
imperative to provide tangible results in order to
give democracy and the present government legitimacy.


-- Weak institutional capacity at all levels of
government to execute coherent policies.


-- Widespread corruption and an almost stagnant non-
oil economy.


-- A pervasive mindset that looks to government for
solutions to every problem.


3. Economic policy and performance in 2000 and, thus
far, in 2001 have been mixed. Reforms have not yet
gone far enough to stimulate significant growth in
production or new investment. Expansion in the
economy in 2000 seems to have been between 2.8 and 3.8
percent (depending on statistical source), but not
clearly greater than the average of 2.9 percent since
1993, which was barely sufficient to keep up with
population growth. Even the top end of the growth
range would allow for only a very small emocracy
dividend - a significant increase in the average
Nigerian's standard of living expected as a result of
democratization -- and definitely less than the 5.9
percent per annum achieved during 1987-93, the last
period of economic reform. Moreover, it is unlikely
there ever will be a large "dividend" so long as so
much of the economy, especially energy production and
distribution, remain in State hands and insufficient
budgetary resources are devoted to poverty alleviation
and growth.


----------------------------------------
Economic Setting -- Positive Elements:
Privatization, Deregulation, IMF Targets
----------------------------------------


4. The ongoing process of selling off parastatals:
(a) fourteen state-owned (or partially owned)
enterprises in the banking, cement, and fuel retailing
sectors have been sold; (b) the Government has
announced that consultants to start Phase II
privatization of Nigerian Airlines, vehicle assembly
plants, palm oil companies and fertilizer plants have
been selected; (c) the transparent and financially
successful January auction of GSM licenses for mobile
telephones was especially encouraging, both for the
prospect of rapid improvements in mobile telephone
service as well as a harbinger of the privatization of
NITEL itself, optimistically scheduled for September
2001. (Note: In a surprise move June 12, President
Obasanjo abruptly dismissed Minister of Communications
Mohammed Arzika, Minister of State for Power and Steel
Danjuma Goje, and Special Advisor for Economic Affairs
Philip Asiodu (Ref C). Press reports have described
these advisors as dragging their feet on
privatization. The removal of Asiodu, in particular,
leaves Vice President Atiku Abubakar a free rein to
exercise his broad supervisory authority over
privatization and deregulation. End Note.)


5. The attempt to liberalize fuel prices, even though
mishandled, and now delayed, shows recognition of the
non-sustainability of the current subsidy structure
costing in the neighborhood of 2.6 billion USD
annually (Ref E). The Government continues to prepare
public opinion for an eventual deregulation of fuel
prices. We are reassured in private, and leading GON
officials, e.g., Minister for Finance Ciroma, have
said publicly that deregulation is a done deal, that
it's not a question of whether but rather when.


6. For the first time in over a decade, Nigeria
agreed to set macroeconomic targets under a 2000
Stand-by Arrangement (SBA) with the International
Monetary Fund, although it was not expected that any
funds would be drawn under the arrangement. As part
of this agreement, a mechanism was created to
stabilize government income by stashing away part of
the oil revenues for a "rainy day." The Standby paved
the way for an agreement in principle with the Paris
Club to reschedule Nigeria's debt. Otherwise, the SBA
process has been arduous and less than successful thus
far.


7. The GON remains in conversation with the IMF about
the reestablishment of targets for a new SBA and quick
decisive action could still pull the economy from the
brink of macroeconomic instability. In an attempt to
address the budget issue, the government has agreed
with the IMF to undertake a "due process" review of
the capital budget, where most of the problem lies.
Ostensibly, this review is merely to ensure that
correct procedures have and will be followed in the
contracting of works valued at over 250 million Naira.
This process is also the GON's attempt to address
transparency and corruption issues. It is hoped that
due process review could prevent improper disbursement
of as much as 2 billion USD from the 2001 capital
budget.


--------------------------------------------- -
Economic Setting -- Problem Areas:
Fiscal Policy, Inflation, Exchange Rates, Debt
--------------------------------------------- -


8. Implementation of the 2000 budget was problematic
and the 2001 budget is far in excess of what can be
prudently financed. President Obasanjo had the
misfortune to come into office at a time of high oil
prices, which created unrealistic expectations and
temptations to spend on over-dimensioned and prestige
projects. After low spending in the first half of
2000 because of the stalemate between the President
and the National Assembly, spending began in earnest
in the second semester. Expenditures quickly exceeded
the agreed-to targets for the deficit, international
reserves, and other indicators of the SBA.


9. Disturbing signs continue in 2001. The government
missed virtually all its targets under the 2000
Standby and has not signed a new SBA with the IMF
because of disagreements over the 2001 budget, both
for its expansionary aggregate numbers and the
structure of expenditures.


10. The FY 2001 budget, as passed, calls for 910
billion Naira (7.0 billion USD) in total spending for
the federal government, a 40 percent increase over the
year before. Some sources forecast a 200 billion
Naira (1.53 billion USD) deficit for FY 2001, up from
a 137 billion Naira deficit (1.05 billion USD) in FY
2000. This is largely a result of the capital
expenditures, which are almost three times as great as
the amount agreed for FY 2000 under the SBA and about
80 greater than budgeted in the year before. To
further complicate matters, on top of the ordinary
budget, under pressure from the States, the Federal
Government has agreed to distribute about 60 percent
of the "rainy day" fund to the States and Local
Governments this year, about 900 million USD.
Moreover, plans seem to be afoot for a "supplementary"
budget that would further exacerbate the macro-
economic picture. Nevertheless, GON senior advisors
maintained June 12 that the approximately 100 million
USD "supplementary budget" would have "absolutely
zero" net effect on capital spending for the year (Ref
A). Notwithstanding that assurance, full execution of
the 2001 budget, with the additional pressure from a
supplementary budget, could threaten a macro-economic
meltdown.


11. A review of the 2001 budget reveals unnecessary
spending on wasteful or over-dimensioned capital
projects like the national stadium, a huge water
supply project for Abuja, and investments in moribund
state-owned enterprises like the Ajeokuta steel mill
(Refs F&I). A high proportion of the capital budget
goes to building Abuja, the new seat of government,
and the construction of government buildings in other
parts of the country.


12. The government has announced re-introduction of
fertilizer subsidies even though these have never
reached the poor and are a fount of corruption (Refs
G&H).


13. Signs of impending instability from budget
mismanagement abound. During April, for example, the
Central Bank, in order to mop up the excess liquidity
from large capital projects, was forced to raise the
Minimum Discount Rate from 15.5 to 16.5 percent, the
Cash Reserve Requirement from 11 to 12.5 percent and
the Minimum Liquidity Ratio from 35 to 40 percent. At
the time, CBN officials said the moves were very
temporary. In a conversation with EconChief June 15,
however, CBN senior staff said the new rates could
remain in effect indefinitely and there would be
further hikes if the National Assembly were to show
further "irresponsibility." In response to the CBN
actions, the inter-bank lending rates peaked in recent
weeks at 50 percent, but have dropped back to the 25-
35 percent range, still up from the February maximum
lending rate of 26 percent.


14. Inflation, which by the end of 1999 was virtually
zero, 2-4 percent, by April had climbed back to over
23 percent per annum. It seems to have moderated
somewhat since then but still remains excessive,
particularly for food which accounts for two-thirds of
the "basket of good and services" the CBN uses in
computing the Consumer Price Index. That measure of
price increase, according the Central Bank, is fully
17 percent higher today than it was at this time last
year.


15. IMF and World Bank economists tell us that for
large GON capital undertakings, 65 to 85 percent of
the money actually spent on projects goes to foreign
inputs. The total effect of purchasing these inputs
(denominated in U.S. dollars) and of exchanging Naira
skimmed from contracts has been to exert extreme
downward pressure on the value of the Naira, which the
CBN must defend in foreign exchange markets. Thus far
in 2001, the Inter-Bank Foreign Exchange Market (IFEM)
rate has gyrated dramatically from near 100 Naira to
the dollar to almost 130 Naira per dollar. A
disturbing and variable gap between the IFEM and
parallel market has developed, increasing the
incentives for corruption through "round-tripping," a
procedure by which funds obtained from the Central
Bank at preferential rates are then sold at a mark up
in the parallel market.


16. Apart from the issues of deficit, soaring
inflation, and the plunging value of the Naira -- and
the political problems these will entail -- one cannot
but wonder if the FY 2001 budget represents a return
to the mentality of the 70s and 80s in which
government, not the private sector, was seen to be the
engine of economic growth. As in previous years, the
budget systematically UNDER funds: primary health
care; education; farm-to-market road construction and
maintenance; collection, analysis, and publication of
data; the judiciary; and funding of the elections and
anti-corruption commissions.


17. At the end of 2000 Nigeria's external public
medium- and long-term debt was estimated at 32.2
billion USD consisting of 28.4 billion USD to
bilateral and multilateral donors (less than 1 billion
to the U.S.) and 3.8 billion USD to commercial
creditors. Debt service due in 2000 was 14.5 percent
of exports, not high for Africa, but actual payments
reached only 8.1 percent of exports. Nigeria reached
an agreement in 2000 with the Paris Club to reschedule
22.7 billion USD. Payments due under the agreement
were 700 million in 2000, not fully paid, and 1.0
billion USD in 2001. The Paris Club rescheduling also
is complicated by a stall in the bilateral
negotiations between Nigeria and 10 of it creditors.
Debt Management Office officials told EconChief June
12 that the GON would request a three-month extension
on the Paris Club bilaterals so that the U.S. and nine
other creditor nations might "develop reasonable
positions" on debt relief (Ref A). Further, Nigeria's
argument that its development is strongly inhibited by
debt is undermined both by the current price of oil
and its record so far of failing to direct it's OWN
resources to poverty-reducing and developmental ends.


------------------------------
The Way Ahead & USG Assistance
------------------------------


18. Should the overall picture discourage us? No,
there are positive signs and a commitment in many
quarters to substantive reform. The government has
reiterated is decision to deregulate fuel prices, for
instance, the first step in being able to privatize
fuel production, refining and distribution.
Privatization is moving into Phase II and has a strong
champion in President Obasanjo, Vice President
Abubakar and other leading government officials; the
BPE has a dynamic leader in Nasir el-Rufai.


19. In macro-economic policy, we have seen CBN, with
the blessing of the Ministry of Finance, go to the
market with a new instrument, the CBN Certificate
issued in 180- and 360-day terms and bearing a better
rate than the traditional T-Bills. CBN Director of
Research Joseph Nnanna up-dated EconChief on the
certificates program June 18. Originally, the CBN had
planned on sterilizing 100 Billion Naira via the
certificate program. Eighty billion of that goal was
reached through four public offerings by mid-term of
the second quarter. Seventy-five percent of the
certificates sold pay 19 percent per annum on a 180-
day term; the balance pay 21.5 on a 360-day term.
Additionally, and due to three rediscount rate hikes
this year, the CBN had, as of June 15, sterilized an
additional 51 billion Naira via the sale of 90-day T-
Bills at 17 percent per annum. Although these
movements may not be enough in the short-run, they do
represent a change in interest rate policy that is
necessary for macroeconomic management in the future.
The CBN clearly is prepared to take the heat for its
increased prudence in managing macro-economic policy
development.


20. The U.S. is actively engaged in seeking to
influence the course of Nigerian policy-making
procedures and economic performance. Early in the
Obasanjo Administration, the US responded to an IMF
request for placement of a long-term advisor in the
nascent Economic Policy Coordinating Committee (EPCC)
in the Vice President's office. The EPCC is a kind of
economic cabinet, covering a wide range of macro-
economic and poverty reduction issues. The U.S.
advisor has been well received and put in charge of
chairing fortnightly meetings of the Technical
Committee, which he initiated. This will be the first
time economic policies are discussed in an open forum
with all key Ministers present. The EPCC also will
host public fora for discussions of inflation and
unpopular reforms such as petroleum price
deregulation. Our Embassy is also developing programs
to engage labor leaders and others as constructive
interlocutors in the national economic policy dialog.


21. The U.S. has also secured GON agreement to placing
two Treasury employees at critical interstices of the
GON's financial structure. One, at the Ministry of
Finance, will provide assistance to the resurrected
Budget Office in developing a rational budget process
for the GON. This is critical support for a
government without a formal budget process, where
individual Ministries hold private bank accounts, and
no one knows the actual number of Federal Government
employees. The possibility of further support is
under consideration. The second Treasury employee,
assigned to the recently re-structured Debt Management
Office, will provide domestic debt management
expertise, complementing a World Bank officer already
working the external debt account. The assistance of
our advisor should prove critical in Nigeria's effort
to create a stable demand for Federal debt instruments
of extended maturity and at reduced interest rates.


22. The U.S. also has provided the Bureau of
Privatization (BPE) with a team of advisors
specializing in areas essential to a rational
privatization process, among them, valuation
procedures, transaction dynamics, labor retrenchment
issues and public awareness. The U.S. is the leading
external supporter of the BPE. Other donors see USG
assistance as a precondition for their own
involvement.


-------
Comment
-------


23. Even if the Nigerian economy is in for a rough
ride in the short and medium term -- higher inflation
and a soaring exchange rate upporters of Nigeria
economic transformation
need to keep in view a longer-
term perspective, and perhaps even ratchet down
expectations of the possible in the short-run.
Democracy is a learning process and suffering the
consequences of mistakes can itself be a learning
experience. We need to work with people -- and there
are a lot of them -- who share our vision of reform.
We should seek solid results that make a difference in
the short-run, that build capacity for the longer-
term, and that help our counterparts to fulfill
effectively their charge to ensure an enabling
environment that fosters transparent, responsible and
democratic government. Our efforts must continue.
JETER

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