Cablegate: The Economy in 2003: Triumph of Politics

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




E.O. 12958: N/A
SUBJECT: The Economy in 2003: Triumph of Politics

1. Summary. The economic outlook for the New Year is
cloudy. Academic experts and business leaders fear that
Nigeria will experience little if any real per capita
growth in 2003. They bemoan Nigeria's OPEC oil
production quota of 1.9 million barrels per day, which
limits the country's potential oil exports. These
experts fear even more what they say are irresponsible
fiscal policies despite President Obasanjo's relative
frugality. Central Bank data show that such policies
are putting Nigeria on shaky economic ground as it
heads toward 2003. Nigerian economists we have talked
to do not expect a policy change during the next
quarter, which will be the last before critical federal
and state elections in April 2003. End summary.

Real Economy

2. The economic clouds of 2002 have obscured the view
of likely economic activity in the New Year. In early
November 2002, IMF experts estimated that Nigeria's
gross domestic product would decline 0.9 percent in
real terms in 2002 owing to falling oil revenues. This
figure, if confirmed, will be in stark contrast to the
3.8 percent growth achieved in 2001. The Central Bank
has challenged the IMF figure and forecasts 3.2 percent
growth for 2002. Its basis for optimism is that non-
oil sector output may have risen 5.3 percent in 2002,
buoyed by a 4.1 percent increase in agricultural
production owing to favorable rainfall. (The
discrepancy points to the weak database and less than
robust analysis.) The GON also points to the dynamism
of the telecommunications sector, which was energized
by deregulation and the introduction of GSM telephone
systems. Both the IMF and the GON recognize that the
manufacturing sector remained weak in 2002, as capacity
utilization did not exceed 41 percent during the year.
Partly because of this fact, there is increasing
consensus among Nigerians on the need to accelerate
privatization, and market determination of the exchange
and interest rates. The Dutch Action System (DAS),
which was introduced in mid 2002 to deal with the
pressure on the exchange rate, has facilitated improved
management of the exchange rate.

3. Whether one uses the IMF or Central Bank figures,
the data still point to a setting in which purchasing
power remains weak. Not only is the annual per capita
income of the Nigerian population estimated to be below
300 USD, its rate of growth approximates only 2.8
percent a year. Consequently, the optimistic 3.2
percent growth results in only a 0.4 percent rise in
per capita income under the better of the two scenarios
mentioned above. At such a low rate of increase,
Nigerians are condemned virtually to perpetual poverty.
It is a far cry from the 7.2 percent real per capita
income growth that Nigerians would need to experience
continually over the next ten years to double their
income within a decade.

4. To achieve 7-10 percent real growth in any given
year calls for an environment conducive to business.
Last year's has not been so, according to Doyin Salami,
a macroeconomics professor at the Lagos Business
School. In mid-November, he shared data with us and
business executives that showed that private sector
turnover had just kept pace with inflation during the
first half of 2002. A Lagos Business School survey of
fast moving consumer goods then disclosed that the
fastest moving items (like powdered milk) were
necessities being packaged in ever smaller containers
to be within reach of consumers' falling purchasing
power. Expenditure switching was associated with this
decline in sales volume, Salami asserted. Companies
marketing consumer goods had to lower their margins in
2002 to attract buyers since many poor people chose to
buy goods like GSM telephones rather than essential
items, notwithstanding their low level of income.
Consequently, unadjusted profits for the non-financial
sector fell by 6.4 percent during the period, he said.
The ratio of losers to winners during this time was
three to one, he added. A report appearing in the
December 30 issue of Business Day carried the headline,
"Economic Lull Impacts on Companies' Profits."

5. Except for cases in which the purchase of cellular
phones facilitates earning a living, other instances of
inessential purchases may rightly be considered
conspicuous spending. Such spending affects aggregate
growth only at the margin. The reason is simple: there
are simply too few Nigerians with substantial
purchasing power. Salami and his better-known colleague
at the business school, Pat Utomi, presented data
bearing out this point. Regarding distribution of
wealth, Salami said the richest four-percent of the
population in Nigeria possesses 48 percent of the
country's wealth. The next cohort accounts for 46
percent of the population and holds 44 percent of the
wealth. The bottom 50 percent of the population
accounts for 8 percent of the wealth. This highly
skewed distribution of wealth is sub-optimal with
respect to economic growth. Since the richest cohort's
propensity and ability to import is much larger than
that of the other two- thirds of the population, much
of the income of the top four percent of the population
helps to sustain foreign economies, not Nigeria. But
this group is numerically so small that it absorbs
little of Nigeria's manufactured products. This group
also generally disdains Nigerian goods and will buy
imported items whenever it can, further compounding the
problem. Its savings or surplus income, which accounts
for a large proportion of total private savings, is
consequently often channeled abroad. Such capital
flight further holds back Nigeria's economic growth.

6. There is another dysfunctional form of conspicuous
spending in Nigeria: that for political position. In
many other countries, people with money invest in
industry or services as these sectors of economic
activity generate wealth. In Nigeria, however, many
people with money invest directly in the political
sector or indirectly by backing politically ambitious
individuals. It is common knowledge that in Nigeria
politics can be the short road to massive wealth. How
else can one account for the substantial cost of recent
electoral activity in Nigeria? Funding of it, whether
originally through a draw down of foreign exchange
reserves, has been distributed primarily in naira to
advance the political prospects of various people. An
Emboff's informed estimate of the cost of the Peoples
Democratic Party convention in Abuja last week is that
it approximated 60 million USD.

7. Continuing in this vein, Utomi added that statistics
show that funding for the federal, state, and local
governments has quadrupled since 1998, yet little of it
is used productively. (Central Bank data confirm that
the revenues that accrued to the state and local
governments increased by a factor of four in nominal
terms during 1997-2001. Federal government revenues
nearly doubled during the same period. The greater
distribution of revenue to state and local governments
during the Fourth Republic (relative to the
distribution in 1997-1998 during military rule) is
partly the result of a requirement imposed on the
federal government by the 1999 constitution.) To make
his point, Salami referred to a value-for-money audit
that the IMF and the World Bank conducted in Nigeria
and said its value-for-money index was put at fourteen
percent at the Conference on Development that was held
in Monterrey, Mexico in March 2002. Consequently,
little of the government revenue allocated to economic
and social services has the intended effect. (Comment.
We were told that a value-for-money coefficient of 14
signifies that only 14 out of every 100 naira collected
by the federal government is spent effectively. End
comment.) According to Utomi, no more than a tenth of
the 100,000 young men and women who graduate from
Nigeria's post-secondary institutions every year obtain
adequate urban employment within one year of
graduation, for example. Few of these adults find
meaningful alternative employment in the rural sector
since the wages are too low to attract them. Rural
wages remain low partly because forty percent of total
agricultural production is lost owing to inadequate

Fiscal Policy

8. Nigeria's less-than-reassuring fiscal policies are
the cause of the overcast 2003 outlook. The central
government's overall budget deficit target for 2002 was
set at -446 billion naira (about 3.7 billion USD).
Reviewing the performance of the federal government
during the first part of the year, Salami showed that
the overall fiscal balance stood at minus Nl19.5
billion (about 1.0 billion USD), which equaled 4.3
percent of GDP (assuming 3.2 percent real growth in
2002). This figure for the deficit appeared in the
Central Bank's report for the first half of 2002.
Should it turn out that the target figure for 2002 was
realized, fiscal policy will have been as expansionary
in 2002 as any policy of the last four years. Although
oil revenues were 36 percent lower during the first
half of 2002 than during the first half of 2001 because
Nigeria's OPEC quota limited its export volume, federal
government revenues still exceeded the budget estimate
by 29.7 percent in the first six months of 2002.
However, recurrent expenditures alone rose 14 percent
during the period relative to those of the first half
of 2001. The total of recurrent expenditures and the
federal government's capital expenditures and net
lending "resulted in a large monetary financing of a
huge deficit" during the first half of 2002, according
to the Central Bank. More recent Central Bank data
indicate that recurrent expenditures accounted for 77.7
percent of the central government budget and exceeded
the target by 10.6 percent during the first ten months
of 2002. Personnel costs associated with a bloated
civil service accounted for 70 percent of these
recurrent expenditures.

9. The Central Bank's announcement of late December
that the federal government had recorded a deficit of
47.5 billion naira (about 400 million USD) during the
first ten months of 2002 was unexpected, given that the
budget deficit for the first semester 2002 totaled
119.5 billion naira. The reason for the remarkable
turnaround was the inclusion in the government's
retained revenue of the proceeds of the sale of
external reserves and of borrowing from the banking
system. As noted in the Bank's report for October, "in
the ten-month period, the Federal Government
substantially drew down on its deposits with the
Central Bank of Nigeria, resulting in further injection
of liquidity in the banking system." Although Obasanjo
slashed capital expenditures during the first nine
months of 2002, we expect that the data for the last
quarter will show that the federal government's net
lending, capital expenditures, and transfers to state
and local governments will have picked up in 2002. We
further expect that this trend will continue during the
first six months of 2003 because of expenditures
associated with contracts typically awarded at the end
of a presidential administration and other handouts of

Monetary Policy

10. Nigerian analysts know that the Central Bank has
the unenviable task of ensuring that monetary policy
accommodates fiscal policy. Although the rate of growth
of the monetary aggregates had slowed during the first
six months of this year relative to the figures for the
first half of 2001, by the end of October broad money
(M2) had risen by 32 percent against a target of 15.3
percent for 2002. The increases were driven by
excessive bank credit to the domestic economy;
primarily government credit, which rose 602.1 percent
during the first six months of this year relative to
the corresponding period a year ago. The Central Bank
itself subscribed to 45 percent of the treasury bills
issued during the period. Reflecting the government's
inability or unwillingness to make further cuts in the
budget in the light of a continuing budget deficit,
government borrowing picked up during the subsequent
four months (July-October) of 2002. Central Bank data
for October show that government credit rose a whopping
836 percent during the first ten months of 2002.

11. The crowding out of the private sector has thus
been an important feature of the money and capital
markets in 2002. Bank credit to the private sector rose
by only 8.7 percent in the first ten months of the
year, a far cry from the annual target of 34.9 percent.
Equally important was the fact that non-bank public
subscription to treasury bills rose by a factor of ten
in the first half of 2002 relative to the corresponding
period the year before. (The Central Bank's and
commercial banks' subscriptions to treasury bills rose
by a factor of seven during the same period.) While it
may have appeared that the Central Bank's reduction of
the Minimum Rediscount Rate (MRR) by 400 basis points
in late October, to 18.5 percent, would stimulate
private sector lending, the reduction also lowered the
cost of government borrowing and so may have encouraged
such further borrowing. For these reasons, the cut in
the MRR late in the year is particularly worrisome;
such action is counter-intuitive since the budget
deficits have caused the liquidity overhang.

12. Bowing to political pressure, the Central Bank of
Nigeria (CBN) nonetheless further reduced the
rediscount rate to 16.5 percent in late December and
called on banks to lower the prime lending rate to MRR
+ 400 basis point. Unpublished preliminary data of the
Central Bank that we saw on December 30 indicate that
this reduction in the MRR has lowered inter-bank
lending rates. Rates have come down partly because the
first tranche of the December 2002 statutory federal
government allocation to the state and local
governments trickled into bank vaults in late December.
Professor Salami and other economists we have talked to
caution that the lower rates are unlikely to hold since
inflation and default risk drives interest rates. Since
neither of these two drivers will lose momentum during
the next six months, lending rates will remain high as
institutional investors flock to treasury bills in a
flight to quality. Moreover, deposit banks are likely
to find ways to increase their lending rates, Salami
said. He anticipates the development of an underground
market in which loans will be extended at MMR plus 400
basis points plus a premium to take account of erosion
of asset values induced by an expected rise in
inflation early next year. An Emboff already knows of
an instance in which a contact of his who wants to
import equipment to process cashews asserted that he
was recently quoted a rate of interest of 35 percent,
plus a 2 percent charge for documentation, and a 5
percent transfer charge. The interest rate plus the
charges total 42 percent, a far cry from the 20.5 prime
interest rate that the Central Bank is recommending.

Foreign Account

13. Central Bank data show that Nigeria's trade
surplus declined 45.3 percent during the first half of
2002-to 2.6 billion USD-relative to the corresponding
period the year before. During the first six months of
2002, export revenue declined 40 percent, to 6.5
billion USD, and imports fell 35 percent. The
invisibles account (services and income) totaled about
-4.0 billion USD and current transfers equaled 697
million USD during the first six months of 2002.
Consequently, the current account deficit totaled 714
million USD compared to a 1.35 billion USD surplus
during the corresponding period in 2001. As a result,
foreign exchange reserves fell from 10.45 billion USD
at the start of the year to 8.7 billion USD at the end
of June 2002. At the end of October, Nigeria's foreign
reserves totaled about 8.0 billion USD. A review of
Central Bank data shows that the expected trade,
current account, and overall account figures for 2002
are likely to be as bad as any data of the last three

14. To stanch the expected outflow, the Central Bank in
July began allocating foreign exchange through a Dutch
Auction System, which has narrowed the gap to about ten
points between the parallel and official rates of
exchange throughout fall 2002. But pressure has built
up and there is no reason to expect it to decline. The
Central Bank recently re-authorized twenty-one banks to
buy foreign exchange, lifting a ban ahead of time that
had forbade these banks from engaging in such
transactions owing to violations of foreign exchange
regulations. The demand for forex by these banks will
put pressure on the naira and may lead to further
depreciation. Consequently, and given the political
uncertainty ahead, we expect that a larger than normal
volume of funds will flow out of the capital and money
markets and into the foreign exchange market during the
next several months. Such movement will test the recent
stability in the foreign exchange market, as funds
drift out of the money and capital markets in response
to the uncertain electoral prospects in spring 2003.

15. In the light of the developments mentioned above,
Professor Salami warns that Nigeria is experiencing a
"lull before a damaging storm." He cautions that the
central government might soon find itself unable to use
foreign reserves as the primary mechanism to manage the
exchange rate. Nigeria's foreign reserves rose slightly
in November relative to October, but the volume remains
close to the CBN's self-imposed minimum six-month limit
necessary to sustain imports. We expect a further
temporary rise in foreign exchange as a result of the
recent spike in oil prices and slightly larger OPEC
quota for Nigeria, which will yield larger revenues,
and repatriated funds associated with the end of year
holidays. These flows, associated with the seasonal
weakening of demand for forex by manufacturers, have
led to a temporary appreciation of the naira that is
unlikely to be sustained for the reasons mentioned
above. Should reserves fall much below that floor, the
government will have no choice but to look for other
adjustment mechanisms in 2003. These might comprise
extensive import bans and tightening of foreign
exchange regulations (which would again widen the
differential between the official and parallel

Prospects for 2003

16. Salami suggested enigmatically that 2003 be called
the Year of Two Halves. He, like several other analysts
that we have talked to, expects that expansionary
fiscal policy will characterize the first half of 2003.
Salami thinks that a contractionary policy will follow
during the second half of the year to cure what Salami
calls fiscal hangover. Continuing deficit spending
during the first half of the year, coupled with general
uncertainty and capital flight, will maintain pressure
on the exchange rate. As the naira depreciates during
this time, Nigeria's heavy dependence on imports will
induce a rise in inflation. This will cause continued
erosion of asset prices, and savings will fall as a
percentage of GDP. Given the relatively low level of
foreign exchange, the Central Bank will be compelled to
mop up excess liquidity and the attendant effect will
be higher interest rates, if the rise is not suppressed
by administrative fiat. In the light of these
prospects, investors will be wary about imperiling
dollar resources for naira; consequently, domestic and
foreign investment in the non-oil sector in 2003 will
be low relative to 2000-2001.

17. A few positive aspects may nevertheless emerge in
2003. The willingness of banks to devote 10 percent of
their profits before tax to equity investments may
boost investment in the real sector in 2003. In 2002
little was done with this pool of investible funds,
which is building up, but creative initiatives by some
banks and venture capital companies may lead to
investments that will create employment. Additional
jobs are likely to be created in 2003 by the next phase
of the deregulation of the telecommunications sector as
the second national carrier, Globalcom Ltd., begins to
deploy facilities early in 2003.

18. One key issue highlighted by the reports given us
is the paucity and unreliability of data. This is
dramatized by the discrepancy between the projected
growth rate for 2002 by the IMF (-0.9%) and the Central
Bank of Nigeria (3.2%). While there is little the
analyst can do about the poor data, it is important to
footnote this defect and add the necessary caveats to
the robustness of the analysis. While the central
message of a possible cloudy outcome is right on the
mark, analytical focus on the fiscal and fiscal policy
stance and foreign account suggests that Nigeria's
economic outcome is almost solely the result of policy.
A rigorous decomposition of the structure of the
economy shows, however, that the oil and agricultural
sectors account for about 60 percent of the GDP, and
performance in both sectors is not driven essentially
by monetary and fiscal policies. Performance in the
oil sector is primarily driven by OPEC and
international oil prices, while agriculture is still
largely weather dependent (recall the basis for the IMF-
Central Bank of Nigeria huge discrepancy on 2002 growth
rate). Much of Salami's and Utomi's analysis focuses
on the formal (largely manufacturing) sector, but
manufacturing account for barely 5 percent of GDP.
This is this kind of structural analysis that leads us
to put the appropriate caveats to the gloomy forecast;
it is possible for economic performance to
significantly improve even without any improvement in

19. Nevertheless, Salami's and Utomi's presentation of
late November echoed warnings we have heard from other
experts about the continuing structural imbalances
within the economy. Government deficits accommodated by
monetary policy perpetuate these imbalances. These will
become even more apparent should oil revenues fall.
Many countries engage in deficit spending to stimulate
growth; in Nigeria, however, public spending is largely
ineffective at increasing sustainable development. The
reason is that so little of those public funds are
channeled into productive investment. Moreover,
government spending disproportionately favors the
richest four-percent of the population identified
earlier. These people tend to travel abroad and account
for a disproportionate share of imports. These factors
will put additional pressure on the naira. Since the
rich generally seek to convert naira into foreign
exchange quickly when they have large volumes of
Nigerian currency (as many did so recently during the
political party conventions), to reduce exchange rate
risk and because forex is less bulky, the naira will
surely depreciate during the coming months.
Conversely, interest rates will remain high to attract
capital inflows. So it is to be feared that instead of
stimulating growth, excessive government spending will
crowd out the private sector, which will force
companies to scramble for funds at high interest rates.

20. High interest rates will affect not only the
private sector. The cost of government borrowing will
also remain high. Consequently, investment in
infrastructure (roads, education, and public health)
which has been badly neglected during the last several
years may continue to be so. An Emboff who has
accumulated eight years in Nigeria believes that its
infrastructure is generally decaying. What is certain
is that new investment is insufficient to cover the
needs generated by population growth and depreciation
of existing assets. To redress this situation, fiscal
policy as it has been implemented throughout the last
ten years must change.

21. Improving fiscal policy would call for public
service reform and a budgetary process based on a
better appreciation of economic principles. We have
often heard Nigerian economists criticize their
government's budget formulators for establishing
budgets premised on one scenario and usually based upon
a single oil price. Many of these economists recommend
that budgets be based on multiple scenarios with
clearly defined trigger points. For our part, we think
that the GON should encourage the Central Bank to issue
a directive to banks informing them that any and all
future lending to states and local governments would be
at their risk. The federal government would thus offer
no guarantee and would refuse to "deduct at source"
(i.e., before disbursements from the Federation
Account) any payments on such debt. The Central Bank
could also issue a "caveat emptor" notice to
international banks to discourage lending to states.
While such actions by the Central Bank would annoy some
state-level politicians, there would be little they
might do about it. (Few local governments are in a
position to borrow.) Assuming such actions led to a
modification of Nigeria's budgetary practices, it would
not only reduce uncertainty; it would also reassure
observers that while they may not see improvement in
the next quarter or two, subsequent quarters might hold
promise of a brighter future.


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