Cablegate: Nigeria: Economic Reforms Phase Two

DE RUEHUJA #1793/01 2291254
P 171254Z AUG 07





E.O. 12598: N/A

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.

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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
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.

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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.


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