NIGERIA BI-ANNUAL ECONOMIC UPDATE: FRAGILE RECOVERY No. 1 - April 2017 NIGERIA BI-ANNUAL ECONOMIC UPDATE: FRAGILE RECOVERY Cover photo: Female Nigerian Trader at a textile market in Lagos, Nigeria. Credit: Olufunke Olufon 1 Acronym List BDC Bureau De Change BOP Balance of Payments CBN Central Bank of Nigeria CPI Consumer Price Index CY Calendar Year DISCOs Power Distribution Companies DMO Debt Management Office ECA Excess Crude Account ERGP Economic Recovery and Growth Plan FCT Federal Capital Territory FEC Federal Executive Council FGN Federal Government of Nigeria FRA Fiscal Responsibility Act FRL Fiscal Responsibility Law FSP Fiscal Sustainability Plan GDP Gross Domestic Product GENCOs Power Generation Companies IOC International Oil Companies JV Joint Venture LCU Local Currency Unit mbpd Million barrels per day MDAs Ministries, Departments, and Agencies MTEF Medium Term Expenditure Framework N Naira NASS National Assembly NBS National Bureau of Statistics NEC National Economic Council NNPC Nigerian National Petroleum Corporation NTB Non-Tariff Barriers OAGF Office of the Accountant General of the Federation OECD Organization for Economic Co-operation and Development OPEC Organization of the Petroleum Exporting Countries PPP Purchasing Power Parity PPPs Public-Private Partnerships SLGs State and Local Governments SWF Sovereign Wealth Fund TFP Total Factor Productivity USD US Dollars VAT Value Added Tax WEF World Economic Forum 2 This edition was prepared by the World Bank Macroeconomic and Fiscal Management Global Practice Nigeria Team, led by Gloria Aitalohi Joseph-Raji (Senior Economist, GMF01) and Emilija Timmis (Young Professional, GMF01). Yue Man Lee (Senior Economist, GMF01) prepared the Special Topic (Chapter 3) based on World Bank study (forthcoming) Toward Sustainable Growth in Nigeria: Empirical Analysis and Policy Options, by Santiago Herrera (Lead Economist, GMF01) and Jean-Christophe Maur (Senior Economist, GTC07). Valuable contributions were provided by Khwima Nthara (Program Leader, AFCW2), Sona Varma (Lead Economist, GMF01), and Joseph Orinya Ogebe (Consultant, GMF01) under the overall supervision by Seynabou Sakho (Practice Manager, GMF01) and Rachid Benmessaoud (Country Director, AFCW2).The report benefited greatly from valuable insights and comments from John Litwack (Lead Economist, GMF02) and William G. Battaile (Lead Economist, GMF07). 3 TABLE OF CONTENTS Acronym List.................................................................................................................................................. 2 Executive Summary ....................................................................................................................................... 5 Chapter 1: Economic Update ........................................................................................................................8 1.1 Real Sector .......................................................................................................................................... 8 1.2 External Sector: Balance of Payments and Exchange Rate Developments ...................................... 13 1.3 Fiscal Accounts .................................................................................................................................. 18 1.4 Monetary Sector: Inflation, Monetary and Credit Aggregates and Financial Market Indicators ..... 22 Chapter 2: Economic Outlook for the Rest of 2017 ....................................................................................25 2.1 Outlook.............................................................................................................................................. 25 2.2 Government Policy Response: The Nigeria Economic Recovery and Growth Plan (ERGP) ............. 27 2.3 Risks to Economic Outlook ................................................................................................................ 31 Chapter 3: Economic Growth in Nigeria: Past Determinants and Future Prospects .................................. 33 3.1 Aggregate Growth Patterns and the Impact of Oil on the External and Fiscal Sectors ....................33 3.2 Growth and Productivity Decomposition .........................................................................................36 3.3 Determinants of Economic Growth – Cross-Country Analysis ....................................................38 3.4 Constraints to Firm Productivity and Doing Business in Nigeria ................................................. 40 3.5 Policy Implications for Sustaining Growth.................................................................................. 42 REFERENCES ............................................................................................................................................ 45 4 EXECUTIVE SUMMARY - Figure 1. Sectoral contribution to GDP growth Aggregate Supply Chapter 1 provides an overview of recent 10 10 developments in the Nigerian economy. In 2016, Setor Contribution to GDP Growth (%) Nigeria experienced its first full-year of recession in 25 8 8 years. Global oil prices reached a 13-year low and oil Real GDP Growth (%) 6 6 production was crushed by vandalism and militant attacks in the Niger Delta, resulting in severe contraction 4 4 of oil GDP. While the oil sector represents only 8.4 2 2 percent of GDP, the lower foreign exchange earnings from oil exports had significant spillover effects on non- 0 0 2011 2010 2012 2013 2014 2015 2016 2017 oil sectors, especially industry and services, which are -2 -2 dependent on imports of inputs and raw materials. Compounded by inadequate policy responses, these -4 -4 challenges caused the overall real GDP to contract by 1.5 Agriculture Industry Services Real GDP growth percent. Source: National Bureau of Statistics Low oil revenues and the lack of major tax policy number of important reforms to improve fiscal reforms to significantly increase non-oil revenues led transparency, accountability and sustainability at the to large revenue shortfalls at all levels of government state government level. in 2016. Consequently, the Federal Government budget was under-executed,1 especially on capital spending, and Monetary policy remained accommodative, with the fiscal deficit widened despite progress made in broad money growth at 18.5 percent, driven by rationalizing recurrent expenses. Although the increased lending from the Central Bank to the consolidated public debt-to-GDP ratio remains low (17 Government to finance the budget deficit. The percent of GDP), the World Bank's estimate of the combination of the rising costs of power and transport, interest payments-to-revenue ratio for the Federal increases in petrol prices, the depreciated Naira and the 2 Government is as high as 59 percent for 2016. The fiscal growth in money supply resulted in average inflation of deficit was largely domestically financed, although the 15.6 in 2016. Together with rising unemployment, this Federal Government successfully marketed USD 1.5 hurt private consumption, which fell by 6 percent in Q2 3 billion worth of 15-year Eurobonds in February and 2016. March 2017. The subnational fiscal crisis continued in 2016 despite the first financial bailout in mid to late 2015, After a sharp depreciation of the exchange rate and the states' public spending has been curtailed following the June 2016 liberalization of the Naira, significantly, given their reliance on statutory transfers. the Central Bank of Nigeria (CBN) maintained the The Fiscal Sustainability Plan, the condition for the interbank exchange rate at around N 305 per USD. To second financial bailout, is a significant achievement, as increase foreign exchange reserves, the Central Bank the Federal Government and states have agreed to a limited its supply of foreign exchange in the 1 As of the end of calendar year 2016. 2 Unlike Federal Government accounts, World Bank’ measure of revenue excludes inflows in the fiscal accounts which should be considered financing items. IMF further excludes unbudgeted revenues and estimates debt-service-to-revenue ratio at 66 percent (IMF Article IV, 2017). 3 Latest available data, as the demand side GDP figures are published with longer lags than supply side data. 5 interbank market and introduced a number of foreign private investment and external financing foreign exchange allocation/utilization rules. to complement public financing. Private sector Subsequently, imports declined even faster than financing will, in turn, hinge on restoring investor exports, yielding an estimated current account confidence through further monetary, exchange surplus of 0.6 percent of GDP in 2016. The rate and fiscal policy adjustments to lower shortage of foreign exchange from the interbank inflation, increase access to foreign exchange and and Bureau de Change (BDC) channels increased increase fiscal revenues. demand for foreign exchange on the parallel market, leading to the parallel market rate rising, The credibility of the ERGP will depend on by February 2017,to more than N 500 per USD, evidence of concrete progress in implementing and creating round-tripping opportunities and the reform program. A positive start to ERGP distortions in the economy. After foreign reserves implementation is the approval of the Power recovered to USD 29.6 billion, the Central Bank Sector Recovery Plan in March 2017, which aims increased its supply of foreign exchange into the to optimize the delivery of at least 10GW of interbank market and BDC channels, and the operational capacity by 2020. Restoring financial parallel market rate appreciated steadily, reaching viability to the sector is crucial to ensure sufficient just under N 400 per USD at the end of March investment in the sector, and this will require tariff 2017. adjustments over the medium term. Chapter 2 describes the World Bank's view on Chapter 3 summarizes the findings of a Nigeria's economic outlook for 2017. Economic forthcoming Bank report Toward Sustainable growth is expected to recover slightly, to above 1 Growth in Nigeria: Empirical Analysis and Policy percent in 2017, driven mainly by the restoration Options , which analyzes the patterns of of oil production to normal levels (2.1 million economic growth in Nigeria; the underlying barrels per day) due to the Government's efforts to determinants of growth from both a macro and resolve the fragile Niger Delta situation, as well as micro perspective; and policy priorities to higher oil prices and continued strong growth in support higher growth. Over the last four agriculture. However, sustaining and building on decades, Nigeria's GDP growth rate failed to keep the oil-driven recovery will require strengthening pace with those of more developed economies, the macroeconomic policy framework by (a) reflecting an all-too-common experience among addressing the exchange rate and foreign commodity exporters. Oil continues to dominate exchange issues that have severely affected the the country's growth pattern, but the volatility of private sector; and (b) implementing the structural oil-dependent growth imposes substantial welfare reforms needed to diversify the economy and costs that impede progress on the country's social breakout of the oil boom and bust cycle. The and economic development objectives. A cross- Government has outlined an ambitious set of country analysis of the determinants of growth infrastructure programs and structural reforms in carried out for the report underscores the the Economic Recovery and Growth Plan (ERGP) importance of sound macroeconomic 2017-2020, which was released in early March management and stability for growth; while 2017. Successful implementation of the ERGP confirming that inflation, government relies on strong coordination with the subnational consumption and currency misalignment governments, and on mobilizing domestic and (overvaluation) are negatively correlated with 6 growth. Policies and reforms to promote capital productive to more productive sectors. In investment and trade are positively associated addition, analysis of constraints to doing with growth. While oil and other natural business and the impact of current trade policies resource rents tend to positively impact growth highlights the need to improve access to finance, in the short term, this effect is greatly diminished improve the reliability of power supply, and by the impact of poor governance of these rents adjust trade policies to promote productivity on the quality of public institutions. Investment growth. in education is also found to be a significant determinant of growth, and particularly important in Nigeria to increase factor mobility from less 7 Chapter 1: Economic Update 1.1 Real Sector Gross Domestic Product: Aggregate Supply 1. Nigeria's real economic growth collapsed to-1.5 2016, respectively, compared to 2.2 mbpd in 2015 percent in 2016, marking the first full year of (Figure 1.2). Despite the Government's efforts to negative growth in more than two decades. The address security challenges in the Niger Delta, which recession was driven by a large contraction in the oil restored the oil production to 1.9 mbpd by the end of 5 sector. In addition to the global price of crude oil 2016, oil production averaged only 1.9 mbpd in falling to a 13-year low in January 2016 (Figure 1.1), 2016, compared to 2.1 mbpd in 2015. As a result, oil Nigerian oil production declined as a result of GDP contracted by 13.6 percent throughout 2016 vandalism and militant attacks on oil installations in (Table 1.1). the Niger Delta. Production averaged only 1.7 and 4 1.6 million barrels per day (mbpd) in Q2 and Q3 Figure 1.2: Oil Production (in millions of Figure 1.1 Crude Oil Price (US$/Barrel) barrels per day) 160 2.5 2.2 2.2 2.2 140 2.1 2.1 2.0 1.9 120 1.7 1.6 100 1.5 80 mbpd 60 1.0 40 20 0.5 0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 0.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2015 2016 Crude Oil Price (US$/Barrel) Source: National Bureau of Statistics Source: National Bureau of Statistics 2. While the oil sector represented only 8.4 Furthermore, lower resource rents reduced public percent of GDP in 2016 (Table 1.2), the lower and private consumption, reducing aggregate foreign exchange earnings from oil exports had demand and thus further negatively affecting the significant spillover effects on non-oil sectors non-oil sectors, especially real estate and other dependent on imports of inputs and raw services. These negative materials, in particular manufacturing and trade. 4 The oil production definition according to NNPC, which the sum of crude oil and condensate. The publicly available OPEC numbers are for crude oil only. 5 NBS data as published in February 2017. 8 spillover effects were magnified by uncertainty negative growth (-0.8 percent) in 2016. However, around the Government's exchange rate policy and performance among its sub-sectors was varied: for foreign exchange restrictions, which created severe example, trade (17.7 percent of GDP) contracted by foreign exchange shortages at the interbank rate. As a 0.2 percent, real estate by 6.9 percent, finance and result, manufacturing contracted by 4.3 percent insurance by 4.5 percent, while ICT grew by 2 overall in 2016, with a particularly sharp drop at the percent. Agriculture, which contributes 24.4 percent beginning of the year (-7.0 percent in Q1 2016; Table to GDP (Table 1.2), recorded solid and accelerating 1.1). Construction contracted more gradually, with growth, driven by strong crop performance in quarterly declines oscillating around the 2016 favorable weather conditions and also reflecting the average of -5.9 percent. Services, the largest sector of impact of Government’s strong support to the sector. the Nigerian economy (53.6 percent of GDP) and normally the strongest driver of economic growth (Executive Summary Figure 1), also recorded Figure 1.3 Real Oil & Non-Oil GDP YOYGrowth 10.0 8.2 5.0 3.5 3.1 3.1 5.6 3.96 -0.2 -0.4 0.03 -0.3 2.35 2.84 2.11 0.0 1.1 -0.36 -2.06 -1.3 -5.0 -2.24 -1.9 Percent -6.8 -10.0 -8.3 -15.0 -12.4 -20.0 -17.5 -22.01 -25.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2015 2016 Oil GDP Non-Oil GDP Real GDP Year on Year Growth (%) Source: National Bureau of Statistics 9 Table 1.1: Real GDP growth by sector and selected sub-sector, aggregate supply (y-o-y, percent) Annual Quarterly Activity Sector 2014 2015 2016 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Total GDP 6.2 2.8 -1.5 -0.4 -2.1 -2.2 -1.3 Agriculture 4.3 3.7 4.1 3.1 4.5 4.5 4.0 Industry 6.8 -2.2 -8.5 -5.5 -9.5 -12.2 -6.7 Oil &gas -1.3 -5.4 -13.6 -1.9 -17.5 -22.0 -12.4 Manufacturing 14.7 -1.5 -4.3 -7.0 -3.4 -4.4 -2.5 Construction 13.0 4.4 -5.9 -5.4 -6.3 -6.1 -6.0 Services 6.8 4.8 -0.8 0.8 -1.3 -1.2 -1.5 Trade (wholesale & retail) 5.9 5.1 -0.2 2.0 0.0 -1.4 -1.4 Accommodation &food services 18.3 2.3 -5.3 -7.4 -6.4 -4.9 -2.7 Information &communication 7.0 6.2 2.0 4.1 1.4 1.1 1.4 Arts, entertainment& recreation 14.9 9.4 3.7 8.4 1.8 2.0 2.0 Finance &insurance 8.1 7.1 -4.5 -11.3 -10.8 2.6 2.7 Real estate 5.1 2.1 -6.9 -4.7 -5.3 -7.4 -9.3 Public administration 2.5 -12.3 -4.6 -4.4 -6.1 -3.6 -4.1 Oil GDP -1.3 -5.4 -13.6 -1.9 -17.5 -22.0 -12.4 Non-oil GDP 7.2 3.7 -0.2 -0.2 -0.4 0.0 -0.3 . Source: National Bureau of Statistics Table 1.2: Sector and selected sub-sector shares in Nigeria's GDP, aggregate supply (%) Annual Quarterly Activity Sector 2014 2015 2016 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Total GDP 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 22.9 23.1 24.4 20.5 22.5 28.7 25.5 Industry 24.9 23.7 22.0 24.3 22.6 21.1 20.3 Oil & gas 10.4 9.6 8.4 10.3 8.3 8.2 7.2 Manufacturing 10.0 9.5 9.3 9.5 9.4 9.2 9.0 Construction 3.8 3.9 3.7 4.1 4.3 3.1 3.4 Services 52.2 53.2 53.6 55.2 54.8 50.2 54.2 Trade (wholesale & retail) 16.6 16.9 17.2 18.2 17.6 16.4 16.7 Accommodation &food services 1.0 0.9 0.9 1.1 0.7 0.9 1.0 Information & communication 10.8 11.2 11.6 12.0 12.7 10.1 11.6 Arts, entertainment& recreation 0.2 0.2 0.2 0.3 0.2 0.2 0.2 Finance & insurance 3.0 3.1 3.0 3.1 3.0 2.9 2.9 Real estate 7.7 7.6 7.2 6.5 7.6 7.2 7.6 Public administration 2.8 2.4 2.3 2.3 2.4 2.1 2.4 Oil GDP 10.4 9.6 8.4 10.3 8.3 8.2 7.2 Non-oil GDP 89.6 90.4 91.6 89.7 91.7 91.8 92.8 . Source: National Bureau of Statistics 10 Gross Domestic Product: Aggregate Demand contracting 8.8 percent in 2015, the decline in the 3. Final household consumption contracted wage bill accelerated to -10.7 and -17.6 percent in in the first half of 20166 after stagnating in 2015 2016 Q1 and Q2, respectively, in response to (Table 1.3). This contraction in the largest economic recession and high inflation. The reported expenditure component (Table 1.4) accelerated from positive growth of exports and imports reflected an estimated -1.1 percent in the first quarter of 2016 to depreciation of the Naira rather than an increase in -6 percent in Q2. The decline in household volumes (see next section). consumption was driven in part by a severe contraction in real wages paid to employees: after Table 1.3: Real GDP growth by expenditure and income Components (y-o-y growth rates) Annual Quarterly 2014 2015 2016 Q1 2016 Q2 GDP by Expenditure 6.3 2.7 -0.4 -2.2 Final consumption expenditure of household 2.0 0.0 -1.1 -6.0 Final consumption expenditure of non -profits serving households 3.0 1.4 5.3 -12.8 Final consumption expenditure of general government 5.6 -22.4 -22.6 6.2 Changes in inventories 5.1 -5.7 -6.9 -7.8 Gross fixed capital formation 13.4 -1.3 -7.2 3.1 Exports of goods and services 15.6 7.0 1.0 8.1 Less imports of goods and services 6.7 -27.4 -26.3 16.5 GDP by Income 6.3 2.7 -0.4 -2.2 Compensation of employees 2.2 -8.8 -10.7 -17.6 Operating surplus 7.5 7.2 3.1 3.8 Consumption of fixed capital 9.1 2.8 -0.5 -3.5 Other taxes on production (net) 17.0 8.7 6.1 1.7 Net taxes on products 13.9 -8.2 -6.1 -18.4 Source: National Bureau of Statistics. Table 1.4: Expenditure and income shares in Nigeria’s GDP aggregate demand (%) Sector Contribution to GDP (%) Annual Quarterly 2014 2015 2016 Q1 2016 Q2 GDP by Expenditure 100.0 100.0 100.0 100.0 Final consumption expenditure of household 64.3 62.6 58.1 58.6 Final consumption expenditure of non-profits serving households 0.4 0.3 0.5 0.2 Final consumption expenditure of general government 6.9 5.2 4.5 5.1 Changes in inventories 0.8 0.7 0.7 0.8 Gross fixed capital formation 15.5 15.0 15.7 17.7 Exports of goods and services 22.6 23.6 27.5 26.3 Less imports of goods and services 10.5 7.4 7.0 8.7 GDP by Income 100.0 100.0 100.0 100.0 Compensation of employees 25.8 22.9 21.3 21.1 Operating surplus 67.0 69.9 71.6 71.5 Consumption of fixed capital 5.2 5.2 5.2 5.7 Other taxes on production (net) 0.9 0.9 1.0 0.9 Net taxes on products 1.2 1.1 0.9 0.8 Source: National Bureau of Statistics. 6 Demand-side GDP data are released with longer lag times than supply-side data. The latest available demand-side data are for 2016 Q1 and Q2. 11 4. The strong negative effect of recession on Unemployment private consumption has worrisome implications for poverty. Poverty increased 5. Unemployment and under-employment slightly in 2015 as a consequence of the slowdown rates continued to increase in the first three in GDP growth and steadily growing population, quarters of 2016 (Figure1.4). By the third quarter, and continued to rise in 2016. The share of the population living below the USD1.9 PPP poverty 13.9 percent of the Nigerian labor force was line increased from 49.4 percent in 2015 to about unemployed and 19.2 percent was under-employed. 50.2 percent in 2016. The high growth rates enjoyed The labor force itself grew by a staggering 7 percent by Nigeria before the current crisis had been driven in the first three quarters of 2016 compared to the by the coastal and capital areas but with limited same period of 2015, and together with the negative trickle down to the rest of the country; the good economic growth, contributed to increasing overall economic performance concealed the unemployment and under-employment rates. limited inclusiveness of growth. Insecurity and displacement in North East Nigeria led to low farming and production, substantial destruction of basic services and infrastructure, depleted household food stocks and reduced purchasing power, with several million people facing food security crisis. Figure 1.4: Unemployment and labor force growth 25 9 Percentage of Labor Force 8 20 7 Growth rate (percentage) 6 15 5 4 10 3 5 2 1 0 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2015 2016 Unemployment Rate (%, LHS) Underemployment Rate (%, LHS) Total Labour Force (y-o-y growth, RHS) Source: National Bureau of Statistics. 12 1.2 External Sector: Balance of Payments and Exchange Rate Developments Exchange Rate and Foreign Exchange Policy 6. The exchange rate depreciated sharply 7. The shortage of foreign exchange from from N197/USD to N282/USD after liberalization the interbank and BDC channels increased of the Naira in June 2016, and progressively to demand for foreign exchange on the parallel around N305/USD by September 2016. Since then, market, leading to the parallel market rate rising the interbank exchange rate has been fixed at around – to above N500/USD by February 2017 (Figure N305/USD. To improve foreign exchange reserves– 1.6) – and creating round-tripping opportunities which declined steadily from August 2015 to USD 24 and distortions in the economy. That same month, billion in October 2016 – the Central Bank limited and after foreign reserves recovered to USD 29.6 its supply of foreign exchange into the interbank billion, the CBN started to use its foreign exchange market and imposed several foreign exchange reserves to take more aggressive measures to narrow allocation/utilization rules. These included the the gap between the official and parallel market rates. mandate that the banks had to allocate at least 60 These measures include providing additional foreign percent of all their foreign exchange sales to the exchange to banks for “invisible” transactions manufacturing sector (the 60/40 rule). The Central (personal and business travel, medical and education Bank also retained the restrictions on foreign fees) at 20 percent above the interbank market rate; exchange access for 41 import products. As the gap and “visible” transactions (goods imports). The CBN between the interbank and parallel rates widened also abolished the 60/40 rule; however, the (Figure 1.5), in November 2016 the CBN capped the restrictions on foreign exchange access for41 Bureau De Change sell rate at N400/USD, (although imports remained. not all BDCs fully adhered to this rate). 13 The CBN backed the articulated policy change by interbank market, the parallel market rate increasing its weekly spot foreign exchange appreciated steadily, reaching just under th offerings(USD 6 million on February 20 2017, N400/USD at the end of March. compared to the usual USD 1.5 million), as well as forward sales. As a result of increased liquidity in the Figure 1.5 Exchange Rates and Foreign Reserves (Monthly Averages) 550 36.00 500 34.00 450 32.00 400 30.00 Naira / USD USD Billion 350 28.00 300 26.00 250 24.00 200 150 22.00 100 20.00 Aug Aug Jul Jul Jan Jun Sep Jan Jun Sep Jan Mar Dec Mar Dec Mar Oct Nov Oct Nov Apr Apr Feb Feb Feb May May 2015 2016 2017 External Reserves (Gross, 30 day MA) Interbank BDC Parallel Source: Central Bank of Nigeria, abokiFX online platform. 14 Figure 1.6 Exchange Rate and Foreign Reserves (Daily Movement) 550 520 2.7 500 2.6 450 390 2.5 400 Naira / USD 2.4 Percent 350 300 2.3 250 2.2 200 2.1 150 100 2.0 4-Jan 9-Jan 12-Jan 17-Jan 20-Jan 25-Jan 30-Jan 3-Mar 8-Mar 13-Mar 16-Mar 21-Mar 24-Mar 29-Mar 2-Feb 7-Feb 10-Feb 15-Feb 20-Feb 23-Feb 2017-Jan 2017-Feb 28-Feb 2017-Mar Parallel (Sell) Interbank (Sell) % Change in Reserves (30-day MA) Source: Central Bank of Nigeria, abokiFX online platform. Balance of Payments 8. The value of goods and services exports billion in 2016) than exports. This effect was continued to decline in 2016 (USD 38.3 billion particularly strong in the last quarter of 2016, when a compared to USD 49 billion in 2015 and USD positive quarterly goods and services trade balance 97.5 billion in 2014). As oil and gas exports was recorded, the first since Q3 2014. As a result, the constitute more than 80 percent7 of Nigeria's current account balance was positive in three out of exports (Figure1.7), this decline was driven by four quarters of 2016, with an overall Current low crude oil prices and reduced oil production Account surplus of USD 2.3 billion. from the vandalism in Niger Delta. Consequently, with lower foreign exchange earnings, amplified by policies restricting access to foreign exchange, imports of goods8 and services contracted even more sharply (from USD 106.2 and USD 72 billion in 2014 and 2015, respectively to 47.2 7 Down from over 90 percent before the drop in oil prices. 8 Please note these are preliminary CBN numbers. 15 Figure 1.7: Exports and imports (goods and services) and current account balance (USD billion) Source: Central Bank of Nigeria 9. T h e F i n a n c i a l A c c o u n t i m p ro v e d 10. The drawing on foreign reserves also substantially since 2015, reverting to a small slowed down substantially, from USD billon 5.9 overall surplus of USD 0.8 billion in 2016 (Table in 2015 to USD 1.0 billion in 2016, with the last 1.5) as the outflows of all types of investments quarter recording an accretion to reserves and slowed down. The Net Direct and Portfolio reflecting largely, the Central Bank's use of foreign Investment also recovered to 2014 levels; however, exchange restrictions to rebuild foreign reserves, as both inflows and outflows largely continued to discussed above. Net errors and omissions, which decline in both 2015 and 2016. swung substantially in the preceding years, stood at USD -4.1 billion in 2016, reflecting lower levels of unrecorded capital and informal trade movements in Nigeria. 16 Table 1.5: The Balance of payments of Nigeria (USD billion) Annual 2016 Quarterly 2014 2015 2016 Q1 Q2 Q3 Q4 CURRENT ACCOUNT BALANCE 1.3 -15.4 2.3 1.0 -1.8 0.0 3.2 Trade Balance 21.0 -6.4 -0.5 -0.8 -1.8 -0.1 2.3 Exports (fob) 82.6 45.9 34.7 7.6 9.3 7.9 9.9 o/w crude oil & gas 76.5 42.4 32.0 7.0 8.3 7.4 9.2 Imports (fob) -61.6 -52.3 -35.2 -8.4 -11.1 -8.0 -7.7 Services(net) -22.5 -16.5 -8.4 -2.0 -2.1 -2.4 -1.9 Credit 2.0 3.2 3.6 1.1 0.9 0.8 0.9 Income(net) -19.2 -12.7 -8.6 -1.8 -2.3 -2.1 -2.4 Current transfers(net) 21.9 20.2 19.9 5.6 4.3 4.6 5.3 FINANCIAL ACCOUNT BALANCE 4.7 -6.7 0.8 -8.3 6.7 5.0 -2.6 Net Direct Investment 3.1 1.6 3.1 0.6 0.6 1.0 0.9 Outflows -1.6 -1.4 -1.3 -0.3 -0.3 -0.4 -0.3 Inflows 4.7 3.1 4.4 0.9 0.9 1.4 1.3 Net Portfolio Investment 1.8 0.9 1.7 0.2 0.5 0.7 0.3 Outflows -3.4 -1.7 -0.2 -0.1 -0.1 0.0 0.0 Inflows 5.3 2.5 1.9 0.2 0.6 0.8 0.3 Net Other Investment -0.2 -9.2 -4.1 -9.1 5.6 3.2 -3.8 Outflows -10.9 -10.3 -3.0 -9.6 6.4 1.0 -0.7 Inflows 10.7 1.0 -1.1 0.6 -0.8 2.2 -3.1 CHANGE IN RESERVES (positive number indicates reserve spending; i.e., reduction in reserves) 8.5 5.9 1.0 0.7 0.8 2.7 -3.3 NET ERRORS AND OMISSIONS -14.4 16.3 -4.1 6.6 -5.7 -7.6 2.6 Source: Central Bank of Nigeria . . 17 1.3 Fiscal Accounts Federally Collected Revenue 11. Net9 revenue accruing to the Federation (Figure 1.8 and Table 1.6). In the first two months of Account includes all oil and gas revenues and some 2017, oil revenues started recovering, as the price of non-oil revenues (customs revenue, corporate taxes, Nigerian crude oil increased to USD56/bbl, on and solid minerals revenue); and is the main revenue average. stream for all tiers of Government. The revenues are distributed to the three tiers of government as 13. While the decline in Federation revenues follows: 52.68 percent accrues to the Federal during 2014 and 2015 was driven by falling oil Government (of which FGN retains 48.5 percent revenues, the 2016 revenue shortfall relative to after transfers to special funds and the FCT), budget targets was due to the under-collection of 26.72percent to the 36 state governments, and 20.6 non-oil revenues and VAT, which stagnated percent to the local governments. In addition to the throughout the recession period. The targets for non- revenues accruing to the Federation Account, VAT is oil revenues in 2016 had been increased ambitiously; also federally collected and then distributed to the but without any changes in tax policy or tax rates, Federal (15 percent, of which 14 is retained), state actual revenues did not increase, despite many (50 percent), and local (35 percent) governments. efforts to strengthen tax administration. Only 56 percent of the budget amount of non-oil revenues 12. Reflecting Nigeria's over-reliance on oil was collected, compared to 97 percent of oil revenue revenues, the net Federation Account revenue has collections. Only 55 percent of the budgeted VAT decreased dramatically, from N5,462 billion in amount was collected. The under-collection of these 2014 to N2,902 billion in 2016 (a decline of 47 revenues translated to significant revenue shortfalls percent in nominal terms). This sharp drop has at all tiers of government in 2016. entirely been driven by the decline in oil and gas revenues in response to (a) the decline in global oil prices (from USD53/bbl in 2015to USD45.2/bbl in 2016); and (b) the lower oil production in 2016 9 From gross revenue items such as revenue agency cost of collection, 13 percent derivation to oil producing states, JV cash calls, revenues in excess of specific targets and transfer to Excess Crude Account, and any subsidies are deducted to arrive at the net measure, which is then distributed according to the formulae described. 18 Figure 1.8: Net Federation Account Revenues and VAT (Actual) 4,500 4,000 3,500 3,000 Naira illion 2,500 2,000 1,500 1,000 500 0 Oil and Gas Non-Oil VAT (Net) Revenues Revenues 2014 2015 2016 Source: OAGF Table 1.6: Federation Account revenues 2014 2014 2014 2015 2015 2015 2016 2016 2016 Budget Budget Budget Naira Billion Budget Actual perform. Budget Actual perform. Budget Actual perform. Net Federation Account Revenues 6,234 5,462 88% 5,557 3,994 72% 4,304 2,902 67% Oil & gas Revenues 4,360 4,076 93% 3,377 2,512 74% 1,479 1,439 97% Non-oil revenues 1,871 1,386 74% 2,162 1,483 69% 2,605 1,463 56% Other revenues 3 0 0% 17 0 0% 219 0 0% VAT (Net) 812 762 94% 1,232 748 61% 1,416 779 55% Source: OAGF Note: Other revenues include balances in special accounts and other items not directly attributable/disaggregated to oil or non-oil revenue. Federal Government's Budget and Policy 14. The Federal Government of Nigeria has only 16 percent of the Federal Government's experienced a significant revenue shortfall in 10 Independent Revenue, which was budgeted to 2016, with only 76 percent of budgeted revenues account for about 39 percent of its inflows, was and inflows actually collected (Table1.7) . In realized. addition to federally collected revenue shortfalls, 10 The Government’s Independent Revenue includes the Personal Income Tax of the Foreign Service, Armed Forces and Police; operational surpluses of government-owned enterprises; and revenues of ministries, departments and agencies (MDAs) . 19 15. Following the revenue shortfalls, the 17. The Federal Government's offering in Federal Government budget was under- February 2016 of USD 1 billion in 15-year executed,11 especially on capital spending, for Eurobonds at 7.875 percent yield to finance which allocations in 2016 budget targets had the 2016 FGN budget was eight times been increased. At the end of the calendar year oversubscribed despite the uncertainty over and representing 7 months of execution, only 33 exchange rate policy and foreign exchange percent of capital expenditures budgeted for 2016 management. This most likely reflected were executed. Despite the Government's investors' search for yields in the high-liquidity progress in rationalizing recurrent expenses, global environment. Subsequently, the Federal certain recurrent expenditure items (overhead Government sought the National Assembly's costs and other service-wide votes, including the Presidential Amnesty Program) exceeded the approval for an additional Eurobond issue of budgeted limits by 79 percent. Consequently, the USD 500 million. Approved in March 2017, fiscal deficit widened from 2.1 percent to 2.5 this15-year Eurobond was issued at 7.5 percent percent of GDP. Given the delayed budget yield. As the yields are lower than the cost of approval by the National Assembly (NASS), the borrowing domestically, this will help improve capital budget will continue to be implemented the Government's debt service cost, but it until May 2017.While this will allow for higher increases exchange rate-related risks. capital expenditure implementation, it is likely to further increase the deficit. 18. While the consolidated debt-to-GDP ratio (17 percent in 2016) remains low by 16. The Federal Government's plan to international standards, the debt service-to- finance 29 percent of the deficit from external revenue ratio has risen sharply. The Federal sources faced delays, and the bulk of the deficit Government's interest payment-to-revenue ratio was financed domestically, likely with increased from 34 percent in 2015to 43 percent(if crowding-out effects on private sector credit. all Federal Government inflows are included, as NASS declined to approve the medium-term accounted by the Office of the Accountant General of the Federation), or to 59 percent (if external borrowing plan submitted by the transfers between FGN consolidated and capital Executive in November 2016, delaying the accounts and other non-revenue inflows are fulfillment of any international loans. While the 12 excluded). first tranche (USD 600 million) of the budget support from the African Development Bank was approved and disbursed in December 2016, there was no disbursement from the World Bank in 2016. 11 As of the end of calendar year 2016. 12 The World Bank's calculation of the Government's interest payments-to-revenue differs from the Government's numbers in two aspects: first, the World Bank separates out interest payments from the debt service (which includes principal payments); and second, the World Bank's calculation of revenues excludes inflows in the fiscal accounts, which it considers to be financing items. IMF further excludes unbudgeted revenues and estimates debtservice-to-revenue ratio at 66 percent (IMF Article IV 2017). 20 Table 1.7: Key Federal Government fiscal indicators (FGN definitions) 2016 Budget 2016 Actual Total FGN revenue and Inflows (%GDP)* 3.8 2.9 o/w oil and gas revenue (%GDP) 0.8 0.7 Total expenditure and outflows (%GDP) 5.9 5.4 o/w FGN interest payments (%GDP) 1.3 1.2 Fiscal deficit (%GDP) 2.1 2.5 Consolidated public debt (%GDP)** 17.0 Debt service (%total revenue and inflows)*** 35.3 44.6 o/w interest payments (%total revenue inflows)*** 34.0 42.7 Capital expenditure (%total expenditure) 26.2 9.5 Capital expenditure (%fiscal deficit) 72.0 20.2 Source: OAGF, DMO. Note: The numbers are calculated using FGN definitions. Capital expenditures include disbursements only (not releases) up to the end of December 2016, and exclude capital expenditures in 2017 for 2016 budgeted programs. * Revenue includes any inflows as defined in the 2016 approved budget. ** as of 2016 Q2. *** FGN definition of debt service includes interest and principal payments. Sub-national Government Fiscal Developments 19. With most states relying heavily on obligations. The package included three Federation Account transfers (Figure 1.9), a components: budget top-up, commercial bank debt reduction in oil revenue since mid-2014 has restructuring, and soft loans from the CBN. lowered revenue transfers from the Federation However, the first bailout did not require state Account to state governments. This has led to governments to make any fiscal adjustments. As oil indebtedness among numerous states and their revenue continued its downward trend, some states inability to pay salaries to civil servants, cover experiencing negative cash flows requested overhead costs, and honor debt service obligations. additional short-term relief. In response to this crisis, the first financial bailout by the Federal Government in July 2015 was aimed primarily at assisting distressed states to pay salary arrears and meet other critical expenditure 21 Figure 1.9: 36 States' Major Revenues (before deductions) 1,600 1,400 1,200 N. billion 1,000 800 600 400 200 - 2013 2014 2015 2016 States' share of Federation Account States' share of VAT Internally Generated Revenue Source: OAGF, NBS. 20. The second financial bailout– the “Budget (monitoring is currently underway), and whether the Support Facility”- was approved by the National reform efforts will be fully sustained once the Economic Council (NEC) in May 2016, and was disbursement is complete. conditional on the implementation of a 22-point Fiscal Sustainability Plan (FSP) agreed to by the 1.4 Monetary Sector: Inflation, Monetary and Federal Government and the states. The Credit Aggregates and Financial Market objectives of the FSP reform agenda are to: improve Indicators accountability and transparency; increase public revenue; rationalize public expenditure; improve Money and Credit public financial management; and ensure sustainable debt management. Implementation of the FSP is 21. Broad money continued to grow at double expected to take 18 months to complete, while the digits in 2016 (Table 1.8), reflecting monetary bailout funds will be disbursed over a 12-month authorities' prioritized focus on supporting period. The new bailout loans are financed by growth rather than addressing rising inflation. government bonds sold to the private sector and Net domestic credit to the public sector more than guaranteed by the Federal Government. The loans doubled in 2016, albeit from a small base relative to bear a 9 percent interest rate. If successfully net credit to the private sector. After slow growth in implemented, the FSP should increase fiscal 2015, net credit to the private sector growth picked transparency, accountability and sustainability in the up in the second half of 2016 and averaged 19 percent state governments. However, it is unclear how much for the entire year, but remains crowded out by bank progress states have made in implementation to date lending to the public sector. 22 22. The monetary policy rate was increased to percentage of general government revenues; lack of 14 percent in the third quarter of 2016, up from 12 transparency; and uncertainty about macroeconomic percent since March 2016 and 11 percent at the policy developments. Standard & Poor's downgraded beginning of the year. This slight monetary the sovereign's rating by one notch, from “B+” with a tightening, however, has not been sufficient to curtail negative outlook to “B” with a stable outlook, reflecting the accelerating inflation (see below). that the risks to the country's credit rating are currently balanced. Moody's downgraded Nigeria from Ba3 to B, 23. The main international rating agencies and Fitch downgraded it from BB- to B+. lowered Nigeria's long-term foreign and local currency sovereign credit ratings on the basis of weakened GDP growth; rising debt servicing cost as a Table 1.8: Monetary and financial indicators 2015 2016 Monetary policy indicators (% growth, end of period y-o-y) Broad money 6% 18% Narrow money 24% 33% Net foreign assets -19% 57% Net domestic credit 12% 26% o/w to the Federal Government (net) 152% 66% o/w to the private sector (net) 3% 19% Monetary policy rate (period average) 12.7 12.8 Exchange rates (period averages) Exchange rate (LCU/USD) 195.5 253.5 Real effective exchange rate index (Nov 2009=100) 70.8 78.7 Financial market indicators (end of year) Stock market index 28,642 26,875 Fitch sovereign long-term foreign Debt Rating BB- B+ Moody's sovereign long-term foreign debt rating Ba3 B1 S&P sovereign long-term foreign debt rating B+ B Sources: Central Bank of Nigeria, Fitch, Moody’s, S&P, Bloomberg. Inflation 24. Inflation reached double digits in Figure 1.10: Consumer Price Index (y-o-y) February 2016and accelerated to 18.6 percent (y- o-y) in December 2016, averaging 15.6 percent in 2016 (Figure 1.10) – well above CBN's long-term target of 6-9 percent. It was fueled by a combination of the rising cost of power and transport, an increase in the price of petrol, the growth in money supply (driven by increased lending to the Government to finance the budget deficit), the depreciated Naira (interbank, BDC and parallel market values), and the pass- Source: National Bureau of Statistics. 23 through to imported final consumer goods. Food, celebrated decrease in February 2016, food inflation which accounts for 50.6 percent in Nigeria's has actually continued accelerating. Consumer Price Index (CPI), registered accelerating price growth of 17.4 percent over the course of 2016. Although overall inflation recorded a much- 24 Chapter 2: Economic Outlook for the Rest of 2017 2.1 Outlook 25. The Nigerian economy is expected to start of foreign exchange supply is uncertain in the recovering in 2017 from the recession and the absence of a foreign exchange policy regime that is other macroeconomic imbalances that have transparent, supports the free flow of autonomous plagued it since late 2014. Economic growth is capital flows, and is able to mitigate external shocks. forecast to return to positive territory, largely on the Any new shock to the oil price or to Nigeria's oil back of recovery in the oil sector. The average Bonny output under the current policy regime will threaten Light oil price in the first quarter of 2017 was 56 the country's external reserves and limit CBN's percent higher than in the corresponding period of ability to keep up the buoyant foreign exchange 2016. For the same reason, fiscal revenues accruing supply. to the Government are expected to be higher, and the current account of the balance of payments should 27. Although the CBN intends to restrain the strengthen. However, given that the expected growth of narrow money in 2017, in line with its recovery hinges on the oil sector, the recovery has a monetary growth benchmarks, inflation high degree of fragility and risks. expectations remain high in the short term. Consequently, private consumption is expected to Growth deteriorate further in 2017 before slowly recovering in the medium term. Government spending will be 26. Economic growth is expected to recover constrained in 2017, as ambitious non-oil revenue slightly to above 1 percent in 2017, driven mainly targets (although slightly less ambitious than in 13 by the restoration of oil production (to 2.1 mbpd) 2016) are unlikely to be met by tax administration and supported by continued strong growth in measures alone in the absence of tax policy reforms. agriculture. The recovery of non-oil industry and The Federal Government intends to increase capital services will depend to a large extent on the sustained spending further in 2017 (30 percent over the 2016 supply of foreign exchange to the markets, as scarcity budget and almost 300 percent over actual spending of foreign exchange had constituted a major as at December 2016). In addition, sub-national constraint during 2016. In line with its new foreign governments will likely continue to settle their exchange policy measures unveiled on February 20, domestic arrears. Therefore, current government 2017, the CBN has significantly increased its supply consumption is expected to decline further before of foreign exchange to the markets (supplying more recovering ahead of the 2019 elections. than USD2.0 billion between February 21 and March 21, 2017). However, the sustainability of such levels 13 The forecast for oil production of 2.1 mbpd in 2017 is based on the current efforts of Government to restore peace and stability in the Niger Delta region, which has reportedly yielded some result so far – oil production has been restored from 1.5 mbpd in August 2016 to almost 2.0 mbpd in January–February 2017. Furthermore, the recent agreement between the Government and the international oil companies (IOCs) to settle joint venture (JV) cash call arrears and establish a new funding mechanism for JV arrangements is expected to stabilize production from the JV contracts. 25 28. Exports will likely recover in 2017 due to lower than budgeted and non-oil revenues come increased oil production, as oil and gas exports in lower than budgeted implies that revenues constitute over 80 percent of Nigeria's exports. accruing to the Federation Account and available Imports, which were initially constrained by the for distribution to the tiers of Government may foreign exchange shortages in January and parts of come in lower than budgeted. To the extent that this February, may recover on the back of increased happens (and this has been the case so far in the first foreign exchange availability. However, as noted quarter of 2017), all net oil revenues will be above, the sustainability of this increased supply of distributed and nothing would accrue to the Excess foreign exchange is in question. Growth in total Crude Account (ECA). In other words, the oil price- capital investment will be limited in 2017 as based fiscal rule is being applied as a revenue rule, increased capital spending by the Federal rather than just an oil price rule. Government is offset by uncertain private investment. Despite the increased foreign exchange 31. The fiscal deficit is not expected to supply since February 21, 2017, private investment narrow significantly, if at all. Despite the recovery will likely be slow and measured in the short term, as in oil production and price, ashortfall in fiscal the private sector seeks clarity on the certainty and revenues compared to the budget target is still sustainability of foreign exchange supply. expected in 2017.Faced with a revenue shortfall, the Federal Government may choose to go beyond its Federal Government Fiscal Operations targeted deficit of 2.1 percent (proposed budget) to protect expenditure, especially if it is related to 29. The Federal Government's total revenue implementation of the Economic Recovery and in 2017 is projected to grow significantly to 3.5 Growth Plan 2017–2020 (see below). percent of GDP, up from 2.1 percent14 in 2016, largely on account of improved revenues from oil Balance of Payments and the Exchange Rate and gas. The share of net oil and gas revenues accruable to the Federal Government from the 32. Also on account of projected higher oil federation account is expected to grow from 0.9 output and prices in 2017, Nigeria's current percent of GDP in 2016 to 2.3 percent in 2017 on account balance is expected to improve from an account of both higher oil prices and output, as well estimated surplus of 0.6 percent of GDP to 3.0 as a modestly depreciated Naira in 2017, while non- percent of GDP in 2017. Both imports and exports oil and other revenues are projected to modestly of goods and services will increase, but exports increase from 1.2 percent of GDP in 2016 to 1.3 (mainly oil exports) will likely increase at a faster percent in 2017, as the Federal Government pace, from an estimated 9.3 percent of GDP in 2016 intensifies its non-oil GDP revenue administrative to around 13 percent of GDP in 2017. Imports are reform efforts. expected to recover more slowly due to uncertainty around the foreign exchange policy regime. On the 30. While the excess oil revenue derivable basis of improved foreign exchange supply as a from a higher-than-benchmarked oil price is result of foreign reserves growth, imports will assumed to be saved, the fact that oil output is still increase from an estimated 11.5 percent of GDP in 2016 to 12.8 percent in 2017. 14 The figure excludes inflows that are financing items rather than revenue/inflows. 26 2.2. Government Policy Response: (including the World Bank, International Monetary The Nigeria Economic Recovery and Fund and African Development Bank), the National Growth Plan (ERGP) Economic Council (NEC) and the National Assembly. 33. In recognition of the deep weaknesses of the economy and the potential for further 34. The ERGP serves as an umbrella' weakening, the Federal Government has framework that incorporates 60 strategies, of developed an Economic Recovery and Growth which 12 – including infrastructure, industrial Plan (ERGP) for the period 2017–2020. Released and power sector development – have been on March 7, 2017, the ERGP lays out the identified as priorities (boxes 2.1 and 2.2). The Government's strategy for achieving the Federal Ministry of Budget and National Planning is Government's vision of sustained and inclusive coordinating the development of action plans growth. The Plan aims at economic recovery in the containing the detailed activities, milestones, shortterm, and structural reforms aimed at timelines and key performance indicators and diversifying the economy to set it on a path toward targets for each of these strategies. The detailed sustained and inclusive growth over the medium to action plans are due to be unveiled by the end of longterm. The process for developing the ERGP was April 2017. A delivery unit will be set up in the broadly consultative and involved engagement with Presidency to oversee implementation of the ERGP a range of stakeholders, including academics and alongside the Ministry of Budget and National other economic experts, the organized private sector, Planning. civil society groups, organized labor, sub-national governments, international development partners Box 2.1: The Nigeria Economic Recovery and Growth Plan 2017 -2020 The three broad strategic objectives of the ERGP are to (a) restore growth;(b) invest in human capital; and (c) build a globally competitive economy. The 12 strategic priorities for executing the Plan fall into five main categories: a. Stabilizing the macroeconomic environment 1. Align monetary, trade and fiscal policies 2. Accelerate non-oil revenue generation 3. Drastically cut costs 4. Privatize selected public enterprises/assets b. Achieving agriculture and food security 5. Deliver on agricultural transformation c. Ensuring energy sufficiency (power and petroleum products) 6. Urgently increase oil production 7. Expand power sector infrastructure 8. Boost local refining for self -sufficiency d. Improving transportation infrastructure 9. Deliver targeted high priority transportation projects 10. Enable private sector financing of infrastructure e. Driving industrialization, with a focus on small and medium-size enterprises 11. Improve the ease of doing business 12. Accelerate implementation of the National Industrial Revolution Plan . 27 35. The ERGP sets the ambitious target of 7 Nigeria's growth story, and sets a growth target for percent real GDP growth by 2020, initially driven the agriculture of over 8 percent by 2020. The by the oil sector and then increasingly by strong authorities also anticipate strong growth in the non-oil sector growth (agriculture, manufacturing sector, particularly in agro- manufacturing and services). From the negative processing and in food and beverage manufacturing. growth of -1.5 percent recorded in 2016, Nigerian Ongoing strategies to improve the ease of doing authorities project that real GDP will accelerate to business are expected to boost other manufacturing 7.0 percent in 2020 (Table 2.1). Strong recovery and sector activities, including light manufacturing. expansion of crude and natural gas production is Overall, the ERGP estimates an average annual expected by FGN in 2017, as challenges in the oil- growth of 8.48 percent in manufacturing between producing areas are overcome. Investment in the 2018 and 2020, rising from -5.8 percent in 2017 to sector is also expected to begin to increase. The 10.6 per cent by 2020. Furthermore, services, Federal Government estimates the average price of already the largest sector in the GDP, are expected to crude oilat USD 42.50–52.00 over the Plan period, grow at an average annual rate of 2.5 percent during while output is forecast to rise to 2.5 mbpd by 2020. the Plan period. The ERGP has a strong focus on agriculture, which is expected to continue to play an important role in Table 2.1: Nigeria Economic Recovery and Growth Plan Projections (Federal Government) Implement the ERGP 2017 2018 2019 2020 Growth Scenario GDP growth (percent) 2.2 4.8 4.5 7.0 Oil Production (mbpd) 2.2 2.3 2.4 2.5 Oil Price Benchmark (USD) 42.5 45 50 52 Inflation (percent) 15.7 12.4 13.4 9.9 Per capita GDP (USD) 2,542 2640 2,731 2,854 Unemployment (percent) 16.32 14.51 12.90 11.23 Net job creation (million) 1.5 3.8 4.3 5.1 Poverty Poverty rate decline from to 50-55 percent by 2020 Source: ERGP 36. Considering the severe and multifaceted Nigeria Integrated Infrastructure Master Plan, the challenges that Nigeria faces, the ERGP is an Medium-term Expenditure Framework (MTEF), the important step forward. It is a reform strategy that “7 Big Wins” in the Oil and Gas Sector Initiative and seeks to be comprehensive in addressing the the Power Sector Recovery Plan (Box 2.2) that has country's challenges. The Plan contains a generally recently just been approved by the Federal Executive frank assessment of Nigeria's economy, its Council (FEC). Central to the sustainable economic vulnerabilities and the underlying structural recovery and growth, the Power Sector Recovery weaknesses (dependency on oil for revenues and Plan is promising, with strategies to restore financial exports) and governance challenges, recognizing the viability to the Nigerian Power Sector, improve role of 'previous economic policies, deplorable transparency and service delivery. Furthermore, the infrastructure, corruption and mismanagement of Plan sends some positive signals on further policy public finances'. In addition, it leverages, and is adjustments to ensure much-needed macroeconomic generally consistent with other plans and strategies, recovery. including the National Industrial Revolution Plan, the 28 Box 2.2: The Nigeria Power Sector Recovery Program The Ministry of Power, Works and Housing and the Ministry of Finance are committed to taking urgent and decisive actions that are needed to put the power sector on a track of sustainable development. Three years after privatization, the power reform program has not yet delivered substantial improvement in electricity services and the sector is in a state of emergency. The privatized Generation Companies (GENCOs) and Distribution Companies (DISCOs) may be insolvent. Unless power sector market failures are addressed, there could be further deterioration in power supply and the power sector reform program itself may not deliver the anticipated results. This would have a calamitous impact on the country's ability to revive growth and restore confidence for private investments. In view of the urgent need to address the dire challenges within the power sector, a Power Sector Recovery Program (PSRP) has been developed. The Federal Executive Council (FEC) of the Federal Government of Nigeria (FGN) approved the Power Sector Recovery Program on March 22, 2017. The PSRP approved by FEC will be further elaborated in the coming months as implementation details are defined. It will be adjusted as necessary to take account of changing circumstances during its implementation. Key objectives of the Program The objectives of the PSRP are to restore the sector's financial viability; to improve power supply reliability to meet growing demand; to strengthen the sector's institutional framework and increase transparency; to implement clear policies that promote and encourage investor confidence in the sector; and to establish a contract-based electricity market. Components of the Recovery Program The plan outlines specific strategies for achieving the above objectives. These are presented under the following components: · Eliminate of cash deficits that have accumulated in the past through to December 2016, including through the full disbursement of the Central Bank's Nigerian Electricity Market Stabilization Facility (“NEMSF”) · Implement an end user tariff trajectory that ensures cost reflective tariffs in the next 5 years · Funded payment of future sector deficits · Ensure DISCO performance and accountability, including through the enforcement of commitments made in Performance Agreement signed with the Bureau of Public Enterprises (BPE) and reflected in the tariffs at privatization · Ensure grid stability by attaining effective and dependable generation and distribution of at least 4,000MW in order to build confidence with consumers · Ensure that accumulated MDA electricity debts are paid and implement payment mechanism for future bills, including through the introduction of a system where bills are paid centrally on behalf of MDAs and deducted from their budgetary allocations · Improve sector governance, including through the appointment of vacant boards in all the sector institutions · Increase electricity access by implementing off grid renewable solutions · Develop and implement an FX policy for the power sector · Make contracts effective where penalties are imposed on sector participants that fail to fulfill their contractual obligations Implement a comprehensive communication strategy that results in buy-in of all sector stakeholders and Nigerians into the PRSP 29 37. However, certain aspects of the ERGP potential amounts derivable from each source. The appear more challenging, especially on growth effectiveness, governance and sustainability of targets, the financing of the plan and the current development financing schemes, including subnational governments' support and CBN directed financing at priority sectors, need to be contributions. Firstly, the GDP growth targets are evaluated and improved before appropriately very optimistic, given the weaknesses of the expanded. Increasing private sector financing will current macroeconomic policy framework and the require restoring investor confidence and implementation risks associated with the establishing the necessary regulatory and structural reforms in the ERGP. The growth institutional frameworks, especially for Public- scenario presented in ERGP assumes full oil sector Private Partnerships (PPPs). recovery, macroeconomic stabilization and full implementation of ERGP strategies, including fiscal 39. Lastly, the strategy for engaging and stimulus, major infrastructure investment and other incentivizing sub-national governments in structural reforms. On the macroeconomic front, the delivering the outcomes of ERGP implementation ERGP contains insufficiently detailed commitments is not fully articulated. Many of the ERGP on further policy adjustments to fully restore strategies, in particular strengthening fiscal credibility and confidence among the private sector transparency and sustainability, improving the and investors; for example, the ERGP discusses the business environment, governance and local service need to move to a more market-determined, delivery rely on state and local governments (SLGs) competitive exchange rate, but contains no firm to implement reforms at the subnational level. policy commitments and time frame for removal of remaining foreign exchange restrictions. The Bank 40. The credibility of the plan – whether it can estimates that without adjustments in monetary and restore confidence in the government and exchange rate policies, and some substantive tax economy - depends heavily on its implementation. policy reforms15 and mitigation of the implementation Rapid identification and expedited delivery of some risks of the structural reforms, real GDP growth “quick wins” will be very useful to establish would only recover to just above 2 percent by 2018 credibility. The credibility of the ERGP will depend and remain at around 2-2.5 percent through the on showing concrete progress in implementing the medium term. reform program. A positive start to the ERGP implementation is the approval of the Power Sector 38. Secondly, the ERGP also contains little Recovery Plan in March 2017, a major milestone in discussion on the estimated costs and financing achieving one of the 12 priorities. sources for implementing the Plan. The various financing sources (public financing through the budget, development financing programs and private sector financing) need to be assessed, including the 15 For example, rationalization of existing tax incentives, raising of selected tax rates such as standard VAT rates or excises on tobacco and alcohol. 30 2.3 Risks to Economic Outlook relies on favorable external conditions. Further policy adjustments, including removal of remaining 41. The risks to the economic outlook foreign exchange restrictions, and improving the presented above are significant. Nigeria's transparency and functioning of the interbank economic recovery in the short term is highly exchange rate is needed. dependent on recovery of the oil sector, both directly through oil revenues, and indirectly through 43. The budget remains dependent on oil spillovers (especially through foreign exchange revenues; significant revenue shortfalls would availability) on non-oil sectors and revenues for all lower government capital spending as well as tiers of government. Oil production (projected at 2.1 consumption. This would jeopardize important mbpd in 2017 by the World Bank) is susceptible to development spending, including for the ERGP. The downside risks, including from unrest in the Niger Government needs to continue its efforts to improve Delta, which is not yet fully stabilized; and from non-oil revenues by complementing tax barriers to implementation of Joint Venture cash call administration initiatives with selected tax policy arrangements. Any shock to global oil prices or reforms. domestic production can derail the fragile economic recovery. 44. Incomplete implementation of the structural reforms outlined in the ERGP would 42. In the absence of a foreign exchange affect the ability of the Government to set the regime that promotes a predictable inflow of economy on the path of sustained and inclusive foreign exchange, Government's foreign reserves growth over the medium to long term. Therefore, constitute the main source of foreign exchange to the Government must begin to vigorously the economy. The CBN has used the rising reserves implement the reforms contained in the ERGP to (which grew from USD23.9 billion at end-October ease the constraints on the non-oil sector, which is 2016, to USD25.8 billion at end-December, and then expected to drive growth over the medium to long 16 to USD29.6 billion at end-February 2017) to pump term, starting with identified high-impact quick considerable volumes of foreign exchange into the wins. markets. However, this method of improving liquidity is not a sustainable long-term strategy, as it 16 Thirty-day moving average. 31 Table 2.2: Key economic indicators and short-term projections 2014 2015 2016 e 2017 f Real GDP growth, at constant market prices 6.3 2.7 -1.5 1.2 Private consumption 0.6 1.4 -0.8 -1.3 Government consumption -7.0 -11.9 -20.9 -4.6 Gross fixed capital investment 13.4 -1.3 -13.0 0.1 Exports, goods and services 24.1 -0.3 -5.2 10.6 Imports, goods and services 6.0 -26.9 -31.7 3.1 Real GDP growth, at constant factor prices 6.2 2.8 -1.5 1.2 Agriculture 4.3 3.7 4.1 4.7 Industry 6.8 -2.2 -8.5 2.6 Services 6.8 4.8 -0.8 -1.0 Inflation (CPI) 8.1 9.0 15.6 16.5 Current account balance (% of GDP) 0.2 -3.2 0.6 3.0 Fiscal balance (consolidated government, % of GDP) -1.8 -3.5 -4.7 -5.0 Debt (consolidated government, % of GDP) 12.5 13.2 17.0 21.5 Poverty rate Poverty rate ($2.5/day PPP terms) 49.4 49.4 50.2 50.5 Poverty rate ($4/day PPP terms) 73.7 73.7 74.3 74.5 Source: World Bank and IMF staff projections . 32 Chapter 3: Economic Growth in Nigeria: Past Determinants and Future Prospects 17 20 3.1 Aggregate Growth Patterns and the Impact percent of its foreign-exchange earnings. By 1970, however, oil had become the country's largest of Oil on the External and Fiscal Sectors export, and by 1975 it comprised 94 percent of total 45. Over the last four decades, Nigeria's GDP goods exports—a share that has remained broadly growth rate did not keep pace with those of more unchanged until now. From the 1970s through 2012, developed economies, reflecting an all-too- the oil sector accounted for about 80 percent of total common experience among commodity Federation receipts.21 However, in 2015 and 2016, exporters. In 1970, Nigeria's per capita GDP was the simultaneous decline in oil prices and production equal to 5 percent of the OECD average, but by 2014 caused this share to fall to 63 percent. While GDP it had fallen to 3 percent. Many other commodity growth averaged 5.7 percent between 2006 and producers, including Venezuela, Gabon, and 2016, volatile oil prices drove the growth rate to a Mexico, experienced a similar relative decline, but high of 8 percent in 2006 and to a low of -1.5 percent some, such as Botswana, Chile, Indonesia, and in 2016. Colombia, managed to narrow the GDP gap with more advanced economies. The literature has 47. Because oil exports represent the identified two critical determinants of economic overwhelming majority of Nigerian exports, the success among commodity exporters: institutional inherent volatility of global oil prices is quality and productivity growth in the non-resource transmitted directly to the external balance sectors. 18 Previous analyses have found that (Figure 3.1). Although oil prices recovered after the Nigerian oil exports heightened the country's global financial crisis, Nigeria ran only a small exposure to macroeconomic volatility, crowded out current account surplus between 2010 and 2014. The the production of other tradable goods (Dutch substantial decline in oil prices led to a current disease), increased inequality, and contributed to account deficit in 2015 for the first time since 1998. 19 violent conflict. With falling capital inflows, Nigeria's foreign reserves declined. In response to the oil production 46. Oil continues to drive the country's shocks in 2016, import compression policies growth pattern, despite representing only 14.5 (including restrictions on foreign exchange percent of GDP in the past decade, as it continues allocations) were adopted to bring the current to dominate export earnings and public revenues. account back into a small surplus by the end of Nigeria began producing oil in the late 1950s. In the 1960s, Nigeria was a major producer of palm oil, palm kernels, groundnuts, cocoa, and rubber; together, agricultural exports generated about 75 17 This chapter summarizes the findings of a forthcoming World Bank report: Towards Sustainable Growth in Nigeria: Empirical Analysis and Policy options (Authors: Santiago Herrera et al., forthcoming) 18 Acemoglu and Robinson (2014) focus on institutional quality, while much of the literature highlights the role of productivity growth in accounting for differences between successful and unsuccessful resource exporters. See Casseli, 2005, and Klenow and Rodriguez-Clare, 1997. 19 Ross, 2003. Fesnke and Zurimendi, 2015. 20 Akindele, 1986. 21 Budina and VanWinbergen (2008) report oil revenue for the 1970s and 1980s. 33 2016. These policies had a significant negative imported inputs, including manufacturing and retail impact on the growth on non-oil sectors reliant on trade. Figure 3.1: Global oil prices and Nigeria's current account balance (1996-2016) and fiscal balance (2000-2016) 25 60 40 15 20 5 0 -5 -20 -15 -40 Current account balance (Percent of GDP, LHS) Oil Price (Annual Percentage Change, RHS) -25 -60 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 10 60 40 5 20 0 0 -20 -5 -40 General government balance (Percent of GDP, LHS) Oil Price (Annual Percentage Change, RHS) -10 -60 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sources: World Development Indicators, Central Bank of Nigeria, IMF. 48. Revenue from oil is extremely volatile, and if this volatility is directly transmitted to savings when oil prices were high and then using the government spending (Figure 3.1) fiscal policy savings to supplement revenues when oil prices were becomes pro-cyclical. In Nigeria, the standard low. The FRA was adopted in 2007 and the SWF in deviation of oil revenue is seven times larger than that 2011. The ECA balance increased from USD3 of non-oil revenue.22 Prior to 2010, the consolidated billion in 2004 to USD20 billion in 2008 (Figure fiscal balance tracked changes in the oil price, with 3.2). In 2009, international oil prices fell, and unrest rapidly rising prices accompanied by significant in the Niger Delta region disrupted output. Crudeoil fiscal surpluses before the oil price decline in 2009. exports dropped from USD75 billion in 2008 to After 2009, despite recovering oil prices, the fiscal USD48 billion in 2009. The Government balance did not significantly improve. successfully used the ECA as a fiscal buffer and its international reserves as an external buffer. 49. Nigeria has made some progress towards However, the ECA was almost exhausted by 2010, counter cyclical fiscal policy by adopting several and its balance was never fully replenished even as fiscal savings and stabilization mechanisms, oil prices rebounded and reached all-time highs in including the Excess Crude Account (ECA), the 2011-13. A number of factors played into this: (a) the Fiscal Responsibility Act (FRA), and the slight decline in oil production from 2012 despite Sovereign Wealth Fund (SWF). However, these high oil mechanisms are not fully effective. In 2004, the Government established the ECA to stabilize oil revenues going into the budget by accumulating 22 IMF, 2015. 34 prices; (b) the growth in cash calls financed directly intensified expenditure pressures. The adoption of from oil revenues; and (c) most importantly, the the FRA in 2007 and an Act establishing the SWF in escalating costs of fuel subsidies in 2011-2014, 2011 largely failed to remedy this situation, and the financed directly from oil revenues outside of the balances in the ECA and SWF rose only marginally. budgetary and fiscal responsibility framework. The absence of a robust legal framework for the operation of the ECA gave rise to political controversy and Figure 3.2: Crude oil exports, international reserves, ECA and SWF balances 50. The volatility of spending is associated is detrimental to growth because it disrupts the with volatility of consumption, which imposes implementation of investment projects with long welfare losses. Household consumption volatility lead times, including investments in infrastructure imposes significant welfare costs because consumers and human capital development. prefer smooth consumption paths rather than uncertain and volatile ones.23 Poor households are 51. The international literature shows that especially vulnerable to consumption volatility, and pro-cyclicality is associated with lower rates of their risk management strategies often include economic growth.24 Over the past five decades, extreme measures such as reducing calorie intake, Nigeria's fiscal policy has been among the most pro- foregoing healthcare, or withdrawing children from cyclical in the world,25 with increases in revenue school to contribute to household labor, with deeply during economic expansions tending to increase negative implications for long-term consumption and expenditures. 26 Avoiding the voracity effect requires welfare. Hence, the gains from reducing volatility strong fiscal rules governing revenue increases, but will disproportionately benefit lower-income Nigeria's legal framework for fiscal savings and households. In addition, public expenditure volatility counter cyclical stabilization remains inadequate. 23 For a review of the literature, see: Loayza, Rancierre, Serven and Ventura, 2007. 24 Fatas and Mihov, 2013. 25 Frankel et al., 2013. 26 Talvi and Vegh, 2005. 35 3.2 Growth and Productivity Decomposition a prolonged downturn in oil prices, and the third (2000-2014) reflects the more recent commodity 52. The linkage between the quality of public boom of the 2000s, when oil prices rose as the institutions and the impact of oil on overall global economy rapidly expanded.The analysis GDPduring the past four and a half decades uses a standard growth decomposition, in which can be demonstrated from a decomposition of GDP growth is attributed to underlying increases Nigeria's historical GDP growth during three in human capital, physical capital, or Total sub-periods (Table 3.1). The first (1971-1984) Factor Productivity (TFP). corresponds to Nigeria's initial oil boom, when oil prices were high and production was rising rapidly. The second (1985-1999) coincides with Table 3.1: Nigeria Growth Decomposition, 1971-2014 (annual average % change) GDP Growth Human Capital Physical Capital TFP 1971-2014 0.9 0.2 0.5 0.2 · 1971-1984 -2.2 -0.4 2.5 -4.3 · 1985-1999 0.7 0.5 -0.9 1.2 · 2000-2014 3.9 0.4 0.3 3.2 Source: Herrera et al., forthcoming. 53. During Nigeria's initial oil boom of 1971- most governance indicators moderately improved 1984, physical-capital accumulation was the during this period, underscoring the importance of primary driver of growth, while TFP growth was institutional quality. deeply negative and overall GDP contracted. Previous studies have found that the oil boom in 55. Aggregate TFP data can obscure Nigeria caused an extreme increase in economic important productivity changes arising from the inefficiency, as the capacity utilization rate fell from movement of resources among sectors with about 80 percent in the mid-1970s to 40 percent by different productivity levels. The existence of large 1984. 27 productivity gaps among sectors implies an inefficient allocation of productive resources. As 54. By contrast, the commodity boom during these resources, especially labor, shift from less the 2000-2014 period was characterized by rapid productive to more productive sectors, overall TFP growth, supported by more modest gains in productivity increases and growth accelerates.29 human and physical capital. This period marked Recent research shows that gaps in productivity Nigeria's return to democracy and the launch of major among sectors are common worldwide, economic and governance reforms, including the privatization of state-owned enterprises, civil service reforms, enhanced banking sector supervision, and 28 trade reforms. Capital utilization also increased and 27 Sala-i-Martin et al., 2012. 28 Okonjo-Iweala et al., 2007. 29 McMillan and Rodrik, 2011. 6 36 Prepared by Nigeria MFM Team but that these gaps tend to be larger in poorer have contributed to Nigeria's economic growth, countries. Narrowing these productivity gaps can this effect is entirely explained by productivity boost per capita growth in developing countries by an differences between the resource and non- estimated 50 percent.30 resource sectors. Minor employment gains in the resource sector, coupled with large differences in 56. Recent sectoral growth studies have productivity between the resource and non-resource revealed a vast disparity in labor productivity sector, accounts for the improvement in overall between Nigeria's resource and non-resource productivity. When the resource sector is excluded sectors, as well as significant productivity gaps from the analysis, the positive effect vanishes, and 31 within the non-resource economy. The non- the increase in productivity from labor reallocation resource sectors with the highest labor productivity becomes insignificant. Increasing the productivity- are services, including wholesale and retail trade, enhancing effect of reallocation would require a finance, insurance, and real estate, and construction; policy framework that reduces both domestic and while productivity is lowest for utilities, the public international barriers to the mobility of factors. sector, and agriculture. These disparities are large by Barriers to factor mobility typically include trade international standards (Table 3.2), and they suggest policy (tariffs and non-tariff barriers), inadequate that reallocating resources, labor and capital from the labor force skills and low access to finance – all of least productive sectors to the most productive ones which are present in Nigeria, as shown in the next could yield significant gains in overall productivity. sections. 57. While shifts in employment among sectors Table 3.2: Ratio of maximum to minimum labor productivity by sector, Nigeria and comparators, 1974-2011 Excluding Country or Aggregate 9 Sectors* Resources High-Income Countries 30 Upper-Middle-Income Countries 48 Lower-Middle and Low-Income Countries 174 Nigeria 1,803 29 Indonesia 72 17 Mexico 64 26 South Africa 19 19 Kenya 22 22 Source: Lennon, 2016. 30 Sinha, 2016. 31 Lennon, 2016. 37 3.3 Determinants of Economic productivity is directly associated with worker education. A better-educated labor force increases Growth – Cross-Country Analysis not only labor productivity but also labor mobility, which facilitates structural transformation. 58. This section presents the main findings of a 151-country empirical analysis covering the 61. Abundant natural resources can be period of 1970 to 2014 on the determinants of GDP 32 either a blessing or a curse; when institutional growth. The analysis looked at the correlation with quality is accounted for in the model, natural growth of education, government consumption, r e s o u r c e s m a ke a m o d e s t b u t p o s i t i v e inflation, currency misalignment, trade openness, contribution to growth. Natural resources can investment, institutional quality, and natural resource affect a country's long-term growth and rents. development through both macroeconomic and political economy channels. Large-scale resource 59. The results underscore the importance of exports can lead to an appreciation of the real macroeconomic management and stability for effective exchange rate, eroding the growth: inflation and government consumption competitiveness of the non-resource tradable were highly significant in all model specifications, sectors through a common phenomenon known as as were investment and trade openness. Inflation “Dutch disease.”The empirical analysis showed an and government consumption are inversely ambiguous relationship between natural resources correlated with growth, while trade openness and and growth, with a positive relationship for the investment are directly correlated with growth. entire sample group of countries but a negative Currency undervaluation is positively associated relationship in Nigeria. However, after controlling with growth, consistent with the findings of previous for both the rule of law and corruption in Nigeria, analytical work 33 . The model estimates that a natural resources appear to have had a positive and 25percent currency overvaluation would reduce statistically significant effect on growth. This growth by 1.25 percentage points versus the highlights the importance of developing strong and counterfactual. resilient institutions to ensure that natural resources are a blessing and not a curse. 60. Education is positively associated with growth, with returns to investment in education 34 62. However, the analysis also confirms the higher in developing economies such as Nigeria. negative association between natural resources Despite improvements since 1999, two-thirds of Nigeria's population still had no secondary education and institutional quality found in other studies, 35 in 2011 and the quality of educational services so developing strong institutions in a resource- remains low. The World Economic Forum ranks rich setting is likely to be challenging. Natural Nigeria last among all countries surveyed in terms of resource rents can represent an enormously valuable public health and primary education. This result is income stream. confirmed by micro-level data, which find that firm 32 Raggl, 2016 using standard cross-country panel framework. The model's growth determinants included the level of GDP per capita at the beginning of each period to control for conditional convergence effects. Human capital was proxied by the share of the working-age population with tertiary education. To reflect relative trade openness, the model included the ratio of imports plus exports to GDP. 33 Rodrick, 2008. 34 In particular, the coefficient of this variable in the case of Nigeria is not only statistically significant, but significantly larger than the coefficient for the complete sample. 35 Beegle et al., 2015 38 63. Without an adequate system of checks and · Scenario 1 shows the impact of an balances, competition among interest groups vying increase in oil revenue (from 8.2 percent of for control of these resources can promote patronage GDP to 11.8 percent by 2025) due to and clientelism, encourage political corruption, or recovery in oil price over the medium- even fuel armed violence. These detrimental effects term.37 This has limited impact on growth, on the institutional environment can discourage boosting per capita GDP growth rate by productive investment and inhibit the long-term only 0.3 percent a year by 2025, revealing growth of the non-resource sectors, especially the the oil sector's limited potential to drive domestic financial market, further intensifying the medium-term growth. economy's dependence of natural resources.36 · Scenario 2 uses the same higher oil price projections as Scenario 1 and assumes 64. Increases in physical capital investment, that educational indicators will 38 gains in education, and improvements in improve, government consumption will 39 institutional quality would have a more decline, physical capital investment will 40 substantial impact on growth than high oil prices. increase, and the economy will become The sensitivity of Nigeria's growth rate to these more open. Given these assumptions, the determinants in the medium to long term has been per capita GDP growth rate is expected to simulated. Figure 3.3shows 4 potential scenarios for accelerate rapidly, reaching 3.8 percent by growth in per capita GDP over the period 2015 to 2025, 1.2 percent higher than in Scenario 2040: 1. · Scenario 3 incorporates the same · Scenario 0 is the baseline scenario, which assumptions as the second scenario and assumes that current trends in the adds improvements in institutional determinants of growth (i.e., no change) will quality. Under this scenario, Nigeria's rule- persist over the medium term. Per capita of-law indicators would improve and GDP growth rate is projected to reach 2.2 corruption indicators would fall.41 Nigeria's percent per year by 2025. per capita GDP growth rate would reach 4.3 percent by 2025, 0.5 percent higher than 36 Raggl, 2016; Lane and Tornell, 1996; Holder, 2006; Mehlum et al., 2006; Badinger and Nindl, 2014; Beck et al., 2000. 37 World Bank, 2016. Oil prices are projected to reach USD60 /bbl by 2020 and USD80 by 2025. 38 The percentage of working age population who have completed secondary and tertiary education would increase from 40 percent to about 50 percent by 2025. 39 Decrease by 0.5 percent of GDP in each five-year period. 40 Increase by 2 percent of GDP in each five-year period. 41 The rule-of-law indicator would increase by 5 percent in each five-year period, while the control-of-corruption indicator would decrease by 10 percent in each five-year period. 39 Figure 3.3: Actual and predicted per capita GDP growth rates (percent) under the baseline and alternative scenarios, 2005-2040 (in 5-year periods) 10 8 6 4 2 0 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 -2 -4 -6 -8 Actual Growth Rates Baseline/Scenario 0 Scenario 1 Scenario 2 Scenario 3 Source: Herrera et al., forthcoming. Note: The growth model by Raggl works with 5 year averages. The last actual period is 2010-2014; while 2015 to 2040 are model predictions. 3.4 Constraints to Firm Productivity and Doing Business in Nigeria 65. In an economy where the public sector is employment and increasing firm productivity (labor very small (total government spending was an productivity and value-added per worker). Analysis average of 14.1 percent of GDP in 2010-2015), of firm-level data from the World Bank's Nigeria growth has to be private-sector led, through rising Enterprise Survey can shed light on the key constraints to raising firm productivity. Figure 3.4: Most important obstacles to doing business in Nigeria, 2008 and 2014 80 75 Percent saying area is major or 60 55 severe obstable 47 35 38 40 28 28 25 24 22 19 20 15 12 15 13 14 15 10 4 5 0 2008 2014 Electricity Access to finance Corruption Political Instability Tax rates Transport Crime Tax administration Licencing and Permit Courts Source: Herrera et al. using panel data from the World Bank Enterprise Surveys . 40 66. The most important constraints to doing 68. The importance of trade for Nigeria's business reported by Nigerian firms are an growth prospects is supported by firm-level data, inadequate electricity supply, the prevalence of which show that higher levels of productivity are corruption and political instability, and limited associated with a greater propensity to import raw access to finance. The relative importance of both materials and to export, 43 and with a greater electricity and finance has decreased over time, but likelihood of foreign participation in the ownership corruption and political instability have not (Figure structure. 42 3.4). The most frequently cited obstacles to doing business differ across regions. Electricity is the most 69. However, Nigeria's trade policies have important obstacle in all regions except the had a negative impact on the allocation of northwest, where corruption is cited as the top productive resources. Combining the Enterprise constraint, followed by political instability. Younger Survey data with the World Bank's Tariff Reform 44 firms, exporters, and manufacturers are most likely to Impact Simulation Tool shows that the existing identify crime, insecurity, corruption and electricity tariff structure systematically increases the access as the key obstacles. Easing these constraints profitability of the country's least productive sectors are consistently associated with higher levels of firm such as apparel, textiles, and wood products, while productivity. Nigerian firms estimate the average leaving the profitability of more productive sectors cost of power outages at about 17 percent of sales. unchanged. In other words, the tariff system Lower corruption affects firm productivity indirectly incentivizes the reallocation of factors toward less- by encouraging investment. efficient economic activities. A hypothetical 10 percent increase in tariff rates would boost the 67. Transportation infrastructure, in profitability of the median firm, but profitability particular roads, is also likely to remain a major would increase most in the country's least productive constraint, especially for the non-oil sectors, sectors. These findings indicate that Nigeria's trade despite improvements in the Doing Business survey. policies inhibit productivity-enhancing structural The lack of transportation infrastructure hinders the transformation. The analysis also finds no evidence natural expansion of the huge non-oil growth that Nigeria's tariffs are contributing to employment agglomeration of Lagos and explains why so many growth. In fact, Nigeria's current trade policy manufacturing firms operate within Lagos, where disadvantages several major sources of employment congestion and very high rents limit their growth, including the retail and hotels and competitiveness, while the economies of restaurants sectors, by increasing prices for their neighboring areas stagnate. inputs and capital goods. The most heavily protected sectors are unprocessed tobacco, apparel, textiles, and leather goods. Retail and hotels and restaurants each contribute more to total employment than all of these sectors combined. 42 Figure 3.4 reports the percentage of firms that rated each constraint as a major or severe obstacle to growth. 43 While causality could run in either direction—high productivity levels may encourage exporting, or exporting may tend to increase productivity—the evidence suggests that more productive firms are more likely to become exporters. 44 Shui and Voneuxkull, 2014, describe this methodology, which estimates the prices of final, intermediate, and capital goods under the current tariff structure and a zero-tariff counterfactual. These price variations imply changes in firm profitability based on the technology involved and the type of good or service being produced. The changes in profitability are short-run static gains derived using a partial equilibrium model. The same methodology was previously used to quantify the impact of Nigeria's adoption of the Common External Tariff. 41 3.5 Policy Implications for Sustaining Growth local governments must respect rules for commercial bank borrowing, including the 70. Both the cross-country growth and firm- necessary authorization from the DMO. level productivity analyses underscore the critical importance of (a) public capital investment, (b) Greater public investment, accompanied by a education, (c) openness to trade and effective stronger public investment management system, trade policy, (d) macroeconomic stability, (e) will be important to support long-term growth. strong public institutions and governance, (f) Nigeria's capital budget is roughly half the size of access to finance, and (g) reliable power supply in those of comparable countries, and the country laying the groundwork for robust and sustained suffers from a severe infrastructure deficit. The growth in Nigeria. Policymakers can accelerate World Economic Forum ranks Nigeria 132nd out of growth through a range of reform options, many of 138 countries for infrastructure quality. Nigeria's which complement and reinforce one another. past periods in which rapidly rising capital spending was accompanied by stagnant TFP growth underscore the pitfalls of focusing on the quantity Short-Term Policy Objectives: Macroeconomic rather than the quality of capital spending. A recent Stabilization and Greater Policy Predictability comparative study of public investment management systems ranked Nigeria in the bottom 71. Diversifying the sources of fiscal revenue fourth of countries worldwide due to serious and deploying an appropriate policy framework 45 deficiencies in project selection and evaluation. An to reduce expenditure volatility and pro- assessment of Nigeria's public investment cyclicality is key. Increasing non-oil revenue management system identified persistent through tax policy (for example, increasing VAT rates discrepancies between budgeted and actual capital and excise rates) and administration reforms could spending, driven by weak cash management and facilitate a sustained increase in public investment procurement practices. without undermining macro-fiscal stability. Nigeria's fiscal institutions are capable of delinking public 72. Given the close correlation among slow expenditure from the volatile revenue base, but growth, high inflation rates and exchange rate adjustments to the Excess Crude Account, the misalignment, further policy adjustments are Sovereign Wealth Fund and the Fiscal Responsibility needed–including slowing the growth in money Law are needed to increase their effectiveness. In supply to reduce inflationary pressures. The multiple particular, rules for deposits and withdrawals from exchange rates and large parallel market premium the SWF and ECA accounts should be more clearly suggest that the currency remains misaligned and detailed in a robust legal framework, coupled with further liberalization is needed. greater transparency in reporting and management accountability. The monitoring and enforcement of borrowing regulations and guidelines for sub- national governments could be strengthened to ensure that fiscal policy targets are achieved. Although many states have their own FRLs, state and 45 Dabla-Norris et al., 2011. 42 This can be achieved by removing foreign exchange 73. Macroeconomic policy adjustments need 46 restrictions and allowing the interbank foreign to be accompanied by structural reforms that will exchange market to function more freely and p ro m o t e e c o n o m i c d i v e r s i f i c a t i o n a n d transparently. In addition, the list of 41 items with productivity improvements. Nigeria's business and limited access to foreign currency in the interbank investment climate is far less hospitable than that of market belong mostly to low-productivity sectors other oil exporters or its regional peers. Indonesia, Mexico, Kenya and South Africa all outperform such as the food, wood, rubber and plastic products Nigeria on measures of infrastructure quality, ease of and apparel. Hence, the NTB reinforce the tariff 47 doing business, access to finance, quality of public structure which protects the least productive sectors. institutions, and human capital (Figure 3.5). These structural constraints tend to slow the movement of Medium-to-Long-Term Policy Objectives: labor and capital among sectors, and low factor Improving the Business Climate and Enabling mobility has been a major obstacle to Nigeria's Factor Mobility to Support Structural economic diversification and productivity growth. Transformation Figure 3.5: Structural determinants of long-term growth, Nigeria and country comparisons Human capital 1 0.8 Mexico 0.6 South Access to 0.4 Doing Africa finance 0.2 business Indonesia 0 Kenya Nigeria Infrastructure Institutions Source: Herrera et al., forthcoming. Note: For each of the five indicators, the country in Capital Index; the Doing Business score is based on the sample with the highest value was normalized, the World Bank's Doing Business report; the and the values for other countries were adjusted to Infrastructure score is based on the number of reflect that benchmark. The human capital score is electrical outages per month as reported in the IFC's based on the World Economic Forum's Human 46 In June 2015, the CBN restricted the foreign currency access of importers of 41 items, including rice, cement, wood products, iron, steel and textiles. The output contraction observed during the first quarter of 2016 was highest in sectors that use items on the CBN list as inputs. 47 Only 12 percent of Nigerian firms reported having a loan in 2014, an extremely low share by regional standards (Nigeria Enterprise Survey) 43 Enterprise Survey; the Access to Finance score reflects the improve educational attainment, access to finance share of Enterprise Survey respondents who reported (though the focus on expanding existing borrowing from a financial institution; and Quality of development finance schemes should be Public Institutions score is based on the Rule of Law accompanied by an evaluation of their effectiveness indicator in the World Bank's Worldwide Governance first), the ease of doing business, strengthen public Indicators. institutions and improve transparency and anti- corruption, expand transportation infrastructure and 74. 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