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### Viewing cable 03LAGOS147, The Economy in 2003: Triumph of Politics

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
03LAGOS147 | 2003-01-17 16:13 | 2011-08-25 00:00 | UNCLASSIFIED | Consulate Lagos

`

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

` `

    UNCLAS SECTION 01 OF 06 LAGOS 000147

    SIPDIS

    PARIS FOR OECD

    E.O. 12958: N/A
    TAGS: ECON EFIN ETRD BEXP PGOV NI
    SUBJECT:  The Economy in 2003:  Triumph of Politics

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

    Real Economy

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

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

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

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

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

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

    Fiscal Policy

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

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

    Monetary Policy

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

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

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

    Foreign Account

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

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

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

    Prospects for 2003

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

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

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

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

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

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

    HINSON-JONES

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