NIGERIA S PREPAREDNESS FOR MONETARY UNION IN WEST AFRICA THE ECO
Table of Contents 1. Introduction 2. The Eco: West Africa 3. A. A single-digit inflation rate at the end of each year B. A fiscal deficit of no more than 4% of the GDP C. A central bank deficit-financing of no more than 10% of the previous year s tax revenues D. Gross external reserves that can give import cover for a minimum of three months. E. Prohibition of new domestic default payments and liquidation of existing ones. F. Tax revenue should be equal to or greater than 20 percent of the GDP. G. Wage bill to tax revenue equal to or less than 35 percent. H. Public investment to tax revenue equal to or greater than 20 percent. I. A stable real exchange rate. J. A positive real interest rate 4. Is a single currency necessary? 2
Introduction In 2000, an official commitment to a common West African currency (the Eco) was stated at the launch of the West African Monetary Zone (WAMZ) 1. Since then, its implementation has been postponed a number of times 1 2020 is the latest date put forward 2. At the 4 th meeting of the Presidential Task Force on ECOWAS Currency Programme in Niamey, Nigeria s president, Muhammadu Buhari, poured cold water on the renewed drive to implement the Eco. Nigeria, he declared, was not in support of the 2020 date. We are concerned that we have not properly articulated and analyzed a comprehensive picture of the state of preparedness of individual countries for monetary integration in ECOWAS by 2020. 3 Taking its cue from the president s declaration, this report examines Nigeria s state of preparedness for the Eco. 1. Harvey, Simon K. and Cushing, Matthew J. (2015). Is West African Monetary Zone (WAMZ) a common currency area? Review of Development Finance, 5(1), pp. 53-63 https://doi.org/10.1016/j.rdf.2015.05.001 2. Yartey, Emmanuel (2015, June 17). West Africa s single currency reliant on economic growth. Retrieved from http://www.africanreview.com/finance/economy/west-africa-s-single-currency-reliant-on-economic-growth 3. Warami, Urowayino (2017, October 25). Buhari rejects same currency for W-Africa by 2020. Retrieved from https://www.vanguardngr.com/2017/10/buharirejects-currency-w-africa-2020/ 3
The Eco: West Africa The West African Monetary Zone (WAMZ) plans to introduce in the Eco as the common currency for non-cfa West Africa by 2020, and consequently merge it with the West African CFA franc. For this to be implemented, four primary and six secondary criteria must be met by each member state 4. Primary criteria: 1. A single-digit inflation rate at the end of each year 2. A fiscal deficit of no more than 4% of the GDP 3. A central bank deficit-financing of no more than 10% of the previous year s tax revenues 4. Gross external reserves that can give import cover for a minimum of three months. Secondary criteria: 1. Prohibition of new domestic default payments and liquidation of existing ones. 2. Tax revenue should be equal to or greater than 20 percent of the GDP. 3. Wage bill to tax revenue equal to or less than 35 percent. 4. Public investment to tax revenue equal to or greater than 20 percent. 5. A stable real exchange rate. 6. A positive real interest rate 4. https://www.vanguardngr.com/2017/11/nigeria-holds-keywest-african-single-currency/ 4
Nigeria s GDP at about $405billion is 78% of West Africa s GDP, and her population at about 200million is 55.25% of West Africa s population, making her crucial to the goal of actualizing the common currency. At the Niamey summit where President Buhari declared his opposition to the 2020 implementation date of the common currency, Marcel de Souza, president of the ECOWAS Commission, stated, too, that the goal of establishing a single currency among West African economies in 2020 had failed because the roadmap has not been implemented vigorously. We cannot move to the single currency in 2020, he added 5. Regardless, the Economic Commission for Africa (ECA) has been tasked to decipher the conditions that might accelerate the attainment of the common currency. While we await their report, it is pertinent to ask: does Nigeria meet the criteria for implementing the Eco? 5. https://www.vanguardngr.com/2017/10/westafrican-blocs-2020-single-currency-goal-fails/ 5
S/No Criteria for implementation of regional currency Nigeria s readiness 1 A single-digit inflation rate at the end of each year Not ready 2 A fiscal deficit of no more than 4% of the GDP Ready 3 A central bank deficit-financing of no more than 10% of the previous year s tax revenues 4 Gross external reserves that can give import cover for a minimum of three months. 5 Prohibition of new domestic default payments and liquidation of existing ones 6 Tax revenue should be equal to or greater than 20 percent of the GDP. Ready Ready Not ready Not ready 7 Wage bill to tax revenue equal to or less than 35 percent. Not ready 8 Public investment to tax revenue equal to or greater than 20 percent. Not ready 9 A stable real exchange rate Not ready 10 A positive real interest rate Not ready 6
8.00% 8.00% 11.80% 10.30% 9.60% 12.00% 18.55% 16% Nigeria s Preparedness For 1. A single-digit inflation rate at the end of each year The Inflation rate is the rate of rise or fall in the general price level in a country within a specified time. It describes a situation where too much money is chasing few goods, thereby increasing the prices of those goods and depreciating the value of money. Inflation is one of the major macroeconomic problems confronting Nigeria today. One of the prerequisites for the adoption of the common currency is a single-digit inflation rate, a prerequisite, as the table shows, Nigeria is far from achieving. Broadly, there are three causes of inflation in Nigeria: 1. Increase in real exchange rate 2. Dysfunctional monetary policy 3. Unchecked activities of businesses as it relates to price increase To achieve the single digit inflation rate, the Nigerian government must: 1. Adopt a consistent monetary policy stance 2. Aggressively pursue an import substitution scheme 3. Consider setting up a monopoly/antitrust regulation commission From the equation of the inflation trend line, we deduce that at optimum output (where output gap is zero), inflation rate in Nigeria will be 8.38% (autonomous inflation). Source: NBS 2010 2011 2012 2013 2014 2015 2016 2017 Fig: 1.0 Inflation rate in Nigeria 7
-2.04% -2.15% -1.82% -1.64% -1.34% -1.42% -0.93% Nigeria s Preparedness For 2. A fiscal deficit of no more than 4% of the GDP The attainment of sustained economic (GDP) growth is one of the macroeconomic goals of every government. To achieve this goal, Nigeria, like other countries, has relied on the use of fiscal policy. However, it has recently been observed that deficit financing and not the level of fiscal deficit (FSD) has significant impact on the growth of the Nigerian economy 6. This is because the maintenance of FSD is due to: 1. Extremely large recurrent expenditure 2. Over-inflation of contracts 3. The prevalence of unproductive projects. For Nigeria s FSD to drive economic growth, she must: 1. Strengthen its fiscal institutions 2. Depoliticize the budget formulation and implementation process 3. Reduce the current lending rate so as to ensure increased access to investment funds by domestic entrepreneurs. 4. Discourage external debt with high service rates and fiscal deficit financed principally via the Central Bank. 2010 2011 2012 2013 2014 2015 2016 2017 Source: NBS y = 0.0002x - 0.0168 Fig: 2.0 Fiscal deficit to GDP in Nigeria Despite rising FSD to GDP rate, Nigeria has consistently remained below the set benchmark of 4%. From the trend equation, in the past seven years (2010 2016), FSD to GDP in Nigeria grows at 0.02%. 6. https://www.arabianjbmr.com/pdfs/kd_vol_2_9/9.pdf 8
0.00% 0.22% 0 0.98% 1.17% 0.01% Nigeria s Preparedness For 3. A central bank deficit-financing of no more than 10% of the previous year s tax revenues Deficit financing arises each time the government has a budget deficit. It refers to borrowing by government to finance its planned excess expenditure over income. In Nigeria, the history of deficit financing dates back to 1978 when the nation absorbed a $1billion jumbo loan presumably needed for rehabilitation, reconstruction and development of Nigeria s post-war economy 7. The 2018 budget deficit, totaling about N2.01 trillion, will be financed mainly through new borrowings. The different sources of deficit financing are: 1. External and internal borrowing 2. Sales of government assets 3. Fiscal and/or monetary policy manipulations 4. The use of external reserves Whichever method(s) a country decides to employ will have effect on its: 1. Inflation rate 2. Capital formation and economic development 3. Income distribution 13.06% Nigeria has regularly met this requirement that CBN deficit financing be less than 10% of the previous year s tax revenue. The 2015 hike is most likely due to the elections and heavy spending on military hardware to combat insurgency. Source: NBS 2010 2011 2012 2013 2014 2015 2016 2017 Fig: 3.0 CBN FSD to previous year tax revenue in Nigeria 7.http://www.journalrepository.org/media/journals/BJEMT_20/2014/Jun/ Ojo4112014BJEMT10618_1.pdf 9
4. Gross external reserves that can give import cover for a minimum of three months External reserves consist foreign currencies, foreign deposits and bonds including gold and silver, special drawing rights (SDRs) and International Monetary Fund (IMF) reserve tranche positions held by Central Banks and monetary authorities of a nation. They are useful in: 1. Meeting balance of payments financing needs 2. Intervening in exchange markets 3. Supporting the local currency and economy However, idle reserves have opportunity as well as social costs. But how large a stash is enough? One common rule of thumb is that reserves that can cover three months' worth of imports are adequate 8. It therefore implies that external reserves exceeding the three months import benchmark might be excess, and their holding cost high. In any case, domestic efficiency should be prioritized in attaining satisfactory macroeconomic performance while ensuring exchange rate stability by holding an appropriate level of external reserves. 4.49 4.54 3.96 2.97 Source: NBS 3.25 2.85 2.55 2010 2011 2012 2013 2014 2015 2016 2017 Fig: 4.0 Foreign reserve to annual import cover 8. http://www.economist.com/node/16793524 Using years as proxy for months in the years under review, the volume of Nigeria s foreign reserves met the ECOWAS requirement only in 2010, 2012, 2013 and 2014. The sharp decline in 2011 and 2015 can be attributed to elections. 10
354 537 720 794 865 1,018 1,228 530 4,551 5,622 6,537 7,118 7,904 8,836 11,058 12,495 Nigeria s Preparedness For 5. Prohibition of new domestic default payments and liquidation of existing ones Since the early 1960s, the ratio of domestic debt to GDP in Nigeria has been increasing. The major factors responsible include high budget deficits, low output growth, large expenditure growth, high inflation rate and narrow revenue base. Since the 2006 debt forgiveness by the Paris Club, successive administrations have deliberately pursued a strategy of financing more than 50 per cent of annual fiscal deficits from the domestic market. Basically, Nigeria s domestic debt comprises of; 1. FGN bonds: currently constitute 67.39% of total domestic debt 2. Nigerian treasury bills: currently constitute 30.23% of total domestic debt 3. Nigerian treasury bonds: currently constitute 1.53% of total domestic debt 4. FGN Savings Bonds: currently constitute 0.05% of total domestic debt, and more recently 5. FGN Sukuk*: currently constitutes 0.80% of total domestic debt stock. *The maiden N100bn Sukuk is offered at N1,000/unit (minimum of N10,000 or 10 units) like a regular bond but represents an ownership interest in the asset (infrastructure) to be financed rather than a debt obligation. While Nigeria s domestic debt grew by 16%, domestic debt servicing only grew by 12% leading to a debt-servicing ratio shortfall of 3%. More worrisome is the sharp decline of debt to servicing ratio in 2017. Source: NBS 2010 2011 2012 2013 2014 2015 2016 2017 (sept) Domestic debt (Nbillion) Debt servicing (Nbillion) Fig: 5.0 Domestic debt and corresponding domestic debt servicing in Nigeria 11
5.20% 8.05% 8.36% 7.60% 7.02% 5.42% 4.86% Nigeria s Preparedness For 6. Tax revenue should be equal to or greater than 20 percent of the GDP The tax-to-gdp ratio gives policymakers and analysts a metric with which they can compare tax receipts from year to year. In most cases, because taxes are related to economic activity, the ratio should stay relatively consistent. Essentially, as the GDP grows, tax revenue should grow as well. However, in cases of major shifts in tax law or during serious economic downturns, the ratio can shift, sometimes dramatically 9. The state capacity (tax capacity, legal capacity and public administration capacity) determines the economic development or GDP growth of any state and vice versa 10. An IMF report indicated that that once the tax-to-gdp level of the average country reaches around 12.88 percent, its real GDP per capita increases sharply and in a sustained manner over several years 10. Less equitable distribution of national income could be a potential reason for a decrease in Tax to GDP ratio of a country. Some other reasons for perennial low tax to GDP ratio may include tax evasion, money laundering, lower tax rates, corruption, high poverty levels amongst others. 20% 15% 10% 5% 0% Source: NBS 2010 2011 2012 2013 2014 2015 2016 2017 Tax to GPD ratio ECOWAS recommendation Fig: 6.0 Tax to GDP ratio in Nigeria With a tax to GDP ratio declining at about 6%, Nigeria's tax compliance is rated as one of the lowest in the world. If Nigeria must meet the ECOWAS precondition, her fiscal policy requires serious reforms. 9. https://www.investopedia.com/terms/t/tax-to-gdp-ratio.asp 10. https://www.imf.org/external/pubs/ft/wp/2016/wp16234.pdf 12
7. Wage bill to tax revenue equal to or less than 35 percent Taxation is the mechanism through which governments obtains money from all categories of citizens/residents of a country, while wage bill refers to the total amount spent by government on its workers (civil servants) by way of salaries, wages and allowances. This precondition stipulates that government should only spend N35 of every N100 it collects from taxpayers on paying itself (civil servants). Only 40 million of Nigeria s 70 million taxable adults currently pay taxes, and only 13 per cent of these taxpayers have their taxes deducted at source under the PAYE scheme. The minimum wage in Nigeria is N18,000 ($50.40). Tax evasion has been an issue in Nigeria for decades with government at loss as to how to effectively curb the menace. Several factors contribute to tax evasion in Nigeria and they include: 1. Inequitable distribution of amenities 2. Misuse or mismanagement of tax revenue. 3. Inability of government/tax authority to census the actual taxpayers 4. Lack of civic responsibility from the public In Nigeria, wage bill constitutes about 47.4% of total recurrent expenditure. Fig: 7.0 shows significant progress in this regard from 2011 to 2014. Unfortunately, Nigeria s wage bill to tax ratio has been on the increase since 2015. 60% 52% 49% 34% 31% 32% 34% Source: NBS 2010 2011 2012 2013 2014 2015 2016 2017 ECOWAS recommendation wage bill to tax revenue Fig: 7.0 Wage bill to tax revenue in Nigeria 13
8. Public investment to tax revenue ratio equal to or greater than 20 percent Tax is collected from the whole society with differentiated intensity, inspired by considerations of justice, efficiency and effectiveness. Thus, it should ideally be largely used for public investment financing the supply of those goods for which it is costly or impossible to prevent consumption, goods that provide no incentive for private investors and that have positive externalities. Government expenditure on public investment (infrastructure development and maintenance of public institutions) is the third rationale for the existence of state after the provision of other services such as defense, law and order. Among factors that affect government expenditure in public investment are: 1. Infrastructure deficit 2. Natural GPD or potential output target 3. Public debt level 4. Fiscal deficit financing strategy 5. Long term real interest rate 31% 20% 17% 23% 17% Source: NBS 22% 19% 2010 2011 2012 2013 2014 2015 2016 2017 Public investment to tax ECOWAS Minimum Fig: 8.0 Public investment to tax revenue in Nigeria The total of capital expenditure was used to proxy public investment for the period. While the ratio fluctuated, there is a downward or declining trendline. Nigeria is struggling to meet this prerequisite. 14
2.77 5.44 3.36 5.14 29.44 12.90 Nigeria s Preparedness For 9. A stable real exchange rate Exchange rates are the amount of one currency you can exchange for another. Except for the Euro, most exchange rates are given in terms of how much a dollar is worth in the foreign currency. Most countries operate a flexible exchange rate policy, which means their exchange rates are determined by fluctuations in the foreign exchange market. The worth of a country s currency in the forex market is determined by: 1. The strength of its economy 2. Country s debt level 3. The Central Bank s interest rate. Nigeria s exchange rate policy has tended more towards the managed floating/flexible exchange rate, where the CBN frequently intervenes to support the naira. Here, the CBN announces an official exchange rate that a large percentage of Nigerians cannot have access to thereby creating demand for the forex parallel market (bureau de change). This disconnect can create scarcity of forex sometimes forcing the exchange rate as high as a hundred per cent over the official pegged exchange rate. 119.37 Exchange rate stability in Nigeria can be proxied using the difference between official and parallel market rates. From Fig: 9.0, we can deduce that the exchange rate in Nigeria is fast rising and unstable. Therefore, Nigeria have not met this ECOWAS prerequisite. Source: NBS 2010 2011 2012 2013 2014 2015 2016 2017 Fig: 9.0 Differnce between official and parallel market rate in Nigeria (Naira to $1USD) 15
-1.68% 4.79% 5.79% 5.72% 8.72% 7.25% 8.55% Nigeria s Preparedness For 10. A positive real interest rate The interest rate is the cost of credit or the lending rate. The real interest rate is, however, the interest rate adjusted for inflation. It is calculated as interest rate (%) minus inflation rate (%). It is important to use the real interest rate as against the nominal interest rate because of the time value of money; what costs N1 today will be most likely cost more tomorrow (inflation). Investors and savers will normally require a positive real interest rate to invest; otherwise they will prefer to spend their money on current consumption or holding fixed dormant assets such as lands rather than lose it investing or business. In the conduct of monetary policy, a Central Bank has at its disposal a number of instruments, most of which depend upon setting or influencing interest rates. They are: 1. Monetary Policy Rate (MPR) 2. Open Market Operations (OMO) 3. Cash Reserve Requirement (CRR) 4. Liquidity Ratio (LR) 5. Foreign Exchange Net Open Position (NOP) Source: NBS 2010 2011 2012 2013 2014 2015 2016 2017 In tune with the ECOWAS prerequisite for a regional currency, Nigeria has maintained a positive though declining real interest rate. However, due to rising inflation rate in 2016 leading to a recession, Nigeria experienced a negative real interest rate. Fig: 10.0 Real interest rate in Nigeria 16
Is a single currency necessary? 1213 RESPONDENTS NO 45% YES Is a regional currency necessary for Africa? 55% NO 39% If implemented, do you think the regional currency will promote socioeconomic unity and prosperity in Africa? YES 61% 42% NO If implemented, will it be in the best interest of Nigeria to adopt the regional currency? YES Responses as at 31-Jan-2018 58% 17
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