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Nigeria’s Preparedness For Monetary Union In West Africa THE ECO

January 2018

January 2018

THE ECO

PREPAREDNESS FOR

MONETARY UNION

IN WEST AFRICA

NIGERIA’S


January 2018 2

Table of Contents

1. Introduction

2. The Eco: West Africa

3. The Eco: Nigeria

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 theprevious year’s tax revenues

D. Gross external reserves that can give import cover for a minimumof three months.

E. Prohibition of new domestic default payments and liquidation ofexisting ones.

F. Tax revenue should be equal to or greater than 20 percent of theGDP.

G. Wage bill to tax revenue equal to or less than 35 percent.

H. Public investment to tax revenue equal to or greater than 20percent.

I. A stable real exchange rate.

J. A positive real interest rate

4. Is a single currency necessary?


January 2018

At the 4th 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.

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 times1—2020 is the latest

date put forward2.

Introduction

3

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/buhari-

rejects-currency-w-africa-2020/


January 2018

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 state4.

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

The Eco: West Africa

4

4. https://www.vanguardngr.com/2017/11/nigeria-holds-key-

west-african-single-currency/


January 2018

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?

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.

5

5. https://www.vanguardngr.com/2017/10/west-

african-blocs-2020-single-currency-goal-fails/

The Eco: Nigeria


January 2018 6

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

Ready

4 Gross external reserves that can give import cover for a minimum

of three months.

Ready

5 Prohibition of new domestic default payments and liquidation of

existing ones

Not ready

6 Tax revenue should be equal to or greater than 20 percent of the

GDP.

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

The Eco: Nigeria


January 2018

Source: NBS

1. A single-digit inflation rate at the end of each year

7

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.

Fig: 1.0 Inflation rate in Nigeria

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).

11

.80

%

10

.30

%

12

.00

%

8.0

0%

8.0

0%

9.6

0%

18

.55

%

16

%

2010 2011 2012 2013 2014 2015 2016 2017

The Eco: Nigeria

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/anti-

trust regulation commission


January 2018

Source: NBS

2. A fiscal deficit of no more than 4% of the GDP

8

The attainment of sustained economic (GDP) growth is one of the macroeconomicgoals of every government. To achieve this goal, Nigeria, like other countries, has reliedon the use of fiscal policy.

However, it has recently been observed that deficit financing and not the level of fiscaldeficit (FSD) has significant impact on the growth of the Nigerian economy6. This isbecause 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 investmentfunds by domestic entrepreneurs.

4. Discourage external debt with high service rates and fiscal deficit financedprincipally via the Central Bank.

-2.0

4%

-1.8

2%

-1.3

4%

-1.4

2%

-0.9

3%

-1.6

4%

-2.1

5%

y = 0.0002x - 0.0168

2010 2011 2012 2013 2014 2015 2016 2017

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

The Eco: Nigeria


January 2018

3. A central bank deficit-financing of no more than 10% of the previous year’s tax revenues

9

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

economy7. The 2018 budget deficit,

totaling about N2.01 trillion, will be

financed mainly through new

borrowings.

0.0

0%

0.2

2%

0.9

8%

1.1

7%

0

13.06%

0.0

1%

2010 2011 2012 2013 2014 2015 2016 2017

Source: NBS

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

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

The Eco: Nigeria

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.


January 2018

Source: NBS

4. Gross external reserves that can give import cover for a minimum of three months

10

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 adequate8. 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.

3.96

2.97

4.49 4.54

3.25

2.552.85

2010 2011 2012 2013 2014 2015 2016 2017

Fig: 4.0 Foreign reserve to annual import cover

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.

8. http://www.economist.com/node/16793524

The Eco: Nigeria


January 2018

5. Prohibition of new domestic default payments and liquidation of existing ones

11

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.

4,5

51

5,6

22

6,5

37

7,1

18

7,9

04

8,8

36 11

,05

8

12

,49

5

35

4

53

7

72

0

79

4

86

5

1,0

18

1,2

28

53

0

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

*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.

Source: NBS

The Eco: Nigeria

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.


January 2018

Source: NBS

6. Tax revenue should be equal to or greater than 20 percent of the GDP

12

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 dramatically9.

The state capacity (tax capacity, legal capacity and public administration capacity)

determines the economic development or GDP growth of any state and vice versa10.

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 years10.

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.

5.2

0% 8

.05

%

8.3

6%

7.6

0%

7.0

2%

5.4

2%

4.8

6%

0%

5%

10%

15%

20%

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.

10. https://www.imf.org/external/pubs/ft/wp/2016/wp16234.pdf

9. https://www.investopedia.com/terms/t/tax-to-gdp-ratio.asp

The Eco: Nigeria


January 2018

Source: NBS

7. Wage bill to tax revenue equal to or less than 35 percent

13

Taxation is the mechanism through which governments obtains money from allcategories of citizens/residents of a country, while wage bill refers to the total amountspent by government on its workers (civil servants) by way of salaries, wages andallowances.

This precondition stipulates that government should only spend N35 of every N100 itcollects from taxpayers on paying itself (civil servants). Only 40 million of Nigeria’s 70million taxable adults currently pay taxes, and only 13 per cent of these taxpayers havetheir taxes deducted at source under the PAYE scheme. The minimum wage in Nigeriais N18,000 ($50.40).

Tax evasion has been an issue in Nigeria for decades with government at loss as to howto effectively curb the menace. Several factors contribute to tax evasion in Nigeria andthey 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

52%

34%31% 32%

34%

49%

60%

2010 2011 2012 2013 2014 2015 2016 2017

ECOWAS recommendation

wage bill to tax revenue

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.

Fig: 7.0 Wage bill to tax revenue in Nigeria

The Eco: Nigeria


January 2018

Source: NBS

8. Public investment to tax revenue ratio equal to or greater than 20 percent

14

The Eco: Nigeria

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%

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.

The Eco: Nigeria


January 2018

9. A stable real exchange rate

15

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.

2.7

7

5.4

4

3.3

6

5.1

4 12

.90

29

.44

119.37

2010 2011 2012 2013 2014 2015 2016 2017

Fig: 9.0 Differnce between official and parallel

market rate in Nigeria (Naira to $1USD)

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

The Eco: Nigeria


January 2018

10. A positive real interest rate

16

5.7

9%

5.7

2%

4.7

9% 8.7

2%

8.5

5%

7.2

5%

-1.6

8%

2010 2011 2012 2013 2014 2015 2016 2017

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 thenominal interest rate because of the time value of money; what costs N1 today will bemost 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 holdingfixed 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 ofinstruments, most of which depend upon setting or influencing interest rates. Theyare:

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)

Fig: 10.0 Real interest rate in Nigeria

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.

Source: NBS

The Eco: Nigeria


January 2018 17

Is a single currency necessary? 1213 RESPONDENTS

61%

39%

If implemented,

do you think the

regional

currency will

promote socio-

economic unity

and prosperity

in Africa?

YES

NO

58%

42%

If implemented,

will it be in the

best interest of

Nigeria to

adopt the

regional

currency?

YES

NO

55%

45%

Is a regional

currency

necessary for

Africa?

YES

NO

Responses as at 31-Jan-2018


January 2018 18

About Phillips ConsultingFounded in 1992 and headquartered in Nigeria, PhillipsConsulting Limited is a leading business and managementconsulting firm, serving clients across Africa through officesin Lagos, Abuja and Johannesburg. Our staff represent adiverse spectrum of professional disciplines, ranging fromengineering, accounting, mathematics, medicine,information technology and much more. We also count onnumerous qualified external professionals, outsourcedproject managers and technical support staff, to deliverquality.

For 25 years, our integrity and proficiency in designingsystems to manage people has enabled us to gain areputation for quality in the services we provide.

Phillips Consulting has been engaged on a wide range ofassignments over the years, principally to help clientsdesign and implement projects, improve efficiency,enhance human capacity and build great institutions.

That is our remit.

who we are


January 2018 19

The firm’s services are provided through its

five practice areas.

what we do


January 2018 20

Phillips Consulting carries out quarterly surveys, which

cut across various industries in the Nigerian economic

space. The survey outcomes enables relevant

stakeholders, investors and potential investors to

identify business opportunities, develop a deeper

understanding of the Nigerian market, and potentially

increase customer satisfaction.

Our Quarterly Surveys

“The use of surveys

is an effective way

of gaining valid

and quantifiable

information”.

For detailed reports, visit:

http://www.phillipsconsulting.net/survey-report

http://www.phillipsconsulting.net/survey-report


January 2018 21

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