US embassy cable - 04LAGOS115

UNCLAS SECTION 01 OF 03 LAGOS 000115 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EINV, ETRD, NI 
SUBJECT: HIGHER AND HIGHER: NIGERIA'S MEANS OF 
FINANCING MEDIOCRE GROWTH 
 
 
1. (U) Summary: Officers' in-country travel, anecdotal 
evidence, and media commentary point to inordinately 
high and steadily rising prices in Nigeria.  People 
regularly complain that frequent increases in the cost 
of living and slow economic growth are hardly the 
dividends of democracy they expected after the demise 
of military rule.  Prices are high and getting higher, 
and real per capita economic growth has averaged little 
more than 3.5 percent per annum over the last five 
years.  The upward trend in prices has multiple causes 
and far-reaching effects, and we expect it to continue 
throughout this year and into the next.  End summary. 
 
2. (U) Nigerians frequently complain of high prices and 
an ever-increasing cost of living.  Market traders 
wonder how to make ends meet, and businessmen and 
agricultural producers lament the high cost of doing 
business.  Even the relatively wealthy grumble about 
over-priced goods and perceive gradual increases in the 
overall price level.  Available data support their 
perceptions: the Economist Intelligence Unit (EIU) 
recently noted that inflation began to trend upward 
(from approximately 10 percent in August) in the fourth 
quarter of 2003 and expects average annual inflation to 
exceed 12.5 percent, a phenomenon driven primarily by 
rising food and domestic fuel prices coupled with loose 
fiscal and monetary policies.  The EIU is not wide of 
the mark: the Central Bank released data January 14 
indicating that the twelve month moving average rate of 
inflation rose from 10 percent in August to 12.3 
percent in October.  Annualized month-on-month 
inflation accelerated from 18.4 percent to 23.6 percent 
during the same period. 
 
3. (U) The rate of inflation in Nigeria is measured by 
movements in a composite urban and rural consumer price 
index (CPI), with the weights assigned to food and 
fuel/electricity representing 70 and 10 percent of the 
CPI basket of goods, respectively.  As such, changes in 
food and fuel prices drive changes in the overall 
index.  Food prices, in turn, are influenced by a 
variety of factors, including rainfall and other 
climatic conditions, wages, domestic inputs, and import 
prices.  As these rise and food prices increase, so too 
does the CPI and the average cost of living.  Changes 
in food prices may be the most noticeable indicators of 
rising prices, but increases in the overall price level 
- the rate of inflation - are related to a variety of 
factors that go beyond fluctuations in rainfall and 
agricultural productivity. 
 
4. (U) Inflation in Nigeria is also closely related to 
expansionary fiscal and monetary policies.  The EIU 
estimated Nigeria's 2003 federal budget deficit at 5.8 
percent of its gross domestic product (GDP) or US$2.8 
billion (with Nigeria's 2003 real GDP estimated at 
US$48 billion at current prices).  To finance the 
deficit, the Government of Nigeria (GON) borrows 
domestically (it sells Treasury bills and recently 
introduced longer-term government bonds to the public) 
and internationally.  And borrow it does: the GON's 
domestic debt equals about 25 percent of GDP and is 
rising fast.  External debt stands at an estimated 
US$30.9 billion.  In attempts to keep the cost of 
government borrowing (or interest rates) at tolerable 
levels, the Central Bank often accommodates the central 
government by simply printing money to fund the 
deficit, especially when private investors choose not 
to buy government debt instruments.  The result is 
excess liquidity, which the Central Bank occasionally 
tries to mop up by raising interest rates.  Whether 
through the government's direct borrowing or the 
Central Bank's printing of money to accommodate a 
deficit, deficit financing tends to fuel inflation. 
 
5. (U) Government borrowing in Nigeria contributes to 
inflation: there is no doubt about that.  It keeps 
domestic interest rates up and thereby raises 
production costs and forecloses investment 
opportunities, especially in agriculture and 
manufacturing.  This is normally the outcome since 
little of the deficit spending finances productive 
investment.  The cost of money is thus relatively high: 
the Central Bank's minimum rediscount rate (MRR) alone 
is 15 percent.  By law, banks can charge interest rates 
equivalent to the MRR plus four, or 19 percent, but in 
reality, rates often reach 29 or 30 percent.  Thus, 
many businesses, particularly small and medium 
enterprises, find it difficult to secure financing. 
When they do, they incur significant expenses.  These 
are factored into production costs and reflected in the 
final prices of goods and services.  High interest 
rates may be less overt contributors to Nigeria's 
relatively high prices, but like the factors mentioned 
above, they raise the cost of doing business. 
 
6. (U) Inflation indicates a rising overall price 
level, but prices are high in and of themselves. 
Insufficient and poorly maintained infrastructure, 
particularly the lack of reliable road and railway 
networks, efficient communications systems, and an 
adequate power supply, increases the cost of doing 
business.  According to Nigeria's Ministry of Works, 
nearly 80 percent of the country's 140,000-km road 
network is in a state of disrepair.  The condition of 
the country's railway network is even worse: the three 
lines are in such poor shape, in fact, that trains 
rarely run.  The dismal state and limited reach of 
Nigeria's road and railway networks make the movement 
of goods time consuming and expensive, and delays at 
Nigeria's borders and ports of entry - particularly at 
the Lagos port complex - exacerbate the problem. 
Nigeria's fixed-line and mobile communications 
networks, too, are grossly inadequate.  The country's 
national operator has an installed capacity of fewer 
than 500,000 lines, and the country's four mobile 
service providers supply only 3 million lines to a 
population of 130 million consumers.  Inefficient 
communications systems raise the cost of doing 
business, as does the country's equally unreliable and 
inadequate power supply.  Nigeria's state-run National 
Electric Power Authority has an installed capacity of 
6,000 megawatts (MW) but typically distributes about 
half that, a quantity far short of the estimated 10,000 
MW the country needs.  Not surprisingly, frequent power 
outages force businesses to supply generators, fuel, 
and diesel storage tanks and raise production costs. 
 
7. (U) Added to this is Nigeria's dependence on 
imports.  The country imports virtually everything, 
including manufactured goods, capital equipment, fuel, 
and food items like dried fish and rice.  Once one of 
the world's leading exporters of palm oil, groundnuts, 
poultry, and other items, Nigeria now exports little 
more than crude oil.  Domestic producers cannot meet 
the demands of a large and growing population, so 
Nigerian consumers rely on relatively expensive 
imported goods and services.  Of course, imports become 
relatively more expensive as the value of the currency 
declines.  The naira was relatively stable (at 
approximately N120:US$1) during the first ten months of 
2003, but increasing demand for foreign currencies - 
particularly in the wake of the GON's decision to 
deregulate the downstream oil sector - pushed the naira 
to its lowest rate (approximately N140:US$1) in years. 
Given the Central Bank's declining reserves and limited 
ability to continue to defend the naira, the currency 
will likely depreciate further.  As a result, imports 
will become even more expensive, and complaints of high 
prices will likely grow louder. 
 
8. (U) Inadequate security and widespread corruption 
also raise costs.  In the absence of an effective and 
well-trained police force, businesses provide their own 
security - and spend heavily on private guards, fences, 
perimeter controls, and electronic surveillance 
systems.  Such precautions raise operating costs, as do 
the payoffs and kickbacks that many individuals 
consider an unavoidable cost of doing business in 
Nigeria.  For the third consecutive year Nigeria was 
named the world's second most corrupt country in 
Transparency International's 2003 Corruption 
Perceptions Index, and anecdotal evidence suggests that 
graft affects every sector of the economy.  Businessmen 
report paying bribes to clear imports through customs, 
lower their tax burdens, win operating permits or 
licenses, and cut through bureaucratic red tape.  Many 
consider bribes a means of getting things done quickly 
and easily: to resist, people think, is to invite 
unnecessary delays.  Payoffs may indeed be a means to 
an end, but they increase costs and perpetuate an 
already inefficient system. 
 
9. (U) Having run large deficits in 2002 and 2003 and 
anticipating a deficit of about 3 percent of GDP in 
2004, the GON will find it difficult to reduce 
expenditures while simultaneously meeting new 
commitments, particularly if oil prices (and government 
revenues) decline in 2004.  As a result, the GON's 
fiscal policy will likely remain expansionary, and it 
will either continue to borrow or attempt to finance 
the deficit by printing more money.  If it does the 
latter, the increased money supply will lead to an 
increase in the overall price level: as the supply of 
money relative to the supply of goods increases, or as 
more money chases the same quantity of goods, vendors 
will adjust their prices accordingly.  The overall 
price level will rise, and individuals will note an 
increasing cost of living. 
 
10. (U) Comment: Following years of military rule, 
Nigerians hoped, possibly against reason, that the 
civilian rule inaugurated in 1999 would quickly yield 
tangible dividends of democracy.  Instead, what they 
have experienced economically are high and seemingly 
ever rising prices.  Their hopes dashed, most Nigerians 
now seem resigned to double-digit inflation, which is 
nothing less than a disguised tax that hits the less 
well to do particularly hard.  Since these "taxpayers" 
are poorly organized and largely silent, we know of no 
reason why inflation should subside dramatically during 
the next two years.  The people who could provide 
relief are least likely to endorse policies that will 
erode their nominal income.  These people generally 
oppose devaluation of the naira, particularly since an 
over-valued naira lowers the cost of their imports. (It 
also renders non-oil exports less competitive, textile 
products being an example, and thus retards development 
of manufacturing.)  The elite also prefer trade bans to 
higher tariffs since bans are the currency of exchange 
for political support and thus directly benefit people 
with influence.  Lastly, everyone opposes personal 
income tax increases, largely because nobody believes 
that such revenues will be used for the common good. 
Under the circumstances, we expect double-digit 
inflation to continue to be the government's preferred 
means of financing what is likely to be mediocre growth 
during the foreseeable future.  End comment. 
 
HINSON-JONES