INTERVIEW: Issuance of domestic dollar bond will put pressure on naira, says IMF official

Since President Bola Tinubu came into office in 2023, Nigerians have witnessed a flurry of fiscal and monetary policies deemed by the authorities as necessary to change the fortunes of the nation, boost revenue, attract local and foreign investors, and make them confident in Nigeria’s economy.

From the infamous “subsidy is gone” declaration, to the naira float and value-added tax (VAT) policies, Nigerians, smitten by the impact of the reforms, have constantly questioned the role of the International Monetary Fund (IMF) in their sufferings.

In this interview with TheCable’s DESMOND OKON, Axel Schimmelpfennig, assistant director and mission chief for Nigeria at the IMF, provided insights on the rationale guiding the fund’s policy recommendations to Nigeria, and also spoke about the lender’s objection to the recent issuance of the $500 million domestic bond.

TheCable: The IMF says some countries hold reserve levels that are insufficient to provide adequate buffers against future shocks. Is Nigeria part of those countries?

Schimmelpfennig: We assess reserve levels for every country as part of our annual report on those countries. For Nigeria, our latest assessment was done as part of our 2024 report that was published in May and based on end-2023 data.

At end-2023, gross international reserves reported by the CBN stood at $33 billion which was 81 percent of the IMF’s reserve adequacy metric. When considering that Nigeria is an oil exporter, and thus exposed to oil price volatility, the adjusted metric was 61 percent. On this basis, our advice was to build gross international reserves and strengthen buffers against shocks.

Over the course of this year, the CBN has been able to accumulate gross reserves. The CBN reports gross international reserves now at $40 billion. The authorities are working to strengthen their external buffers, which is welcome.

For almost all economies — whether developed, emerging, or developing — holding prudent reserves, in conjunction with sound policies and fundamentals, can bring significant benefits. Reserves reduce the likelihood of balance-of-payments crises, help preserve economic and financial stability against pressures on exchange rates and disorderly market conditions and create space for policy autonomy.

While reserves have these important benefits, they also carry an opportunity cost. This includes reserves earning a lower rate of return than could be achieved if the resources were used differently. These costs are an important consideration as countries decide on their “appropriate” level of reserves for precautionary purposes.

We will update our reserve adequacy assessment next year when we do the 2025 annual report on Nigeria.

TheCable: Nigeria’s finance minister recently said the IMF was against the issuing of domestic dollar bonds, even though it was a success. Why did the fund advise against it?

Schimmelpfennig: We appreciate the objective of bringing foreign exchange inflows to Nigeria. Ultimately, this requires strong macroeconomic policies. The CBN’s tightening of monetary policy has helped bring foreign exchange inflows, and as inflation comes down as projected, holding naira will become more attractive again. Fiscal policy also has a role to play, ensuring that the government can provide needed services and invest in people and infrastructure, while keeping debt at a sustainable level and relying on market financing.

In our 2024 report on Nigeria, we discussed the issuance of domestic dollar bonds. While such an issuance can bring in foreign exchange, we see broader risks that could be associated with such issuance. The extent to which these risks materialise depends on the size and frequency of issuing domestic dollar bonds. A one-off, small issuance will not have much impact. But if this instrument becomes a normal part of financing the government deficit, you will see them materialise. What are these risks?

First, issuing domestic dollar securities alongside naira securities leads to market segmentation. As a result, the market for individual securities is less liquid, making it more difficult to do transactions when needed. Price discovery also becomes less efficient.

Second, having a domestic dollar security can push up the cost of issuing naira securities because the dollar security does not come with an exchange rate risk and is therefore a safer asset.

Third, when a dollar security is on offer, Nigerians may look to purchase dollars to subscribe to these securities, thus putting further pressure on the naira. Anecdotally, that is what you saw in the week that the dollar security was issued. There was increased demand for dollars.

Ultimately, issuing dollar securities domestically contributes to dollarisation, which is already elevated in Nigeria and is best avoided.

TheCable: Does the IMF also advise or guide in terms of policy sequencing, especially in the case of Nigeria, considering the implementation of these policies could have painful consequences? If so, are you happy with how Nigeria is implementing some of the difficult policies we are seeing?

Schimmelpfennig: We have continuously advocated for a speedy roll-out of the social transfer system, which includes direct payments to Nigerian citizens. Already 31 million Nigerians are suffering from food insecurity, and the poverty rate reached 41 percent last year and is expected to increase this year. The floods in September have made the situation even worse. Many Nigerians need government support.

That is why we believe and have advocated for putting in place and scaling up the social transfer system as quickly as possible. We understand that the system now reaches 5 million households and that the objective is to have it reach 15 million households eventually.

Our estimate at the beginning of the year was that fuel subsidies would cost up to 2.8 percent of GDP in foregone revenues in 2024. The question is whether this is the best way to spend about a third of government revenue or whether there are better uses. Our research shows that a targeted social transfer system is more effective in providing relief to those in need and frees resources for social and development spending that benefits everyone and supports higher growth.

TheCable: Can you comment on the concern that the IMF is responsible for Nigeria’s economic challenges due to its policy recommendations? Many Nigerians and even prominent voices have expressed this view at some point, and there are reasons for that. When President Bola Tinubu announced that the petrol subsidy was gone, months later, the IMF said the government was still partially subsidising the product and called for a “complete removal”. That is being done now, and the people are crying.

Schimmelpfennig: We are very aware and share the concerns that already 31 million Nigerians are suffering from food insecurity, and the poverty rate reached 41 percent last year and is increasing this year. We are further concerned that the September floods will make this situation worse.

That is why we believe and have advocated for putting in place and scaling up the social transfer system as quickly as possible. Having in place such a social safety net will help soften the impact of difficult reforms on those that already struggle with the ongoing cost-of-living crisis.

Nigeria does not collect enough revenues to provide the services that Nigerians expect from the government. In 2023, Nigeria collected 9.3 percent of GDP in revenues. That is one of the lowest collection rates in the world. This means that the government has very little money to spend on social and development priorities, including health, education, roads, or electricity.

At the federal government level, the spending on interest used up 77 percent of the revenue that was collected. That is not because Nigeria has a debt-to-GDP ratio that is higher than its peers, but because it collects so little revenue.

Increasing revenue collection in Nigeria should go through many different channels, and we welcome the work of the presidential committee, which conducted a comprehensive review of the tax system and is developing policy options.

A lot can be gained by strengthening tax administration. It is important to make sure that everyone who should be paying taxes does in fact pay their taxes. It is also important to ensure that systems and processes are in place to ensure that taxpayers pay the right amount that they owe.

Looking at the VAT rate, Nigeria’s current rate of 7.5 percent is much lower than what other countries in the region have in place. This comparison with regional peers suggests scope exists to increase the VAT rate, with accompanying measures in place to ensure this would not further worsen food insecurity or poverty.

In this respect, it is important to note that many essential items actually have a zero VAT rate, so you do not pay any VAT on these items. The government recently expanded this list of essential items as part of their temporary relief measures. Lower-income households can buy these essential items right now without paying any tax on them.

So, right now, that means the VAT and any increase in the rate falls on items that are mainly purchased by households with higher incomes. What’s also important is that there is a social contract. Citizens are willing to pay taxes when they see their government providing services that they need. If Nigeria raises more in revenues, this should come back to Nigerians through better government services or investment. And likewise, the savings from removing the implicit fuel subsidy should benefit Nigerians through better services or investment.