**Debt Management Office Technical Report**

**Sovereign Domestic Debt Technical Advisory Assistance Program To**

**The Federal Republic of Nigeria**

**Francis Odubekun, Resident Advisor July 2001 -- July 2004**

**Close-Out Report -- August, 2004**

**INTRODUCTION**

In line with the Office of Technical Assistance (OTA's) overall
government debt issuance and management assistance mission statement,
the Nigerian sovereign domestic debt management program's central focus
has been to develop, within the host country, market-based issuance
practices and trading mechanisms for domestic government securities that
support macroeconomic stabilization.  Specific targets within the
overall mission include: providing a non-inflationary means of public
finance to the Nigerian federal ministry of finance, assisting the
Central Bank of Nigeria with the development of instruments and markets
in its implementation of monetary policy and providing support to the
development of broadly based financial markets.

**BACKGROUND**

Following Nigeria's transition to a civilian democracy in 1999, an
assessment of the Government of Nigeria's budget and debt management
technical assistance needs was conducted by a Treasury team led by Jim
Fall. The assessment culminated in a "forceful" and specific set of
requests from then Acting Minister of Finance, Jubril Martins-Kuye, for
technical assistance in budget, debt management, tax policy and
administration, and financial crimes law enforcement[^1]. This was
followed-upon by other OTA/GDIM officials and resulted in the
commencement of the GDIM technical advisory program, in July, 2001.

**COUNTRY FINANCIAL AND ECONOMIC BACKGROUND**

Nigeria has a large, Naira-denominated debt, concentrated in the central
bank and the banking system. In recent times, the country spent more on
debt service than on health, agriculture and education combined.
Recently, debt service has hovered around 15% of total budget
expenditures. This is a very high figure, even in comparison to other
developing economies, and one that imposes significant constraints on
the nation's budget and resources.

Approximately 55% of the total securitized debt is held in the form of
91-day Treasury Bills, which are continuously rolled-over. In addition,
it had been the case that every year, for at least the last fifteen
years, an additional amount representing that particular year's total
deficit---initially reflected as an overdraft from the central bank---is
securitized and added to the pre-existing stock. In addition to Treasury
bills, the balance of the nation's public domestic debt has, on average
over the review period, consisted of approximately N500 billion in
longer-term debt instruments; i.e., Treasury Bonds and "Development
Stocks". Historically, development stocks were issued to finance various
capital projects over the years. Treasury bonds were introduced in 1989,
mainly as a means of avoiding paying market rates, which had risen
significantly in the wake of interest rate de-regulation, following
adoption of the then-called, Structural Adjustment Program ("SAP").
Interest on those bonds was set at 5% across the board. The central bank
absorbed almost the entire issue. In subsequent years during the
military era, treasury bonds were issued whenever the government wanted
to raise money at artificially low (non-market referenced) rates.

Close to 60% of the outstanding securitized public domestic debt is held
by the Central Bank. An additional 34% is held within the financial
sector, mainly by banks, and approximately 6% is held by non-bank
investors.

**BACKGROUND ASSESSMENT**

At the onset of the program, Advisor conducted a comprehensive
assessment of the Nigerian government's debt management and issuance
functions and activities as well as the general financial and economic
environment, to identify and analyze the main factors that had a direct
bearing on the debt. The assessment included extensive meetings and
detailed deliberations with all major stakeholders, including banks,
discount houses (i.e., primary dealers and market-makers in treasury
bills), other securities market operators, regional financial
institutions, and regulatory organizations. The assessment also included
a detailed review of the government of Nigeria's budget development and
implementation processes, government's financial and accounting
processes and record-keeping frameworks, legal and regulatory
frameworks, the technological environment within which debt issuance and
management functions and activities were being conducted, controls
around debt issuance and management processes, debt management related
organizational structures and capacity within the various governmental
agencies and private sector outfits where debt issuance and management
activities were conducted.

**REVIEW FINDINGS**

The review, which took place during the first three months of the
program, identified several pervasive factors which hampered the
implementation of sound or effective debt policy. One of these was the
overly fragmented nature of debt management, whereby debt management
operations were conducted from up to five different agencies, including
the Central Bank, Ministry of Finance, Office of the Accountant General,
National Planning Commission, and the National Economic Intelligence
Committee. The review indicated that there was little collaboration
amongst these agencies. Not surprisingly, this lack of collaboration and
dispersal of functions involved conflicting institutional roles. For
example, the Central Bank's pervasive involvement in debt management
along with its substantial holdings of government debt, conflicted with
its monetary management responsibilities. Given the contemporaneous
economic environment, characterized by macroeconomic instability and
persistent inflation, the debt portfolio was overly subject to monetary
policy pressures. And from a legal standpoint, a substantial amount of
the bank's debt management related functions and activities appeared to
lack the appropriate legal mandate.

**RESEARCH ANALYSIS AND DATA GATHERING**

Another finding was that there was a serious lack of an adequate,
debt-related data-gathering or analytical process to guide debt policy
and decision making. This absence of a sound, analytical basis for debt
policy formulation, deliberation or decision-making was indicative of
the way in which debt management was being conducted. Finally, the
review also revealed a lack of a coordinated approach or mechanism for
the dissemination of domestic debt-related information to stakeholders
or the general public -- which as subsequent events showed advisor, were
crucial. This has been a hindrance to consensus building, particularly
in building the institutional (including parliamentary) support often
needed to achieve key debt related activities.

In terms of the portfolio, in addition to the large and increasingly
expanding sovereign domestic debt, fostered by unbridled fiscal
expansion, the nation's debt stock had been and continues to be
characterized by excessive monetization of annual budgetary deficits,
over-reliance on short-term debt and concentration of debt in the
central bank and the banking system, the improper use of the CBN's
statutorily-mandated overdraft "ways and means" account, and the lack of
any appreciable secondary market activity in government bonds.

Given these and other background review findings, Advisor developed a
comprehensive work program which aimed to enhance debt management
practices within the respective agencies responsible for debt management
as well as to develop the capacity of the Debt Management Office (DMO),
the agency conferred with statutory responsibility for managing the
nation's debt. The vision of the work plan was to develop a debt
management organization capable of providing policy alternatives to the
government of Nigeria. The key specific objectives were to improve the
management of the debt portfolio, lengthen the maturity structure of the
debt, inculcate a market-based government debt funding culture, and
enhance secondary market-trading activity through increased liquidity
and enhanced price discovery in the government securities market. The
central mission was to devise and guide the implementation of a
long-range debt issuance and management plan that is supportive of the
ongoing economic reform efforts of the government of Nigeria and
facilitates macroeconomic growth.

**EXTERNAL DEBT RELATED ACTIVITIES**

While the advisory program's mandate was to advise on the government of
Nigeria's domestic debt issuance and management program, Advisor's
attention and advice was periodically sought on matters pertaining to
the nation's external debt. This included, for example, advisor being
requested to review proposals and/or sit on presentations by major
financial institutions offering proposals to restructure Nigeria's
external debt (e.g., Citigroup and Deutsche Bank proposals to
restructure Nigeria's Par bonds, through buy-backs and swaps.)
Particularly worthy of note was when advisor was contacted urgently over
a weekend in mid-2003, in the wake of a key Supreme Court ruling, which
forbade the Nigerian government from further deducting 1% from
federation revenues, for the purpose of servicing the aggregate debt
owed by the federal government and the states. Given the financial and
political implications of the decision, advisor's participation was
sought on devising a program to comply with the decision. Another recent
episode was when the minister of finance called for advisor to meet over
a period of time, with a state governor and the state government's top
economic officials and financial advisors, led by KPMG, to provide
guidance on external currency financing options and the implications of
providing a financial guarantee to the state government, looking to
develop an export-free zone.

**IMPLEMENTATION OF WORK PLAN**

The debt advisory program was implemented in three phases. The first
phase, which spanned the first year and a half of the program, included,
in addition to the comprehensive background review, a broad review of
the proposed debt management act, which legally conferred sovereign debt
management responsibility on the debt management office and laid the
basis for the new debt management structure. Advisor requested the
assistance of GDIM Legal Advisor, Calvin, Ninomiya, who undertook a
detailed review of the new bill and proffered key advice. This led to
the re-draft of portions of the legislation as it related to the
authority to borrow, helped clearly define the relationship with the
central bank as fiscal agent, firmly granted authority to the Debt
Management Office to act as the sole borrowing agent for the State and
authorized the Debt Management Office to select instruments for
borrowing and issue regulations to implement the Act as well as provided
clear, legislative affirmation that existing debt continue to be a
direct obligation of the sovereign as issuer.

**DATA GATHERING AND ANALYSIS**

During the initial phase, advisor established a process within the debt
office, for collating domestic debt related data and establishing the
DMO as the repository for domestic debt related data. Advisor's research
data gathering analytical initiatives also included providing lawmakers
with information connecting improper debt management practices,
including in specifically, persistent monetary financing of fiscal
deficits, to wider macro-economic problems. This included co-authoring a
research study that quantified the adverse effects of the persistent and
excessive monetization of fiscal deficits on the economy. The research
was published in a regional academic journal and used as leverage to
gain attention and push for changes with policy-makers.

**RATIONALIZATION OF INSTITUTIONAL RELATIONSHIPS**

During the early stages of implementation of the work program, advisor
initiated efforts and processes to rationalize roles and
responsibilities among the various agencies handling debt management.
This included reinstating a long-neglected process whereby, the ministry
should formally, by instrument of warrant, instruct the Office of the
Accountant-General of the federation to issue a mandate to the Central
Bank, to conduct offerings of securities on behalf of the federal
government and lay out terms and other features authorizing such
offerings. Prior to this time and since the era of military governance,
the Central Bank had been acting without legal authorization, mandate,
or consultation and inappropriately taking on the role of debt
policy-making and implementation. In order to adequately prepare and
equip the appropriate agencies to take on their proper respective
functions, a substantial portion of advisor's time was spent working
with officials at the ministry and DMO, helping build the institutional
competence needed to enable them to take a more appropriate and
assertive role on debt matters. A key initiative that was conceptualized
and implemented by the Advisor in this regard, was the establishment of
an internal domestic debt management committee (within the debt office),
to enhance debt policy formulation and deliberation. In addition, an
inter-agency Joint Domestic Debt Committee, chaired by the Permanent
Secretary of the Ministry of Finance and including representation from
all the various agencies responsible for debt management, including the
office of the president, was established to deliberate upon issues
pertaining to debt policy. This afforded Advisor the opportunity to
present often technical subject-matters in a manner that enabled
positive debate and action.

**ISSUANCE AND MARKET DEVELOPMENT**

As previously laid out, the central thrust of the advisory program and
focus of the advisor's work was on creating a long-range financing plan
to facilitate debt reform, macro-economic stability and growth. This
involved developing a game plan that addressed the nation's three key
debt-funding related priorities:

#### Limiting monetary financing of annual fiscal deficits and reducing central bank holdings of government debt. 

-   Properly aligning the debt portfolio (to achieve a more appropriate
    asset/liability match) and reducing the burden of debt service by
    lengthening the maturity profile of the debt.

-   Promoting development of the domestic capital market.

In order to accomplish the preceding, a comprehensive, multi-year plan
was developed to issue longer-dated instruments, in order to finance the
annual fiscal deficits and address ancillary objectives. These included,
for example, lengthening the maturity profile of existing debt;
developing the secondary market to reduce reliance on CBN and set the
stage for future restructuring. The issuance program was developed and
is being implemented to accomplish the goals outlined for the attainment
of domestic debt management objectives in general and for the financing
of current and future Federal Government deficits in particular.

**BOND ISSUANCE PROGRAM**

The bond issuance and market development program, in the first phase,
involved the issuance of bonds to finance the (annual) deficit and
eliminate or at least reduce central bank financing of unsubscribed
residuals from treasury offerings. In this regard, during 2003, the
government of Nigeria issued its first bond in approximately fifteen
years. This was also the first fixed rate bond issued by either a
private or public entity in over a dozen years. The offering featured
multiple maturities and fixed and floating rates. The program, which is
expected to continue over the next five years, provides for the annual
issuance of bonds to fund any new fiscal deficits (if any) or for the
partial restructuring of outstanding treasury bills.

**TREASURY BILL RESTRUCTURING**

Another important feature of the issuance program has been the phased
restructuring of a substantial portion of the existing treasury bills.
This entailed in the first phase, a "smoothening exercise", whereby, the
weekly maturing 91 day T-bills were restructured in such a manner that,
instead of widely divergent weekly maturing amounts, the maturing stock
was smoothed out so that an even N60/65 billion was structured to become
due weekly. This de-bunching exercise, in addition to making the
subsequent partial restructuring easier without increasing the potential
for future bunching, is also intended to reduce volatility in the
money-market and the potential "volatility premium" that markets tend to
place on such instruments.

In the other phase of the T-bill restructuring exercise, a certain
percentage of 91 day treasury bills are being rolled into (initially) 6
month bills and (eventually) 12 month bills, in such a manner as to
attain at least a conversion of 40% of the existing 91 day bills over
the next five years.

**MARKET DEVELOPMENT**

With regard to the market development aspects of the work plan, Advisor
devised a program for the implementation of a system of market-makers to
facilitate the secondary market trading of government debt. This
proposal also includes a horizontal as well as a vertical Repo program,
anchored by the major banks and with access to the Central Bank's Repo
window. This was negotiated by advisor. A cautious, phased
implementation of the program has commenced.

With regards to the advisory program's market-development efforts,
counterparts were advised extensively on re-structuring debt and
developing new debt product proposals that should continue to gain
acceptability in the domestic market without crowding out other
borrowers.

Developing the domestic capital market in general and the sovereign debt
market in particular was a key focus of advisory activities. This was to
provide a firm platform for the issuance and aftermarket trading of
government debt, in order to engender the liquidity craved by investors,
and without which investors will not remain committed to investing in
government bonds, as well as to provide a vehicle for the effective
transmission of fiscal and monetary policy implementation.

**OTHER NEW INSTRUMENT PROPOSALS**

In addition to the bond issuance and market development program that was
developed and is being implemented in a phased manner, Advisor also
developed proposals to broaden the government securities market and
satisfy the diverse appetites and requirements of investors, through the
development of proposals for new instruments. This included proposals
for the issuance of: (a) a dollar-linked bond and (b) an index-linked
floater. Both proposals have been positioned for implementation at a
future date, consistent with the broad, long-range plan proposed by the
Advisor.

**SUB-NATIONAL DEBT PROGRAM**

A key aspect of the advisory program was the sub-national debt
management program. The Nigerian federal republic comprises 36 states.
Each one of those states had been, to varying extents, involved in prior
borrowing activity -- which under the previous centralized political
governance structure, were considered to be de-facto guaranteed by the
sovereign. A substantial number of these states are under severe
financial strain. Notwithstanding, most have continued to seek access to
both the private as well as, increasingly, the public debt market.
Neither the borrowing states nor the private bank creditors or public
investors' appear to have are fully come to terms with the economic
realities of borrowing/lending under the new "de-centralized"
legal/constitutional borrowing environment. The challenges presented by
this state of affairs were ripe for advisory support. Advisor recognized
that this was a serious issue, given the aggregate size of the
outstanding debt and efforts being made by sub-sovereigns to continue to
access the market. Counterparts recognized Advisor's concerns and
accorded the issue the proper priority and attention. Subsequently, the
World Bank Country program, and the UK's DFID, and more recently, the
Canadian Forum of Federations and the EU, recognized how pressing an
issue the subject matter was and provided funding support to the
program, which was being managed under the auspices of the advisory
program. (The WB was comfortable supporting the Nigerians on this matter
because it was being managed under the auspices of our advisory
program.) The program has subsequently gained very high visibility and
is used as a platform for consensus-building on other fiscal federalism
related issues between the federal government and the states. Among
other things, the program has produced a draft fiscal responsibility
bill, to guide borrowing by states. The program also involves states in
contributing to and adhering to a uniform debt policy that promotes
overall debt sustainability.

**CASH MANAGEMENT**

At various stages over the course of implementing the advisory program,
Advisor raised the issue of effective cash management and its impact on
effective debt management; in particular, how the absence of effective
cash forecasting had increased the tendency toward sub-optimal debt
management and borrowing practices. For example, at various times, the
government, through its various agencies, has had a substantial average
credit balance at the central bank. Such balances, even though
substantial and maintained for considerable lengths of time on an
average basis, do not attract interest income. At about the same time
however, the government has issued treasury bills or maintained "ways
and means" overdraft debit balances, up to the same amount as its
existing aggregate credit balance.

Advisor proposed a cash management committee, which advisor initially
chaired, until the function was taken over by the Minister of Finance,
who specifically requested that the Advisor continue to serve on the
committee. Following a recommendation on the same issue by the IMF,
advisor was mandated to establish a technical sub-committee to collate
and aggregate forecasts by the various agencies and line ministries.

**STATUS OF WORKPLAN DELIVERABLES**

-   DMO adequately and legally prepared and empowered to assume the
    management of the nation's public domestic debt.

-   Rationalized relationships between the MOF/OAGF, DMO and CBN

-   Reduction of monetary financing of the nation's deficit. The new
    bonds are issued without recourse to central bank participation at
    primary offerings.

-   Availability of debt instruments suited to market demand

-   Longer tenors for government bonds. Proposal developed for the
    establishment of a ten-year yield curve over the next three years.

-   Treasury bill restructuring program initiated

-   Proper legal and regulatory framework for government securities
    primary and secondary markets.

-   Developed and expanded naira-denominated, fixed debt investor base
    that is attractive to institutional investors.

-   Guidelines for sub-national borrowing drafted and has been presented
    to parliament for approval

-   Comprehensive and appropriate legal framework for the government
    securities market, including a rational tax policy for interest,
    dividends and capital gains from securities.

-   Development and implementation of the Sub-Sovereign Debt Management
    Program

SELECTED MACROECONOMIC INDICATORS

(Figures in Naira Billion unless otherwise stated)

+--------------------------------+-----------+------------+-----------+
|                                | 2001      | 2002       | 2003[^2]  |
+--------------------------------+-----------+------------+-----------+
| Revenues                       | 796.98    | 716.75     | 749.40    |
|                                |           |            |           |
| Expenditures                   | 1,018.03  | 1,018.16   | 949.10    |
|                                |           |            |           |
| (Deficit)/Surplus              | (221.05)  | (301.40)   | (199.70)  |
|                                |           |            |           |
| Domestic Debt Service          | 155.42    | 170.64     | 164.87    |
|                                |           |            |           |
| Domestic Debt stock            | 1,016.97  | 1,1666.00  | 1,329.72  |
|                                |           |            |           |
| Debt Market Capitalisation     | 14.20     | 15.60      | 33.60     |
|                                |           |            |           |
| Total Market Capitalisation    | 662.60    | 764.30     | 1,358.40  |
|                                |           |            |           |
| Exchange Rate (=N=/US\$)       | 112.00    | 126.90     | 137.20    |
|                                |           |            |           |
| External Debt Service          | 238.12    | 140.74     | 246.96    |
|                                |           |            |           |
| " " (US\$ billion)             | 2.13      | 1.17       | 1.80      |
|                                |           |            |           |
| External Debt Stock            | 3,176.29  | 3,780.21   | 3,988.61  |
|                                |           |            |           |
| External Reserves (US\$        | 10,415.60 | 7,986.70   | 8,785.37  |
| million)                       |           |            |           |
|                                | 1,166.55  | 1,013.51   | 1,205.35  |
| External Reserves              |           |            |           |
|                                | 2,001.23  | 1,874.87   | 1,967.17  |
| Export (FOB)                   |           |            |           |
|                                | 58.29     | 54.06      | 61.27     |
| External Reserves/Export       |           |            |           |
|                                | 5,702.65  | 5,901.97   | 6,138.09  |
| GDP (current Mkt Price)        |           |            |           |
|                                | 1,062.50  | 1,065.40   | 1,158.79  |
| GDP Per Capita                 |           |            |           |
|                                | 4.20      | 3.30       | 3.50      |
| GDP Growth Rate                |           |            |           |
|                                | 17.83     | 19.76      | 21.66     |
| Domestic Debt/GDP (%)          |           |            |           |
|                                | 2.73      | 2.89       | 2.69      |
| Domestic Debt Service/GDP (%)  |           |            |           |
|                                | 15.27     | 16.76      | 17.37     |
| Domestic Debt                  |           |            |           |
| Service/Expenditures (%)       | 19.50     | 23.81      | 22.00     |
|                                |           |            |           |
| Domestic Debt Service/Revenues | 3.88      | 5.11       | 3.25      |
| (%)                            |           |            |           |
|                                | 179.54    | 64.05      | 64.98     |
| Deficit/GDP (%)                |           |            |           |
|                                | 4.18      | 2.38       | 4.02      |
| External Debt/GDP (%)          |           |            |           |
|                                | 23.39     | 13.82      | 26.02     |
| External Debt Service/GDP (%)  |           |            |           |
|                                | 29.88     | 19.64      | 32.95     |
| External Debt                  |           |            |           |
| Service/Expenditures (%)       | 4,193.26  | 4,946.21   | 5,318.33  |
|                                |           |            |           |
| External Debt Service/Revenues | 73.53     | 83.81      | 86.64     |
|                                |           |            |           |
| Total Debt                     | 393.54    | 311.38     | 411.83    |
|                                |           |            |           |
| Total Debt/GDP (%)             | 6.90      | 5.28       | 6.71      |
|                                |           |            |           |
| Total Debt Service             | 38.66     | 30.58      | 43.39     |
|                                |           |            |           |
| Total Debt Service/GDP (%)     | 49.38     | 43.44      | 54.95     |
|                                |           |            |           |
| Total Debt                     | 540.00    | 694.90     | 833.88    |
| Service/Expenditures (%)       |           |            |           |
|                                | 9.47      | 11.77      | 13.59     |
| Total Debt Service/Revenues    |           |            |           |
| (%)                            | 18.90     | 13.20      | 14.00     |
|                                |           |            |           |
| Gross National Savings         | 40.00     | 40.00      | 40.00     |
|                                |           |            |           |
| Savings/GDP (%)                | 12.50     | 12.50      | 12.50     |
|                                |           |            |           |
| Inflation[^3]                  |           |            |           |
|                                |           |            |           |
| Liquidity Ratio Requirements   |           |            |           |
| for Banks                      |           |            |           |
|                                |           |            |           |
| Cash Reserve Ratio             |           |            |           |
|                                |           |            |           |
| Weighted Average Maturity of   |           |            |           |
| Outstanding Debt               |           |            |           |
+--------------------------------+-----------+------------+-----------+

[^1]: Initial trip report.

[^2]: Provisional

[^3]: Actual