A Critical Analysis Of The Effect Of Domestic Debt On The Nigerian Economy

Project and Seminar Material for Economics

A Critical Analysis Of The Effect Of Domestic Debt On The Nigerian Economy


Abstract


The study examined the impact of domestic debt on economic development of Nigeria with a view to determining amongst other the relative importance and impact of domestic debt on economic growth (GDP) of Nigeria. The study adopted qualitative research focuses on secondary data from CBN. Data relating to domestic debt stock, Gross Domestic product, Interest on domestic debt and capital expenditure of Nigeria from 1990 – 2010 were obtained from the debt management and central bank of Nigeria.

The data obtained was subjected to linear regression model analysed with the aid of E-view statistical package for accuracy. The result reveals strong liner correlation between domestic debt and economic growth. In lights of this finding the study recommended for proper management of domestic debt and appropriate debt serving technique for effective growth of the economy.


Chapter One


1.0 Introduction

1.1 Overview of the Study

Theoretical and empirical studies on the importance of financial development and economic growth relationship had occupied a central position in the macroeconomics literature for developing economies like Nigeria. Domestic debt and economic growth had been identified as one of the areas in the macroeconomics literature that can increase the process of development in an economy. Unfortunately in Nigeria domestic debt has taken a key stage in the economy, because of its negative rising profile. According to Iweala (2011), if not controlled could create some unfavorable consequences in the economy. According to her, Government has to finance projects to grow and one of such options is by using domestic debt instrument. For example, the 2012 national budget presented to the national house of assembly contains a deficit of N1.11 trillion which has to be financed majorly through domestic debt. As at September 2011, Nigerian domestic debt stood at N5.3 trillion, an equivalent of $34.4 billion which amounted to 19.6 percent of GDP (Nwankwo, 2011).

Domestic debt is therefore a major topic to examine at point of national development when unemployment is critically high and the global economic crisis is far from being solved.

According to Gbosi (2004), domestic debts are debt issued by the federal government and denominated in local currency. State and local government also issue debt instrument, but the debt instrument currently issue must consist of Nigerian treasury bills, treasury bonds and federal government development bonds. Alison et al (2003) revealed three principal reasons for government domestic debt. The first is for budget deficit financing, second is for implementing monetary policies and the third is to develop instrument so as to deepen the financial market. Domestic debt have a positive effect on growth via triggering aggregate demand and output in the short run; but in the long-run the positive effect turns into a negative effect because of crowding out of capital and output (Elmendorf et al, 1998).

Domestic debt reduces macro-economic risk; the absorption of the domestic financial resources by the government brings some question like inefficient credit to the private sector and poor financial development. Whatever the purpose, the government should find a way of managing debt so that the level of debt is not counter-productive. The researcher therefore set out to investigate the structure and effect of rising domestic debt on Nigerian economy. Nigerian domestic debt has been on the rise from N1.1 billion in 2001 to N3.2billion in 2009 and N7.1 billion in 2013 (CBN 2013)

The impact of domestic debt on economic growth has been previously studied and the findings are numerous. This research is motivated by the fact that domestic debt has been a major macro-economic problem especially since 1980. For many years now, the country’s domestic debt has been growing is spite of the effort being made by the government to manage and minimize its crushing effect on the economy. The increasing domestic debt profile has affected the growth of the Nigerian economy with some of the identified factors as high budget deficit, low output growth, large expenditure growth and high inflation rate.


1.2 Statement of Problem

The need to finance rising government expenditure has been identified to the rapid increase in the stock of Nigeria’s domestic debt. A recent study by (Abbas and Christerisen 2007) analyzing optimal domestic debt level in low income countries like (Nigeria) and emerging markets between 1999 and 2004 found out that moderate level of marketable domestic debt as a percentage (GDP have significant positive effect on economic growth. the study also provide evidence that debt level exceeding 35 percent of total bank deposits have negative impact on the economic growth.
The money borrowed was not utilize for the benefit of the citizens and for the growth of the Nigerian economy due to the corrupt practices, bad policies and mismanagement of funds by some selfish Nigerians in government. The effect of the global crisis of the Nigerian economy was no doubt reflective on the capital market, with the withdrawal of investment by foreign investors and the crash in the price of crude oil, thereby resulting in the fall in share price in the stock market, and other effect of the banking sector and the economy at large.

Nigeria’s foreign economic relations revolve around it role in supplying the world economy with oil and natural gas, even as the country seeks to diversify its exports harmonize tariffs in line with a potential customs union sought by the economic community of West African states (ECOWAS), and encourage inflows of foreign portfolio and direct investment. In October 2005, Nigeria implemented the ECOWAS common external tariff, which reduced the number of tariff bonds. Prior to this revision,tariffs constituted Nigeria’s second largest source of revenue after oil exports. In 2005 Nigeria achieved a major breakthrough when it reached an agreement with the paris club to eliminate its bilateral debt through a combination of write-down and buybacks. This research therefore will attempt to investigate and profer solution to:

  1. The effect of domestic debt, principal portion of economic growth.
  2. The effect of the cost of servicing domestic debt and economic growth.
  3. The effect of domestic debt instrument on economic growth.
  4. The effect of domestic debt on Gross Domestic product (GDP).

1.3 Objectives of the Study

The objective of the study is to:

  1. Investigate the effect of the cost servicing domestic debt on budget and economic growth.
  2. Investigate the effect of domestic debt on the principal portion on economic growth.
  3. To investigate the effect of domestic debt instruments on economic policies (monetary and fiscal policies).
  4. To investigate the effect of domestic debt on Gross Domestic product (GDP).

1.4 Research Hypothesis

In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with Ho while the alternative hypothesis will be represented with hypothesis Hi.

Hypothesis one

  • HO: There is a negative relationship between the principal portion of domestic debt and economic growth.
  • Hi: There is a positive relationship between the principal portion of domestic debt and economic growth.

Hypothesis Two

  • Ho: There is a negative relationship between the cost of servicing domestic debt, and economic growth.
  • Hi: There is a positive relationship between the cost of servicing domestic debt, and economic growth.

Hypothesis Three

  • Ho: There is a negative relationship between domestic debt instruments and the economic growth.
  • Hi: There is a positive relationship between domestic debt instruments and the economic growth.
Hypothesis Four
  • Ho: There is a negative relationship between domestic debt and gross domestic product (GDP).
  • Hi: There is a positive relationship between domestic debt and gross domestic product (GDP).

1.5 Scope of the Study

This research is based on domestic debt and the Nigerian economy, the extent of study will be limited to Nigerian domestic debts.

It will cover statistical bulletins from CBN and CBN annual reports, the Debt Management Office (DMO) and other cognate publications from the internet. The researcher will use secondary data in eliciting information that will be used in the research work, and it will cover the period between 2001 – 2010.


1.6 Significant of the Study

A study of domestic debt and the Nigeria economy will immensely enable creditors in the economic system to identify the level of risk that are prevalent in the granting of debt loan and its recovery.

Some businesses in Nigeria rely on loans to enable their business survive. This fact has made it imperative to undertake this study and to minimize the effect of debt in the Nigeria economy.

Finally, this study is not only intended to highlight domestic debts in the Nigerian economy but also to boost studies in the area and to serve as encouragement to other students to carry out further research in this field.


Chapter Five


Conclusion, Recommendation and Policy Implications

This study questioned the extent to which domestic debt affects economic growth in Nigeria from 2001- 2010. In expressing this question quantitatively, the paper investigated the relationship between gross domestic product (a proxy for economic growth) on the one hand and domestic debt, interest rate, domestic credit to private sector and budget deficit on the other hand.

The study also engaged various literatures (conceptual, theoretical and empirical) that shaped the nexus between domestic debt and economic growth over time. Besides, the paper illuminated the structure of domestic debt and economic performance during various economic policy era in Nigeria. The paper discovered that GDP has strong relationship with domestic debt, domestic credit to private sector, budget deficit and interest rate. It was also observed that there is a positive and significant relationship between GDP and domestic debt. This obviously implies that the funds generated through domestic borrowing have been used partially to finance those expenditures of government, which contribute to growth rate of GDP. It also implies that increasing domestic debt (up to a certain level) would increase economic growth, so far domestic debt revenues are being channeled into productive activities in the economy. Another reason for the positive relationship between domestic debt and economic growth in Nigeria is attributed to the marketable nature of domestic debt. Market-base domestic debt increases macroeconomic growth and reduces exposure to external real shocks.

Following from the foregoing analysis, the paper recommends that the government should institute efforts to channel Domestic Debt revenue to productive activities in the economy so that debt does not rise to become unsustainable. This would require funding well appraised productive projects to foster economic growth. Also, government should set an umbrella ceiling on domestic borrowing for a chosen period of time and this should be embedded in the national debt strategy. The limits should be reviewed periodically (annually) to ensure that they are still meaningful in the current economic circumstances. Mechanisms should be put in place to monitor the impact of new borrowing on overall debt sustainability based on the evolution of the debt indicators and provide prompt fiscal rectification. The government and the Debt Management Office (DMO) should draw up guidelines to limit the growth of future domestic debt. In this regard, debts service ratio must not exceed 40 percent of allocation from the federation account. Effective mechanism should be put in place to ensure that any new borrowing is judiciously utilized to contribute to economic growth.

Excessive domestic borrowing can be inflationary and may crowd out private sector borrowing. Close monitoring of government borrowing through the domestic market is therefore necessary. The problem of a high domestic debt is more difficult to solve vis-à-vis external debt, mainly because the relationship between the borrower (government) and creditor is different; the solutions of debt write-off, debt conversion, debt rescheduling etc will not apply because these solutions could be counterproductive and would mean government reneging on its commitments, which would affect future mobilization of resources (UNITAR- DFM E-Learning, 2008)


Recommendations

Government should maintain a bank deposit ratio below 35 percent and resort to increase use of tax revenue to finance its projects. Government should divest all projects which the private sector can handle including refining crude oil (petroleum product) and transportation. The regulatory authorities should provide enabling environment for private sector investors such as tax holidays, subsidies, guarantees and most importantly improved infrastructure. Government should maintain a proper balance between short-term and long-term debt instruments in such a way that long-term instruments dominate the debt market. Even if the ratio of the long- term debt is a multiple of deposit, the economy can still accommodate it so long as the proceeds are channeled towards improving Nigerian investment climate.


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