The Effect Of External Debt On Economic Growth Of Nigeria

Project and Seminar Material for Economics

Project and Seminar Material for Economics


Abstract


This work evolved out of the need to provide an in-depth understanding of the economics of debt in Nigeria. This study aims at analysing the effectiveness of external debt on economic growth within a span of 1981-2010. The broad objective of this work is specified to evaluate the impact of external debt stock and debt servicing on economic growth. In all the models were to show the growth relationship between the independent variables-inflation rate exchange rate interest rate government expenditure external debt stock and external debt service and the dependent variable-gross domestic product (GDP).

The data were collected from CBN Statistical Bulletin 2010 and the Debt Management Office (DMO) quarterly report. The Engle & Grenger Cointegration and Ordinary Least Square (OLS) were employed in the cause of this study. The Augmented Dickey Fuller test (ADF) shows that the variables are stationary and reliable for forecasting. The choice of OLS is most appropriate for the study in terms of goodness of fit and significance of regression coefficients.

The result of the analyses showed that rising external debt stock inhibits the pace of economic growth of Nigeria by increasing the cost of its servicing beyond the debt sustainability limit while external debt servicing was found not to impair economic growth. Summary and policy recommendations were presented in line with our stated objectives and facts then conclusions were made. It was found that external debt stock rises rapidly due to accrued compound interest and loans were secured for dubious projects. Part of the policy recommendations were that Nigeria should increase its export base by investing borrowed funds in productive ventures and she should also seek fixed interest payment varying amortization schemes and multi-year rescheduling.


Table of Contents


Preliminary Page(s)

  • Title
  • Declaration
  • Approval
  • Dedication
  • Acknowledgement
  • Abstract
  • Table of Content

Chapter One:

Introduction

  • 1.1 Background to the Study
  • 1.2 Statement of the Problem
  • 1.3 Objectives of the Study
  • 1.4 Research Questions
  • 1.5 Research Hypotheses
  • 1.6 Scope of the Research
  • 1.7 Significance of the Study

Chapter Two:

Review of Related Literature

  • 2.1 Conceptual Review
  • 2.2 Theoretical review
  • 2.3 Empirical Review

Chapter Three:

Methodology

  • 3.1 Research Design
  • 3.2 Nature and Sources of Data
  • 3.3 Specification of Models
  • 3.4 Description of Research Variables
  • 3.5 Further Tests

Chapter Four:

Presentation and Analysis of Data

  • 4.1 Presentation and interpretation of Data
  • 4.2 Statistical properties of variables
  • 4.3 Test of hypotheses
  • 4.4 Implications of Results
  • 4.5 Contribution to knowledge

Chapter Five:

Summary of Findings, Conclusion and Recommendations

  • 5.1 Summary of Findings
  • 5.2 Conclusion
  • 5.3 Recommendations
  • Bibliography
  • Appendices

Chapter One


Introduction

1.1 Background To The Study

It is generally expected that developing countries, facing a scarcity of capital, will acquire external debt to supplement domestic saving (Malik et al, 2010; Aluko and Arowolo, 2010). Besides, external borrowing is preferable to domestic debt because the interest rates charged by international financial institutions like International Monetary Funds (IMF) is about half to the one charged in the domestic market (Pascal, 2010). However, whether or not external debt would be beneficial to the borrowing nation depends on whether the borrowed money is used in the productive segments of the economy or for consumption. Adepoju et al (2007) stated that debt financed investment need to be productive and well managed enough to earn a rate of return higher than the cost of debt servicing.

The main lesson of the standard “growth with debt” literature is that a country should borrow abroad as long as the capital thus acquired produces a rate of return that is higher than the cost of the foreign borrowing. In that event, the borrowing country is increasing capacity and expanding output with the aid of foreign savings. The debt, if properly utilised, is expected to help the debtor country’s economies (Hameed et al, 2008) by producing a multiplier effect which leads to increased employment, adequate infrastructural base, a larger export market, improved exchange rate and favourable terms of trade. This has never been the case in Nigeria and several other sub-Saharan African Countries (SSA) where it has been misused (Aluko and Arowolo, 2010). Apart from the fact that external debt had been badly expended in these countries, the management of the debt by way of service payment, which is usually in foreign exchange, has also affected their macroeconomic performance (Aluko and Arowolo, (2010); Serieux and Yiagadeesen, (2001).

Prior to the $18 billion debt cancellation granted to Nigeria in 2005 by the Paris Club, the country had external debt of close to $40 billion with over $30 billion of the amount being owed to Paris Club alone (Semenitari, 2005a). The history of Nigeria’s huge debts can hardly be separated from its decades of misrule and the continued recklessness of its rulers. Nigeria’s debt stock in 1971 was $1 billion (Semenitari, 2005a). By 1991, it had risen to $33.4 billion, and rather than decrease, it has been on the increase, particularly with the insurmountable regime of debt servicing and the insatiable desire of political leaders to obtain loans for the execution of dubious projects (Semenitari, 2005a).

Before the debt cancellation deal, Nigeria was to pay a whopping sum of $4.9 billion every year on debt servicing (Aluko and Arowolo, 2010). It would have been impossible to achieve exchange rate stability or any meaningful growth under such indebtedness. The effect of the Paris Club debt cancellation was immediately observed in the sequential reduction of the exchange rate of Nigeria vis-à-vis the Dollar from 130.6 Naira in 2005 to 128.2 Naira in 2006, and then 120.9 in 2007 (CBN, 2009). Although the growth rate of the economy has been inconsistent in the post-debt relief period as it plunged from 6.5% in 2005 to 6% in 2006 and then increased to 6.5% in 2007 (CBN, 2008), it could have been worse if the debt had not been cancelled.

However, the benefits of the debt cancellation, which was expected to manifest after couple of years, was wiped up in 2009 by the global financial and economic crisis, which was precipitated in August 2007 by the collapse of the sub-prime lending market in the United States. The effect of the crisis on Nigeria’s exchange rate was phenomenal as the Naira exchange rate vis-à-vis the Dollar rose astronomically from about N120/$ in the last quarter of 2007 to more than N150/$ (about 25% increase) in the third quarter of 2009 (CBN, 2009). This is attributable to the sharp drop in foreign earnings of Nigeria as a result of the persistent fall of crude oil price, which plunged from an all-time high of US$147 per barrel in July 2007 to a low of US$45 per barrel in December 2008 (CBN, 2008).
Available statistics show that the external debt stock of Nigeria has been on the increase after the debt cancellation in 2005. The country’s external debt outstanding increased from $3,545 million in 2006 to $3,654 million in 2007, and then to $3,720 million and $3,947 in 2008 and 2009 respectively (CBN, 2009). It is therefore imperative to examine the effect of external debt of the country on her economy for us to appreciate the need to avoid being back in the group of highly indebted nations.


1.2 Statement Of The Problem

The huge external debt stock and debt service payments of African countries and Nigeria in particular prevented the countries from embarking on larger volume of domestic investment, which would have enhanced growth and development (Clements, etal. 2003). External debt became a burden to most African countries because contracted loans were not optimally deployed, therefore returns on investments were not adequate to meet maturing obligations and did not leave a favourable balance to support domestic economic growth. So, African economies have not performed well because the necessary macro-economic adjustment has remained elusive for most of the countries in the continent. The main interest of this study then is to empirically investigate the effect of external debt on the economic growth of Nigeria.


1.3 Objectives Of The Study

The main objective of this study is to assess the effect of external debt on economic growth in Nigeria.
Other specific objectives that guided the study are:

  1. To assess the effect of increase in external debt on economic growth in Nigeria, using
    per capita Gross Domestic Product (GDP) as proxy for economic growth.
  2. To examine the effect of loans from each of the external debt sources (Paris Club, Multilateral, London Club and Bilateral Creditors) on economic growth in Nigeria.
  3. To examine the effect of external debt services on Nigeria’s per capita Gross Domestic Product (GDP).
  4. To analyze the effect of external debt service outlets to each of the creditors (Paris Club, Multilateral, London Club and Bilateral Creditors) on the nation’s GDP.
  5. To examine the effect of external debt stock on the standard of living of an average Nigerian (using per capita income as a proxy for standard of living in relation to external debt per capita).

1.4 Research Questions

The following research questions were formulated for the study:

  1. To what extent does increase in external debt affect growth in the nation’s gross domestic product (GDP) measured at current market price?
  2. To what degree do the sources of external debt mix (Paris Club, Multilateral, London Club and Bilateral Creditors) contribute to increase in the nation’s Gross Domestic Product (GDP)?
  3. To what extent have external debt services contributed to improvement in the nation’s GDP?
  4. How far does each of the creditor categories (Paris Club, Multilateral, London Club and Bilateral Creditors) of external debt services contribute to improvement in the Nation’s GDP?
  5. To what extent does the nation’s external debt stock contribute to improvement in the standard of living of an average Nigerian?

1.5 Research Hypotheses

The following hypotheses were formulated for the study:

H1. Increase in external debt stock does not have significant positive effect on economic growth and vice versa.

H2. The application of loans borrowed from each of the external debt sources has no significant positive effect on Nigeria’s economic growth

H3. External debt services have no significant positive effect on per capita Gross Domestic Product (GDP) at current market prices.

H4. The external debt service outlets do not have significant positive effect on per capita Gross Domestic Product (GDP)

H5. The nation’s external debt stock does not have significant positive effect on the standard of living in Nigeria.


1.6 Scope Of The Research

The scope of this study shall cover the external debt trend of Nigeria over the years to date. The general overview of the debt cancellation shall be taken with certain issues raised and discussed. However, the empirical investigation of the effect of external debt on the economic growth of Nigeria shall be restricted to 1981 and 2010.


1.7 Significance Of The Study

This study is focused on providing alternative measures to tackling external debt management problems. It will also serve as a tool in revamping government policies towards loan procurement and debt servicing in Nigeria. This work may also serve as a yardstick for further research and documentation on Nigeria’s external debt crisis.


Chapter Five


Summary Of Findings, Conclusion And Recommendations

5.1 Summary Of Findings

Specific findings of the study are as follows:

  1. Aggregate external debt stock in Nigeria could not offer sufficient reasons for changes in Nigerian GDP over the period and also it does not have a significant positive effect on economic growth in Nigeria.
  2. The application of loans from the Paris Club has positive but insignificant effect on economic growth; application of loans borrowed from the Multilateral has positive and significant effect on economic growth; external debt sourced from the London Club has significant but negative effect on economic growth. External debts sourced from bilateral creditors had significance positive effect on economic growth. The overall effect shows that external debt stock borrowed from the various creditors has significant effect on economic growth in Nigeria.
  3. External debt services paid out over the years have insignificant negative effect on economic growth in Nigeria.
  4. External debt services to the Paris Club have insignificant positive effect on economic growth; external debt services to the Multilateral creditors and London Club have insignificant negative effect while those paid to the bilateral creditors have positive and insignificant effect on economic growth in Nigeria. The overall effect of external debt services on economic growth is significant.
  5. External debt has a negative and significant effect on the standard of living in Nigeria. This implies that external debt stock has contributed significantly in degrading the standard of living in Nigeria.

5.2 Conclusion

External sector financing has remained one of the avenues through which nations (developed, developing and under developed) finance their budget gaps. The main essence for such borrowing is to develop the critical sectors of the economy and also improve the standard of living of her citizens. If the loan is applied judiciously and the investment climate is favourable, it will produce a leverage condition that will add to the creation of value chain within the context of the domestic economy.

Apart from external borrowing, Nigeria enters into other forms of bilateral relationships with other countries and international agencies and such affiliations usually produce variations in the credit terms, increase in foreign exchange risk and balance of payment disequilibrium. Often, these factors induce debt servicing risk that out weighs the productive capacity of the debtor country, thus leading to debt overhang which damages the credit capacity of the country and also results to sovereign default.

Also, provision of affordable health care, education as well as employment generation are stunted to the extent that the standard of living of an average Nigerian is degraded. Against this backdrop, the study in the main sought to assess the effect of external debt on economic growth in Nigeria, and found among others that the effect of aggregate external debt stock on the nation’s GDP was not statistically significant; more than 60% of changes in GDP were captured by the disaggregated analysis of external debt stock as external debt services failed to explain changes in economic growth; there was no significant positive effect of external debt services on economic growth and the nation’s external debt stock contributed significantly in degrading the standard of living in Nigeria.


5.3 Recommendations

5.3.1 Major Recommendations for Stakeholders

The study posits the following recommendations:

  1. The aggregate contribution of external debt stock is positive but not significant. Nigeria should review her external debt policies in line with the desire to increase the productive base of the economy and enjoy a leveraged advantage. If the application of the loan stock is done wisely, it will contribute to value creation.
  2. The contributions of the debt stock from the Multilateral, and Bilateral creditors are positive and significant to economic growth. Nigeria should sustain this form of relationship and ensure that Bilateral and Multilateral relationships are established among nations especially by making export of goods a top priority of the government
  3. Aggregate external debt services could explain only 30% of changes in economic growth. Also, there is negative and significant effect of debt services on economic growth in Nigeria. The debt service obligations do not seem to align properly with the debt stock in terms of their effects on economic growth. Nigeria should therefore review her debt management policies to fall in line with the objective to deepen the economy and avoid the debt overhang syndrome that characterised Nigeria’s debt management initiatives before the final exit from the Paris Club.
  4. The contributions of the aggregated external debt service outlets also failed to run at congruence with those of the disaggregated debt stock. This phenomenon is capable of reintroducing the negative experience of unsustainable level of debt arising from poor servicing habits that may also give rise to debt repudiation habits. The contributions of each source of external borrowing should be evaluated in the context of the debt service obligations of the source of borrowig.
  5. The contributions of external debt stock to improvement in the standard of living is significant, but negative. The DMO should consider developing a template that could incorporate the human development index (education, per capita income and health) as a variable to measure economic growth.
  6. The provision of section 48 of the Fiscal Responsibility Act that if any state government defaults in servicing Federal Government Guaranteed debt, it will be deducted at source from the state federation Account will further jeopardise the welfare packages enjoyed by the residents of the state. There should therefore be a review of this section to make the public officers accountable even after leaving the office. To a large extent, this will serve as a deterent to public officers who loot public funds while in the office and also inject a sense of total commitment to the welfare of the citizens.
5.3.2 Recommended Areas for Further Research

The following areas are recommended for further research:

  1. External debt sustainability and economic growth in Nigeria.
  2. Trade Liberation: An alternative option to external sector financing in a developing economy.
  3. Imbalance in Government Fiscal Management: Cause of Debt Overhang in Developing Countries.
  4. Fiscal Responsibility Act and Fiscal Rascality in Public Service: Evidence from a Developing Country.
  5. Implications of Debt Overhang on Economic Development of the Sub-Saharan Africa.
  6. External Debt Currency Domiciliation as an Impetus to Economic Integration in Africa.
  7. Trade Liberalisation as an alternative Economic Growth Strategy in Africa.

The Effect Of External Debt On Economic Growth Of Nigeria


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