Impact Of External Debt On Economic Growth In Nigeria

Project and Seminar Material for Economics

Abstract

The study seeks to determine the effect of external debt on economic growth in Nigeria. Specifically, the study examines whether external borrowings and its major determinants like exchange rate, gross fixed capital formation and inflation rate have supported the growth of the Nigerian economy. The parameters of the model were estimated using the ordinary least squares method. The robustness of the result was enhanced using the generalized least squares technique. The result shows evidence of significant positive correlation between economic growth and the explanatory variables namely external debt, exchange rate and inflation rate. A negative correlation was however observed between economic growth and gross fixed capital formation. The regression estimates for both the ordinary and generalized least squares tests show significant positive impact of external debt, exchange rate and inflation rate on economic growth. The results also show non-significant negative effect of gross fixed capital formation on economic growth. The study concludes that external debt has significantly promoted economic growth in Nigeria.

Chapter One

Introduction

1.1 Background to the Study

One of the key macroeconomic objectives of a nation is the achievement of sustainable economic growth. To achieve this goal, every Government requires a substantial amount of capital finance through investment expenditures on infrastructural and productive capacity development (Umaru, Hamidu and Musa, 2013). Consequently, this facilitates the growth of their gross domestic product (GDP), which if persistent should culminate in economic development, a status vigorously pursued by all less developed countries (LDCs), Nigeria inclusive. However, Ayadi & Ayadi (2008) note that the amount of capital available in most developing countries treasury is grossly inadequate to meet their economic growth needs mainly due to their low productivity, low savings and high consumption pattern. Governments therefore resort to borrowing from outside the country to bridge the resource gap.

Countries borrow to promote economic growth and development, by creating conducive environment for people to invest in various sectors of their economies (Umaru et al, 2013). Similarly, Obudah and Tombofa (2013) argued that the specific reasons why countries may borrow include: to be able to finance their reoccurring budget deficit, as a means of deepening their financial markets, to enable them fund the increasing government expenditures, to enhance their narrow revenue sources and low output productivity which results in poor economic growth. According to Chenery’s (1966) Dual-gap theory, governments borrow to augment their limited resources so as to bridge the savings-investment gap.

The Keynesian economics school of thought posits that government borrowing can be used to promote economic growth, through the financing of government deficit expenditures which stimulates aggregate demand and thus encourage increase in private investments. However excessive public debt can create great debt burden for the country. Soludo (2003) in Okonjo-Iweala et al (2013) argues that once an initial stock of debt grows to a certain threshold, servicing them becomes a burden, and countries find themselves on the wrong side of the Debt Laffer Curve, with debt crowding out investment and growth. Conversely, Bakare (2011) asserts that a country’s indebtedness does not necessarily slow growth, rather it is the nation’s inability to optimally utilize these loans to foster economic growth and development and ensure effective servicing of such debt that hampers the benefits derivable from borrowed capital resources.

Debt, arguably, remains one of the major economic challenges facing governments in low income countries due to their persistence budget deficit and this has continued to attract the attention of international financial institutions, and bilateral lenders. Udeh (2013) notes that this has brought about the adoption of several initiatives capable of alleviating the debt burden which continues to hinder the growth prospects of most highly indebted poor countries (HIPCs) economies. These initiatives range from debt rescheduling to outright cancellation.

Nigeria’s external debt can be traced back to the pre independence period, though the debt level was minimal until 1978, when the first Jumbo loan of more than $1.0 billion was raised from the International Capital Market (ICM)[Debt management office (DMO, 2004)]. However, from 1977, the debt stock incurred by the country has been on a steady increase, rising from $0.763 billion in 1977 to $5.09 billion in 1978 and $8.65 billion in 1980, an increase of over 73.96 percent (DMO, 2004). This subsequently rose to $35.94 billion in 2004. Following the debt relief in 2006 Nigeria was advantaged to offset substantial part of its debt but this later started to record an upward trend. According to Amaefule (2015) Nigeria’s total debt stock as at December 2014 stood at N12.4 Trillion.

1.2 Statement of the Problem

Nigeria like most highly indebted poor countries has low economic growth and low per capita income, with domestic savings insufficient to meet developmental and other national goals. Nigerian exports were primarily primary commodities with export earnings too small to finance imports which are mostly capital intensive (Manufactured) goods which are comparably more expensive (Siddique, Selvanathan and Selvanathan, 2015). Compounding the problem is Nigeria’s drift to mono economy with the discovery of oil. The oil sector generates about 95% of foreign exchange earnings and about 80 percent of budgetary revenue. The inability to diversify her revenue sources coupled with corruption and mismanagement compels Nigeria to have inadequate fund for growth and developmental projects such as roads, electricity pipe borne water and so on.

Nigeria as a developing nation has adopted a number of policies such as the Structural Adjustment Programme (SAP) of 1986 to liberalize her economy and boost Gross Domestic product (GDP) growth. In a bid to ensure the implementation of these policies the government embarked upon massive borrowings from multilateral sources which resulted in a high external debt service burden and by 1992 Nigeria was classified among the heavily indebted poor countries (HIPC) by the World Bank.

Moreover, despite the huge amount of debts which Nigeria has continued to incur over the years, with the aim of achieving economic growth and development, high unemployment, poverty, and low standard of living is still prevalent in the country, as observed by Aiyedogbon and Ohwojasa (2012) and Nwagwu (2014). The inability of Nigeria to effectively meet her debt obligations has adverse effect on the economy, as interests arrears accumulate over the years, thereby creating a much greater debt burden on the nation resulting in a greater percent of her revenue being spent on debt service arrears.

Audu (2004) opined that the debt service burden has continued to hamper Nigeria’s rapid economic development and worsened the social problems; this is because debt servicing crowds out investment and growth. Furthermore, Pattilo et al (2002) assert that at low levels, debt has positive effects on growth but above the threshold point accumulated debt begins to have a negative impact on growth.

This therefore has informed the need to embark on the present study with a view to painstakingly examine the economic impact of external debt liability in Nigeria.

1.3 Objectives of the Study

The general objective of this study is to investigate the economic impact of external debt liability in Nigeria. The specific objectives are:

To determine the impact of external debt on Gross Domestic Product (GDP) in Nigeria.
To examine the effect of external debt servicing on Gross domestic Product in Nigeria.
To find the impact of exchange rate on Gross Domestic Product in Nigeria.

1.4 Research Hypotheses

The researcher intends to test the following hypotheses:

Hypothesis One

H0: There is no significant long run relationship between external debt and economic growth in Nigeria.
H1: There is a significant long run relationship between external debt and economic growth in Nigeria.

Hypothesis Two

H0: There is no causal relationship between external debt and economic growth in Nigeria.
H1: There is a causal relationship between external debt and economic growth in Nigeria

1.5 Significance of the Study

The burden of External debt has been a matter of great concern to the Government of Nigeria and the nation as a whole which has resulted in embarking upon drastic actions like dividing the nation’s scarce resources in servicing of debts annually. This action has thus led to disinvestment in the economy, and as a result a fall in the domestic savings and the overall rate of growth. This study seeks to investigate the direct impact of external debt burden on economic growth in Nigeria by finding a long run and causal relationship between external debt and economic growth. This study is significant as its findings will provide a basis which will aid policy makers in proffering polices aimed at managing the debt crisis situation in Nigeria.

1.6 Scope and Limitation of the Study

This study is primarily concerned with impact of external debt on economic growth in Nigeria. In order to fully capture its effect on the economy, a thorough empirical investigation will be conducted with data covering a period of 32 years i.e. 1980-2012.The researcher encountered some constraints, which limited the scope of the study. These constraints include but are not limited to the following

a) Availability of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

b) Time:

The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.

1.7 Definition of Terms

Impact:

Powerful effect that something has on another.

External Debt:

Is the portion of a country’s debt that was borrowed from foreign lenders including commercial banks, governments or international financial institutions. These loans, including interest, must usually be paid in the currency in which the loan was made.

Economic Growth:

Economic growth is an increase in the capacity of an economy to produce goods and services, compared from one period of time to another. It can be measured in nominal or real terms, the latter of which is adjusted for inflation.

1.8 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows

Chapter one is concerned with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.
Chapter three deals on the research design and methodology adopted in the study.
Chapter four concentrate on the data collection and analysis and presentation of finding.
Chapter five gives summary, conclusion, and recommendations made of the study

Chapter Five

Summary, Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was to ascertain a critical analysis of impact of external debt on economic growth in Nigeria.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations are made, which in the opinion of the researcher will be of benefit in addressing the issues arising from Nigeria’s external debt management.

5.2 Summary

This study aimed at having a critical analysis of impact of external debt on economic growth in Nigeria. Three objectives were raised. These objectives include: To determine the impact of external debt on Gross Domestic Product (GDP) in Nigeria, To examine the effect of external debt servicing on Gross domestic Product in Nigeria, To find the impact of exchange rate on Gross Domestic Product in Nigeria.

5.3 Conclusion

There is an inelastic relationship between Real Gross Domestic Product and External debt service Payments. A unit change in external debt service payments will bring about a less than proportionate change in real gross domestic product.

There is a positive relationship between Real Gross Domestic Product and Exchange rate. A unit crease in exchange rate will bring about a 0.006284 increase in real gross domestic product.

Based on the above findings pertaining to the objectives of the study the following conclusions are drawn.

5.4 Recommendation

Firstly, external debts should be contracted solely for economic reasons and not for social or political reasons. This is to avoid accumulation of external debt stock overtime and prevent an obscuring of the motive behind external debt.

Project Material Download