The Structure Of The Nigerian Domestic Debt And It’s Impact On Foreign Exchange Earning

Project and Seminar Material for Economics

The Structure Of The Nigerian Domestic Debt And It’s Impact On Foreign Exchange Earning


Abstract


The main objective of this study was to ascertain the structure of the Nigerian domestic debt and its impact on economic growth. The paper concludes that domestic debts enhanced growth of the economy while domestic debt service expenditures by the government and lending interest rates by the banks dampened investments and thus limited growth potentials of the country. The main instruments of the domestic debt are the treasury bills and bonds and federal government bonds and stocks. The domestic debt holding of government is far above a healthy threshold of 35 percent bank deposit as the average over the period of study is 114.98 percent of bank deposit and there is evidence of crowding out of private investments. On the determinants of the size of domestic debt, it is observed that low rate of economic growth, foreign exchange rate, inadequate credit to private sector, and unstable monetary policy environment influenced the size. The study recommends that government should rely more on domestic debt in stimulating growth rather than external debt.


Chapter One


Introduction

1.1 Background of the Study

The debt structure of a country affects individual citizens, institutions of government, privately owned corporate organizations like banks and consequently the economy at large. The debt structure in this context is the magnitude of the domestic debt as well as the magnitude of the external debts. The issue of Nigeria’s public debt became important in recent times especially prior to the period of the debt forgiveness because of its magnitude and the amount which was required to service such debts as well as its attendant possible effects on different operating sectors of the economy especially the banking sector and the growth of the economy at large. As at the month of July 2005, Nigeria external debt was US$34 billion of which about $28 billion or 85% was owed to the Paris club of fifteen creditor nations. Apart from external debts, Nigeria’s domestic debt as at 31st December, 2003 was N1.329 trillion and as at July 2006 it was N1.5 trillion as at July 2005 as reported by the debt management office. Nigeria’s domestic debt is defined mainly as debt instruments by the federal government and denominated in local currency. It consists mainly of Nigerian Treasury Bills, Nigerian Treasury Certificates, Treasury Bonds, Federal Government Development Stocks, Ways and Means and recently considered are Contractor debts. According to Alison (2003), three reasons have been advanced for the growing government domestic debt. The first of this is debt incurred from financing budget deficit. The second reason is debt arising from the implementation of monetary policy (the purchase and sale of treasury bills in the open market operations) and thirdly domestic debt incurred to develop the financial sector through the supply of tradable financial instruments so as to deepen financial markets. Ola and Adeyemo (1998), while explaining the reasons for increasing public debt on the part of the Nigerian government came up with the following reasons: Government borrowed to finance emergencies such as natural disasters and economic depression. Government borrowed to finance important capital projects such as water dams, agricultural development projects, river basin development projects. Government borrowed to finance current expenditure in anticipation of reasonable revenue collection. At a point in year 2003 it was estimated that Nigeria needed approximately US$3 billion yearly to fully service her external debt apart from her domestic debt and this is considered unthinkable to do as it will result in the economy getting almost grounded.

Domestic debt reduction in Nigeria has taken centre stage for conversing realistic pricing of petroleum products in Nigeria as the domestic debt profile has been rising astronomically and if not controlled could create some unfavorable consequences as crowding out private sector investment, poor GDP growth etc,(Okonjo-Iweala,2011). On the other hand, government has to continue to finance projects to grow the economy and one viable option of doing so is by issuing debt instruments. For example, the 2012 national budget presented to the national assembly contains a deficit of N1.11trillion 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 while external debt was $5.6 billion bringing the National debt to a total of 40 billion dollar which amounted to 19.6 percent of GDP, (Nwankwo2011) showing that the debt ratio is still below the internationally unacceptable standard of 40 percent of GDP. However, beyond consideration of maximum acceptable debt-GDP ratio of 0.40 a more critical consideration for economic growth is the country’s absorptive capacity which might be quite be low a given threshold. Domestic debt is therefore a topic to examine at this point of national development when unemployment is critically high and the global economic crisis is far from being resolved.

Domestic debts are debts instrument issues by the federal government and denominated in local currency. State and local government can also issue debt instrument, but debt instrument currently in issue consists of Nigerian treasury bills, federal government development stocks and treasury bonds. Out of these treasury bills and development stocks are marketable and negotiable, while treasury bonds; ways and means advances are not marketable but held solely by the central bank of Nigeria, (Adafu et al 2010). The central bank of Nigeria (CBN) as banker and financial adviser to the federal government is charged with the responsibility for managing the domestic public debt. (Alison et al 2003) reveal three principal reasons often advanced for government domestic debt. The first is for budget deficit financing, second, is for implementing monetary policy and the third is to develop instruments so as to deepen the financial market. Whatever the purpose, the government should find a way of managing the domestic debt so that the level of debt is not counterproductive. The researcher therefore set out to investigate the structure and effects of rising domestic debt and for this purpose, the paper is divided into five sections. Besides the introductory section, section two, examines the relevant literature exploring the genesis of public debt financing and its management, section three examines the methodology of investigation, section four discusses the research findings and section five raps it up with summary and policy prescriptions.


1.2 Statement of the Problem

Domestic debts are debts instrument issues by the federal government and denominated in local currency. State and local government can also issue debt instrument, but debt instrument currently in issue consists of Nigerian treasury bills, federal government development stocks and treasury bonds. Out of these treasury bills and development stocks are marketable and negotiable, while treasury bonds; ways and means advances are not marketable but held solely by the central bank of Nigeria, (Adafu et al 2010). The central bank of Nigeria (CBN) as banker and financial adviser to the federal government is charged with the responsibility for managing the domestic public debt. (Alison et al 2003) reveal three principal reasons often advanced for government domestic debt. The first is for budget deficit financing, second, is for implementing monetary policy and the third is to develop instruments so as to deepen the financial market. It is in view of these that the researcher intends to investigate the structure of the Nigerian domestic debt and its impact on economic growth.


1.3 Objective of the Study

The main objective of the study is to ascertain the structure of Nigeria domestic debt and its impact on economic growth. But for the purpose of the study, the researcher intends to achieve the following objectives;

  1. To ascertain the structure of Nigerian domestic debt and it impact on economic growth
  2. To ascertain if there is equilibrium relationship between domestic debt and economic growth
  3. To ascertain the long run effect of domestic debt on economic growth
  4. To ascertain the short run effect of domestic debt on the economic growth of Nigeria.

1.4 Research Hypotheses

For the successful completion of the study, the following hypotheses was formulated by the researcher

  1. H0: the structure of Nigeria domestic debt does not have any significant impact on Nigeria’s economic growth
    H1: the structure of Nigeria’s domestic debt has a significant impact on the economic growth of Nigeria.
  2. H02: there is no equilibrium relationship between domestic debt and economic growth in Nigeria.
    H2: there is an equilibrium relationship between domestic debt and economic growth.

1.5 Significance of the Study

It is conceived that at the completion of the study, the findings will be of great importance to the management of the central bank of Nigeria who are charged with the responsibility of running the financial transaction of the federal government and also advice the federal government on the structure of debt to adopt in need be. The study will also be of great importance national economic planning committee who are saddled with the responsibility of planning the general economy of the country, as the study intends to find out if there is any relationship between debt structure and economic growth. The study will also be beneficial to researchers who intend to embark on study in similar topic as the study will serve as a guide to their study. Finally the study will be beneficial to academia’s students and the general public.


1.6 Scope and Limitation of the Study

The scope of the study covers the structure of the Nigeria domestic debt and its impact on economic growth. In the course of the study, the researcher encounters some constrain which limited the scope of the study;

(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.

(c) Finance:

The finance available for the research work does not allow for wider coverage as resources are very limited as the researcher has other academic bills to cover.


1.7 Definition of Terms

Domestic Debt

Domestic Debt is the amount of money raised by the Government, in local currency and from its own residents. Generally, domestic debt consists of two categories, which are Bank and Non-Bank borrowing.

Foreign Debt

Foreign debt is an outstanding loan that one country owes to another country or institutions within that country. Foreign debt also includes due payments to international organizations such as the International Monetary Fund (IMF)

Economic Growth

Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP, usually in per capita terms

Debt Structure

The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings.

GDP

The gross domestic product (GDP) is one of the primary indicators used to gauge the health of a country’s economy. It represents the total dollar value of all goods and services produced over a specific time period; you can think of it as the size of the economy


1.8 Organization of the Study

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

  • Chapter one is concern with the introduction, which consist of the (overview, of the study), statement of problem, objectives of the study, research question, significance or the study, research methodology, definition of terms and historical background of the study.
  • Chapter two highlight the theoretical framework on which the study its 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 also 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 the structure of the Nigerian domestic debt and its impact on economic growth.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges of domestic debt structure and its impact on the economy.


5.2 Summary

Borrowed money has a positive effect on growth in the short run but debt and budget deficit has a negative impact on growth in the long run. The impact of huge debt on economic growth may not be immediate but could be devastating in the long run. On the whole, in managing public debt, efforts must be made at ensuring fiscal sustainability with adequate consideration to ensuring that the debt profile does not exceed the discounted value of its future net revenue.


5.3 Conclusion

This study has examined the structure of Nigerian domestic debt domestic and its impact on the economic growth of Nigeria. The main caveat of this study is that it considers domestic debt, which is just a fractional part of public or government debt. However, based on relevant diagnostics, appropriate analysis and results, the paper concludes that domestic debts enhanced growth of the economy while domestic debt service expenditures by the government and lending interest rates by the banks dampened investments and thus limited growth potentials of the country. The investments dampening cum economic growth potentials limiting were assumed manifest consequent upon perceived preference for immediate consumption spending by recipients of government domestic debt service expenditures during the period. However, results of the diagnostic analysis provided reliable statistical evidence that domestic debts have the potentials to induce sustainable growth and ultimately development of the economy in the long-run. Further, domestic debts, its service expenditures, lending rates of the banks and growth of the economy have the tendency to adjust to their long-run equilibrium levels from short-run disequilibrium at considerably high speeds. Therefore, the paper emphasizes the need for the government to sustain commensurate growth-inducing levels of domestic debts at all times. This study examines the domestic debt of the Nigerian economy, its structure, impact and its main determinants and observe that the domestic debt has grown astronomically from N407 billion in 1994 to N3228 billion in 2009 and the main instruments of the domestic debt are the treasury bills and bonds and federal government bonds and stocks. The states and local governments are not yet important prayers in the domestic debt market. The debt instrument issued are highly short term in nature as treasury bills and bond controlled over 70 percent of the issues until 2005 when the issue of long term bond became significant. The investor base of the Nigerian debt market is well diversified as both banks and non bank public are active in the market especially from 2002 but the domestic debt holding of government is far above a healthy threshold of 35 percent of bank deposit as the average over the period of study is 114.98 percent of bank deposit and there is evidence of crowding out of private investments. The study of course affirms that level of debt has negative effect on economic growth which is in line with the finding of (Abbas and Christensen 2007). On the determinants of the size of Nigerian domestic debt, it is observed that low rate of economic growth, foreign exchange rate, inadequate credit to private sector and unstable monetary policy environment influenced the size of domestic debt within the period of study.


5.4 Recommendation

Haven completed the study the researcher proffer the following recommendations; it is recommended that investment incentives should be put in place to discourage the perceived immediate consumption spending behavior of recipients of government domestic debt service expenditures. Also, the need to improve infrastructure such as electricity is paramount so as to banks’ operating costs and ultimately lending rates the banks charge on credit facilities, especially for investments. These would in turn increase aggregate investment, output and ultimately accelerate growth of the economy, broader analysis based on entire public debts (domestic and external) is pertinent. The policy implication of this result is that domestic debt rather than external debt will stimulate economic growth in Nigeria. This is because the repayment of the principal and interest on such internal debt is a reinvestment into the domestic which would usually have a chain investment effect on the domestic economy. But with respect to external debt, more resources will be needed to repay and service the debt and this would impair the positive effect of this debt on economic growth. Thus, the paper recommends that government should rely more on domestic debt in stimulating growth rather than external debt. Government should formulate policies aimed at encouraging domestic savings vis-à-vis domestic investment. The need for borrowing is due to gap between domestic savings and investment; therefore, bridging the gap can be a likely solution to Nigeria’s debt accumulation.

Government should maintain a debt bank deposit ratio below 35 percent and resort to increase use of tax revenue to finance its projects as it is our believe that tax revenue is far from the optimum.

Government should divest itself of all projects which the private sector can handle including refining crude oil (petroleum product) and transportation but 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 proceed is channeled towards improving Nigerian investment climate


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