IMPACT OF EXTERNAL DEBT ON ECONOMIC GROWTH IN NIGERIA : 1981-2010

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IMPACT OF EXTERNAL DEBT ON ECONOMIC GROWTH IN NIGERIA : 1981-2010

ABSTRACT

The issue of linkage between external sector financing and economic growth has attracted wide debate within the context of domestic and international economies. Earlier studies have found that the inability of the developing countries to direct resources to productive use has been a disincentive to domestic capital formation resulting in repudiation to loan repayment, slow pace of economic growth, unfavourable credit terms and foreign exchange variations. Most of the studies however failed to align the contributions of each source of external financing to economic growth and also failed to use the human factor index or the standard of living as a major economic growth determinant. Against this backdrop, the study sought to assess the effect of increase in external debt on economic growth; examine the effect of loans from each of the external debt sources on economic growth; examine the effect of external debt services on per capita GDP; analyze the effect of external debt service outlets to each of the creditors on the nation’s GDP and to examine the impact of external debt stock on the standard of living of the average Nigerian. Five models were formulated in line with the five hypotheses. Variables employed alongside the models include: (1) Aggregated external debt stock and economic growth, (2) Disaggregated external debt stock and economic growth; (3) Aggregated Eternal Debt Services and Economic Growth (4) Disaggregated External Debt Services and Economic Growth and (5) Standard of living and External Debt. The study adopted ex-post-facto research design and secondary data used were sourced from CBN Statistical Bulletin, Debt Management Office and CBN Annual Report, covering 30-year time series period (1981-2010). Descriptive statistics (means, standard deviation, etc) was employed and Augumented Dicker-Fuller (ADF) analysis for unit root tests was conducted. The Johanssen Co integration test was performed to establish the nature of co integration in the models. Ordinary Least Square (OLS) regression technique was used to test the hypotheses at 5% level of significance. The results indicated that (1) Aggregate external debt stock in Nigeria does not have significant positive effect on economic growth; (2) 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 and negative effect on economic growth in Nigeria; (4) Effect of external debt services to the various creditors on economic growth in Nigeria is insignificant; and (5) External debt has a negative and significant effect on the standard of living in Nigeria. The study concludes that as a developing country, Nigeria should make judicious use of all loans (borrowed) and should also enter into other forms of bilateral relationships that could reduce her foreign exchange risk and balance of payment disequilibrium. The study recommends that Nigeria’s external debt policies should be reviewed regularly; the debt service obligations should be properly aligned with the debt stock and that external debt management policies should be made to deepen the economy and also avoid the debt overhang syndrome that characterized Nigeria’s debt management initiatives before her final exit from the Paris Club. In contributing to knowledge, the study adopted modified versions of Malik (2010); Levine and Renart (1992); Karagol (2007); Adesola (2009); Uzochukwu (2011); and Fosu (2007). The study also contributed in terms of geography to knowledge by providing evidence in respect of a developing country, Nigeria.

TABLE OF CONTENTS

PAGES

Cover Page i

Title Page ii

Declaration iii

Approval Page iv

Dedication v

Acknowledgements vi

Abstract vii

Table of Contents viii

List of Tables x

List of Figures xi

List of Appendices xii

CHAPTER ONE: INTRODUCTION

1.1 Background to the Study 1

1.2 Statement of the Problem 4

1.3 Objectives of the Study 5

1.4 Research Questions 6

1.5 Research Hypotheses 6

1.6 Scope of the Research 7

1.7 Significance of the Study 7

References 9

CHAPTER TWO: REVIEW OF RELATED LITERATURE

2.1 Theoretical Review 13

2.2 Empirical Review 61

2.3 Summary of Review 70

References 72

CHPATER THREE: METHODOLOGY

3.1 Research Design 80

3.2 Nature and Sources of Data 80

3.3 Specification of Models 80

3.4 Description of Research Variables 84

3.5 Further Tests 86

References 87

CHAPTER FOUR: PRESENTATION AND ANALYSIS OF DATA

4.1 Presentation and interpretation of Data 90

4.2 Statistical properties of variables 108

4.3 Test of hypotheses 115

4.4 Implications of Results 123

4.5 Contribution to knowledge 128

References 130

CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS

5.1 Summary of Findings 132

5.2 Conclusion 133

5.3 Recommendations 133

Bibliography 136

Appendices 149

LIST OF TABLES

Table 2.1 Total Public Debt Outstanding by Original Maturity 2003-2010 (US$) 14

Table 2.2 External Debt Stock by Economic Sectors 16

Table 2.3 External Debt Service Threshold for selected years 19

Table 2.4 Nigeria’s External Debt Outstanding 24

Table 2.5 External Debt Stock of States as at 31st December 2010 26

Table 2.6 Nigeria’s External Debt Stock by major Institutions 30

Table 2.7 External Debt Services by Creditor Composition 34

Table 2.8 Outstanding External Debt to Paris Club 44

Table 4.1 Effect of Increase in External Debt on Economic Growth 91

Table 4.2 Descriptive Analysis of the Effect of Increase in External Debt on Economic Growth 93

Table 4.3 Effect of Loans from each of the External Debt Sources 95

Table 4.4 Descriptive analysis of the effect of loans from various sources 97

Table 4.5 Effect of increase in External Debt Services on economic growth 99

Table 4.6 Descriptive analysis of the effect of increase in External Debt Services 100

Table 4.7 Effect of Debt Servicing to each of the External Debt Service Outlet 103

Table 4.8 Descriptive Analysis of the Effect of Debt Servicing to each of the External Debt Service Outlets 104

Table 4.9 Impact of External Debt Stock on the Standard of Living of an Average Nigerian 106

Table 4.10 Descriptive analysis of Impact of External Debt Stock on the Standard of Living 107

Table 4.11 Summary of Statistics of Variables Applied in the Regression Analysis 109

Table 4.12 ADF Unit Root test for stationarity (with constant, no trend) 110

Table 4.13 ADF Unit Root test for stationarity (with constant, trend) 111

Table 4.14 Johansen Univariate Cointegration Test for Aggregated External Debt Stock and Economic Growth Nexus Model 112

Table 4.15 Johansen Multivariate Cointegration Test for the Disaggregated External Debt Stock and Economic Growth Nexus Model 112

Table 4.16 Johansen Univariate Cointegration Test for Aggregated External Debt Services and Economic Growth Nexus Model 113

Table 4.17 Johansen Multivariate Cointegration Test for the Disaggregated External Debt Services and Economic Growth Nexus Model 114

Table 4.18 Johansen Multivariate Cointegration Test for the Standard of Living and External Debt Nexus 114

Table 4.19 Univariate OLS Test on the effect of Aggregated External Debt Stock on Economic Growth 116

Table 4.20 Multivariate OLS Test on the effect of Disaggregated External Debt Stock on Economic Growth 118

Table 4.21 Univariate OLS Test on the effect of Aggregated External Debt Services on Economic Growth 119

Table 4.22 Multivariate OLS Test on the effect of Disaggregated External Debt Services on Economic Growth 120

Table 4.23 Multivariate OLS Test on effect of External Debt on Standard Of Living in Nigeria 122

LIST OF FIGURES

Figure 4.1 Trend analysis of the movement in GDP and external debt stock 94

Figure 4.2 Trend analysis of the growth rate in GDP and external debt stock 94

Figure 4.3 Trend analysis of the movement in GDP and sources of external Debt stock 98

Figure 4.4 Trend analysis of the movement in GDP and external debt services 101

Figure 4.5 Trend analysis of the growth in GDP and external debt services 102

Figure 4.6 Trend analysis of the movement in GDP and external debt service Outlet 105

Figure 4.7 Trend analysis of the growth rate in per capita income, external debt Per capital, exchange and inflation rate 108

LIST OF APPENDICES

Appendix i External debt services by creditor composition 149

Appendix ii External debt stock by currency composition 149

Appendix iii Comparative economic indicators of selected countries in the world 150

Appendix iv Nigeria’s External debt stock by major institutions151

Appendix v Cases of Lack of Planning in Loan Management that contributed to Nigeria’s External Debt Burden 152

Appendix vi Index of GDP and other related variables 153

Appendix vii List of World Bank active projects in Nigeria 155

Appendix viii African Development Bank programmes in Nigeria 156

Appendix ix ADB Group public and Private Sector operations 162

Appendix x ADF Unit root test 16

Appendix xi Johansen Multivariate test for cointegration 183

Appendix xii Ordinary Least Square (OLS) Regression Analysis 192

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

According to Claudio (2004:4), “the history of developing nations reveal that they have been subjected to repeated economic crises with serious consequences for their long term growth prospects and that the links of these crises to the external sectors performance including the problem of external debt and its sustainability have attracted prolonged debate”. Nations have various reasons for contracting external debt with other nations and borrowing by countries occurs as a result of their inability to generate enough domestic savings to carry out productive activities (Ezeabasili, et.al., 2011). In Nigeria for instance, external debt is secured and channeled to serve as balance of payment support, project tied loans, budget deficit financing, meeting some developmental goals of the various levels of government, embarking on infrastructural development etc. Osinubi, et.al. (2006) observes that the need for government to finance its deficit budget leads to incurrence of external debt. Ezeabasili (2006), Adam (2007) and Anyanwu (1997) are of the opinion that countries borrow to supplement their domestic savings and allow the affected countries to carry out productive activities and if the borrowed funds are channeled to productive investments and the investments enjoy macroeconomic stability, they will be able not only to accelerate their economic growth but also to settle their debt obligations comfortably (Hameed, et. al., 2008). Other studies that have found relationship between debt and growth include Cohen (1995), Borenszteim (1990), Elbadawi, et.al. (1997), Patilo, et.al. (2002), Adeyemi (1996) and Indermit, et.al. (2005). The first external loan contracted in Nigeria was US $28 million in 1958. As a measure to curtail the rising debt profile, the federal government in 1978 promulgated Act No 30 of the same year limiting Federal government external loan to N5 billion. In the same year, a jumbo loan of US $1 billion was raised from the international capital market. Thereafter, the spate of borrowing increased with the entry of state governments into external loan contractual obligations coupled with fall from oil revenue (Adesola, 2009). Fajana (1990) and Olukoshi, et.al. (1990), observe that although the windfall from oil exports led to a considerable economic activities in Nigeria, it did very little to create a solid economic foundation for the country. Muttalab (1984) and Obi (2005) also observe that although the loans obtained by Nigeria from the international financial market were ear marked for specific projects, the disbursement was unrelated to the rate of progress of the projects on ground suggesting that the fund may have been looted by few government officials in collusion with or knowledge of the creditors.

The need to separate debt management from the Ministry of Finance gave rise to the creation of Debt Management Office in 2000 and the office was charged with the responsibility of managing both domestic and foreign debt in Nigeria. Again, in 2005 the government established a fiscal responsibility council and subsequently enacted a fiscal responsibility Act, 2005. These and other efforts were made to keep the nation’s debt stock at a sustainable level.

Claudio (2004) has observed that external debt sustainability is consistent with the objective to keep a debt level that promotes economic growth. Arrow, et.al. (2007) observe that sustainable development is an economic programme along which average well being of present and future generations taken together does not decline over time. As Metwally and Tamaschke (1994) and Geiger (1990) observe, capital inflows have significant impact on growth-debt relationship because when there is a considerable level of inflow of capital, economic growth will be accelerated thus less need for external borrowing. Ogunmuyiwa (2011) however argues that causality does not exist between external debt and economic growth as causation between debt and growth was found to be weak and insignificant in Nigeria. Indermit and Brian (2005) posit that large budget surplus is associated with rapid economic growth. Savvides (1992), Edo (2002), Udoka, et.al. (2010) and Bullow, Rogoff (1990) are of the opinion that debt overhang acts like a high tax margin on the country and could provide disincentive to domestic capital formation. This virus inflicted the Nigerian economy before her total exit from the strong hold of Paris and London club of creditors. Shortly before the exit, her total external debt stock was N4.9 trillion in 2004 (CBN Statistical Bulletin, 2009). In 2006, Nigeria external debt stock was $3.54 billion, in 2007 it rose marginally to $3.67 and in 2008, it further inched up to $3.72billion, dropped slightly in 2009 to $3.62billion only to rise sharply to $8.43billion in March 2010 (Mgboji, 2010). As at 30th September 2011, the external debt stock stood at $5.63 billion made up of $3.316 billion owed by federal government and $2.317 billion owed by the states (Onwuka, 2011). These figures are alarming considering the fact that the country is expected to keep a sustainable level of debt stock after her debt relief experience in 2005. As Sacks (1989), Arslanalp and Henry (2004) argue, the problem faced by debt relief countries is lack of good institutions and if the poor institutional framework is not corrected, any new debt relief initiative would not achieve the objective to promote economic growth.

It is worrisome to note that in spite of the relief package secured in 2005, the World Bank ranked Nigeria as the 87th most indebted country in the World and 139th for purchasing power parity per capita GDP and debt service ratio (ratio of debt service to export) of 1.10% as against the international threshold of 20% (World Bank Report 2010). These phenomena contrast with the expectations that the resources freed from Paris and London Club as well as further debt procured externally would add value to the economy through employment creation, promotion of quality health care delivery, increased capacity utilization, infrastructural development, reduction in inflation rate, enhanced export revenue, reduction in foreign exchange risk, all of which will translate to economic growth (Uzochukwu, 2011; Lora and Olivera, 2006).

As already observed, studies have been conducted on Nigeria external debt and economic growth nexus reflecting on related developments before and shortly after the debt relief. The findings revealed various degrees of interaction on the effect of aggregate external debt stock on gross domestic product but failed to relate these interactions (whether positive or negative) to the various sources of external debt to ascertain the extent to which each source of external borrowing contributes to economic growth in Nigeria. This information is necessary to enable the Debt Management Office (DMO) reappraise Nigeria’s bilateral relationship with her external creditors The timing and scope of the study also failed to accommodate data relating to recent developments, including the exit from both the Paris and London Club which drastically reduced the external debt stock owed by Nigeria. Also, one of the reasons for extending debt relief package to Nigeria was to free resources to improve the standard of living in Nigeria.

Bearing the above short comings in mind, this study is considered timely as it is designed to espouse on the need to disaggregate debt stock and debt services to the various creditors (Paris Club, multilateral, London Club and Bilateral creditors) to ascertain the contribution of each source to economic growth, a measure that would enable Nigeria reappraise both her bilateral trade and other associated forms of external relationship. It is also considered a necessity to accommodate data on the recent development in the management of Nigeria’s external debt and also to appreciate the need to use per capita income as a major control variable to demonstrate its response to changes in external debt per capita in recognition of the importance of human factor index as a measure of economic growth.

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