The Effect of External Debt on Economic Growth in Nigeria
Chapter One
Objectives of Study
The broad objective of this study is to ascertain the impact external debt burden has on economic growth in Nigeria. Other specific objectives include:
- To determine long relationship between external debt and economic growth in Nigeria.
- To examine causality between external debt and economic growth in
- To identify the causes of external debt burden in
CHAPTER TWO
LITERATURE REVIEW
Introduction
The 1950’s and 1960’s are most often described as the “golden years” for developing countries in economic development literature because of the rate of economic growth which was not just high but also internally generated. In the above years these LDC’s increased their investment reliance on external resources however most of the growth in the 1970s was “debt led” and this led to persistent current account deficits with massive borrowings from the international money and capital market (ICM) to bridge payment gaps. External debt has increased steadily over the years in developing countries and as such an analysis of the role external debt plays in economic growth and development is paramount. Aside from being an ardent booster of growth external debt has also been known to cause a number of problems for developing countries. The increases in external debt over the years in developing countries has brought the issue of external debt out of hiding and has become a matter of concern both to the international and local community. The need to constantly borrow as a means of financing has brought about an increasing literature among various economists.
Nigeria, like most other less developed countries (LDCs) has been classified by the World Bank among the severely indebted low income countries since 1992. The nation’s inability to meet all of its debt service payment constitutes one of the serious obstacles to the inflow of external resources into the economy. The accumulation of debt service arrears worsened by high interest payments has catapulted the external debt stock to extremely high levels and all efforts to substantially reduce the debt has been unsuccessful. This chapter therefore carries out an extensive literature review on the subject matter of external debt and economic growth by looking at conceptual and definitional issues, theoretical issues, empirical and methodological issues and summary.
Review of Conceptual and Definitional Issues
The act of borrowing creates debts and this debt may be domestic or external. The focus of this study is on external debt which refers to that part of a nation’s debt that is owed to creditors outside the nation. Arnone et al (2005) defines external debt as that portion of a country’s debt that is acquired from foreign sources such as foreign corporations, government or financial institutions. Acording to (Ogbeifin, 2007), external debt arises as a result of the gap between domestic savings and investment. As the gap widens, debt accumulates and this makes the country to continually borrow increasing amounts in order to stay afloat. He further defined Nigeria’s external debt as the debt owed by the public and private sectors of the Nigerian economy to non-residents and citizens that is payable in foreign currency, goods and services.
Debt crisis occurs when a country has accumulated a huge amount of debt such that it can no longer effectively manage the debt which leads to several mishaps in the domestic political economy (Adejuwon et al). Mimiko (1997) defined debt crisis as a situation whereby a nation is severely indebted to external sources and is unable to repay the principal of the debt.
Origin of Debt Crisis in LDCs
When we trace back countries with debt crises history, the origin can be attributed to the following time periods:
First Period (1973-1978)
The quadrupling of crude-oil price following the Egypt –Israel war of October 1973 led to disorder in the international market. To neutralize the effect, producers in the industrialized world increased market price both in the domestic and international market. This created inflationary pressure around the industrialized world and left many of the developing countries with severe balance of payment issues. This was because the economies of these LDC’s were not well developed to withstand the price shocks due to the increase in the price of crude oil and imported goods. The current account deficit in LDCs increased from 8.7 billion US$ in 1973 to US$ 42.9 billion in 1974 and US$ 51.3 billion in 1975. As a result many of them resorted to borrowing from banks in the international capital market (ICM). This also created room for major banks to re-channel the funds generated from dollar-based oil exporting countries to budget deficit oil- importing countries and by 1978 foreign indebtedness had risen significantly from US$130 billion in 1973 to US$336 billion.
CHAPTER THREE
THEORETICAL FRAMEWORK & RESEARCH METHODOLOGY
Introduction
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The aim of this research study is to examine the impact of external debt on the growth of the Nigerian economy. This chapter consists of the theoretical framework which provides the theoretical basis of this study and the research methodology which throws more light into the empirical investigation conducted. Also in order to fully assess the impact of the external debt burden, a model with dependent and explanatory variables to be estimated is specified, a priori expectations of these variables, techniques of estimation and method of data analysis are all treated in this chapter.
Theoretical Framework
The constant need to borrow from foreign sources arises from the recognized role of capital in developmental process of any nation. Sustainable economic growth requires a given level of savings and investment and in a case where it is not sufficient, it results in external borrowing. Herein lays the basis for the dual-gap analysis. The dual-gap theory postulates that for development to occur it requires investment and this investment is a function of savings and investment which requires domestic savings is not sufficient enough to ensure that development takes place. The dual- gap framework is coined from a national income accounting identity which states that excess investment expenditure over domestic savings is equivalent to the surplus of imports over exports. Thus at equilibrium the following identities hold;
I – S = m – X (1)
S – M = x – m (2)
Where: I = Investment
S = Savings M = Import X = Export
The above equations show that the domestic resource gap (S – I) is equal to foreign exchange gap (x – m). An excess of import over export implies an excess of resources used by an economy over resources generated by it. This further implies that the need for foreign borrowing is determined overtime by the rate of investment in relation to domestic savings.
Research Methodology
The methodology adopted in this study is Co-integration analysis using the Augmented Dickey Fuller (ADF) unit root test, Johansen co-integration and Vector Error Correction techniques of estimation which provides coefficient estimates of the time-series data used in analysis. Also a test for causality between external debt and economic growth using Granger Causality Test is carried out.
CHAPTER FOUR
DATA ANALYSIS & INTERPRETATION
This research seeks to examine the impact of external debt on economic growth in Nigeria. This chapter therefore comprises of the data presentation, estimation and results of the empirical investigation carried out. It also addresses the relationship between external debt and economic growth in Nigeria in the long run. This chapter is further divided into trend analysis which shows the trend of the time series data used from 1980-2012, descriptive analysis which contains the measures of central tendency which include mean, mode, median as well as measures of variation and other statistical characteristics of the variables and econometric analysis which focuses on test for unit root, Johansen test for Co-integration and the Vector Error Correction Model.
CHAPTER FIVE
SUMMARY, RECOMMENDATIONS & CONCLUSION
Summary of Study
The aim of this study is to examine the impact of external debt on economic growth in Nigeria. This is done by examining the long-run and causal relationship between external debt and economic growth. The study carries out an empirical analysis to determine the relationship between the variables. This brought about a number of findings and these findings will provide recommendations for managing the debt situation in Nigeria all of which are outlined in this chapter.
Summary of Findings
Summary of Empirical Findings
The empirical analysis carried out revealed a significant long run relationship between real gross domestic product (LRGDP) and external debt service payments (LDSP) and Real Gross Domestic Product exchange rate (EXR) and an insignificant long run relationship between LRGDP and external debt stock (LEDS). Also the Granger causality test showed that external debt (LEDS) Granger causes economic growth (LRGDP) and economic growth (LRGDP) Granger causes external debt (LEDS).
Theoretical Findings
The result shows an inelastic relationship between Real Gross Domestic Product and External Debt Stock. A unit change in external debt will bring about a less than proportionate change in real gross domestic product.
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.
Recommendations
Based on the above findings, the following recommendations are given:
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.
Secondly, the authorities responsible for managing Nigeria’s external debt should adequately keep track of the debt payment obligations and the debt should not be allowed to pass a maximum limit so as to avoid debt overhang.
Lastly the Nigerian government should promote exportation of domestic products as a high exchange rate will make our goods more attractive in the foreign market and will increase foreign exchange earnings.
Conclusion
This study examined the impact of external debt on economic growth in Nigeria. The study sought out to find a significant long run and causal relationship between external debt and economic growth. Real gross domestic product was used as a proxy for economic growth which is the dependent variable while external debt stock, external debt service payments and exchange rate were the independent variables. External debt stock and external debt service payments were used to capture the external debt burden in Nigeria.
The Johansen co-integration test was used to test the first hypothesis of no long run relationship between external debt and economic growth. The null hypothesis was accepted as the results showed no long run relationship between external debt and economic growth. The Granger causality test was used to test the second null hypothesis of no causal relationship between external debt and economic growth in Nigeria. The null hypothesis is rejected as the results show that there exist bi-directional causal relationship between external debt and economic growth. Based on these findings recommendations were given.
Limitations of Study
The researcher faced challenges in acquiring secondary data on some variables for Nigeria and as such these variables were exempted from the model.
Suggestions for further research
Further research should be done on the channels through which external debt may affect economic growth in Nigeria.
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