External Debt and Economic Growth in Nigeria. An Overview From 1986 to 2016

Contents

Abstract

Introduction

Research Questions

Research Objectives
Research Hypotheses
Review of Related Literature

Empirical Review

Methodology
Sources of Data
Method of Analysis
Model Specification
Vector Error Correction Model (VECM)
Granger Causality

References

Appendix

Abstract

The main objective of this study is to examine the relationship between External Debt and Economic growth in the case of Nigeria. The study used annual data covering the period 1986 to 2016. The study used Augmented Dickey Fuller test to check the stationarity of the data, Johnson’s Cointegration approach was employed to test the Cointegrating relationship existing among the variables in the model and Granger causality was also used to test the direction of the relationship among variables. The Vector Error Correction Model was employed to capture both short run and long run dynamics. Generally, the results reveal that External Debt has a negative impact on the economy.

Introduction

No government is an island on its own; it would require aid so as to perform efficiently and effectively ( Sulaiman and Azeez, 2012). This is because without aids, governments will find it difficult to perform its statutory functions to the citizen. In the words of Kudaisi (2015), the insufficient internal financial resource prompt most countries especially developing countriesto incur debts. Sulaiman and Azeez (2012), notes that one major source of aid is foreign borrowing or external debt.

According to Ajayi and Oke (2012), the decade of the 1950’s and 1960’s were often described as “GOLDEN YEARS” for developing countries in most economic development literature because the rate of growth of these economies were not just high but was mostly internally generated. They averred that contrary to those decades when the Less Developed Countries (LDCs) increased their investment with less reliance on external resource, most of the growth in the 1970s was “debt led”. Up to these present times, this trend has continued unabated as countries undertake heavy borrowing from such international financial organisations as the World Bank and the International Monetary Fund (IMF).

Soludo(2003) opines that countries borrow for two broad reasons: macroeconomic reasons (such as investment and consumption) and to finance transitory balance of payment deficit in order to lower nominal interest rateabroad, among others. Ogunmuyiwa (2011) notes the existence of two conflicting views for borrowing and states that while one of these views argues that countries can increase their economic potential by borrowing, the other argues that borrowing cannot increase the countries’economic potentials.

In Nigeria, the genesis of the high external debt the country is currently immersed is, according to Ibi and Aganyi (2014), traceable to 1958 when the country borrowed 28 million dollars from the World Bank for the purpose of railway construction. But from 1978 upward, it became necessary to borrow so as to finance projects and to correct balance of payment difficulties which were created by the fall in oil prices (Adeniran, Azeez and Aremu, 2016). The fall in oil prices and hence oil receipt in 1977/78 forced the country to raise the first jumbo loan of more than $1.0billion from the international capital market (Hassan and Mamman, 2013).

The Debt Management Office (DMO), as quoted by Hassan and Mamman (2013), puts Nigeria’s external debt stock in the periods preceding 1977 to be less than $0.8 billion, but that beginning from 1978, the stock of external debt grew astronomically to $5.09 billion in 1978 and to $8.855 billion in 1980. Hassan and Mamman (2013), also avail that the country’s debt stock which stood at $19 billion, $30.99 billion and $37.76 billion in 1985, 2002 and 2004 respectively, declined to $7.69 billion in 2006 due to the 2005 debt cancellation agreement between Nigeria and Paris Club of lenders.

Although Omotoye et al (2006) as stated in Abubakar (2011) posits that the effort of Nigerian government to negotiate for debt cancellation and relief had dropped the external debt stock by a significant proportion, it is safe to say that there has been a re-accumulation of the country’s debt stock by succeeding governments. According to Adeniran, Azeez and Aremu (2016) who quoted the Debt Management Office (DMO), Nigeria’s total debt rose to ₦12.06 trillion or $65.42 billion as at December 2015, up from ₦11.2 trillion in 2014, an increase of 12.5%. Of this amount, foreign bonds and loans stood at $10.7 billion or ₦2.1 trillion, an equivalent of about 16% of total debt and up from $9.71 billion at the end of 2014, a statement posted on the website of the Office showed. In spite of the increasing debt burden on the country, the government recently submitted what it called 2016-2018 External Borrowing Rolling Plan of $29.960 billion to the National Assembly for approval to enable it execute key infrastructural projects across the country.

Contrary to the expectation that these loans would increase the country’s prosperity, the economic growth of the country has maintained an inexplicable vagarious tendency. According to Bayo (2005), as the effects of the Structural Adjustment Programme (SAP), gathered momentum, the Gross Domestic Product (GDP) growth rate fell from 26.8% in 1981 to 8.3% and 1.2% in 1990 and 1994 respectively. He further asserts that the rate increased to 5.4% in2000 but dropped to 3.5% in 2002. The country’s Real Gross Domestic Product (RGDP) has continued to espouse its volatility, decreasing from 7.01% in 2005 to 6.73% in 2006. The rate which stood at 7.32%, 7.20% and 8.35% in 2007, 2008 and 2009 respectively declined to 2.79% in 2015.

Given the paradox of inconsistent economic growth in the midst of growing external debt, it has become pertinent to investigate the plausibility of the existence or otherwise of a relationship between external debt and economic growth in the country. It is with a view to achieving this aim that the study is being undertaken.

Research Questions

1. What are the trends of external debt and economic growth in Nigeria?
2. What is the relationship between external debt and economic growth in Nigeria?
3. What is the nature of causality between external debt and economic growth in Nigeria?

Research Objectives

The major objective of this study is to ascertain the impact of external debt on economic growth in Nigeria. Specifically the study aims at the achievement of the under listed objectives:

1. To show the trends of external debt and economic growth in Nigeria.
2. To establish the nature of relationship between external debt and economic growth in Nigeria.
3. To ascertain the nature of causality between external debt and economic growth in Nigeria.

Research Hypotheses

Hypothesis one:

Hypothesis two:

Review of Related Literature

Theoretical framework

Debt Overhang Theory: developed by Krugman (1988), this theory argues that humongous borrowing begets high debt traps and retards economic prosperity. In his opinion, accumulation of debt stock crowds out private investment by causing a rise in taxes.

According to Mbah, Agu and umunna (2016), this means that due to large debt stock, potential investors would be discouraged on the expectation that government debt service burden may be financed by the imposition of high taxes. Such disincentive may act as an albatross to economic growth.

Osinubi and Olaleru (2006) present this discourse in simpler terms. According to them, the theory is based on the premise that if debt exceeds the repayment ability of a country with some future probability, a huge potential exists for the expected debt service to be an increasing function of the country's output level. Consequently, returns from investment in the country are taxed away by foreign creditors, thereby hampering investment. Ekperiware and Oladeji (2012) avail that this theory may also be referred to as the Incentive Mechanism Theory.

Dual Gap Theory: postulated by Holis Chenery, this theory posits that Less Developed Countries (LDCs) seek external sources of finance in order to augment their savings-investment gap. It is a truism that the economic growth of any country is a function of investment which, in turn, is determined by the level of savings in the economy. However, due to the rarity of savings occasioned by low income per head in LDCs, such countries are compelled to seek external sources of borrowing in order to promote investment. In this regard, Ajayi and Khan (2000) provide a guiding principle on when to borrow. To them, external borrowing should be done insofar as the funds acquired generate a rate of return that is higher than the cost of borrowing the foreign funds.

According to this theory, the two independent gaps that act as constraints to a nation's economy are savings gap and foreign exchange gap. While the former is between savings and investment, the latter is a connotation of an inherent gap between export and import.

Empirical Review

Ekperiware and Oladeji (2012) examined the structural break relationship between external debt relief and economic growth in Nigeria between 1980 and 2009 using time series quarterly data of external debt, external debt service and real gross domestic product. The Chow test result shows that the 2005 external debt relief precipitated a structural break in economic growth relationship with external debt in the country. In addition, it was found that the debt relief freed up resources for economic growth projects in health and education sectors. The study recommended that countries should tend towards discretional concessional borrowing.

In a study titled “Nigeria's External Debt and Economic Growth: An Error Correction Approach, "Ezeabasili, Isu, and Mojekwu (2011)chose the period 1975-2006 due to data availability and the escalation of Nigeria’s external debt. While the variables used in the study were stationary at first difference, the Johansen Cointegration technique confirmed the existence of one Cointegrating relationship at the 1% and 5% level of significance. Additionally, the error correction estimates revealed that external debt had negative relationship with economic growth in Nigeria. On its part, the Pairwise Granger Causality test showed a unidirectional causality between external debt service payment and economic growth at 10% level of significance. In addition, external debt was found to granger cause external debt service payment at 1% level of significance. However, statistical interdependence was found between external debt and economic growth.It was recommended that debt accumulation for projects must be matched with the timing of repayment in order to ameliorate the negative influence of external debt on economic growth. The study further recommended a diversification of the country’s debt portfolio in terms of sources and types with a view to avoiding harmful concentration and recurrence of the past.

Sulaiman and Azeez (2012) studied the effect of external debt on the economic growth of Nigeria, measuring economic growth as a function of external debt, ratio of external debt to export, inflation and exchange rate. Econometric techniques such as the Ordinary Least Squares (OLS), Augmented Dickey-Fuller (ADF) unit root test, Johansen Cointegration test and Error Correction Model (ECM) were employed on the dataset obtained from the Central Bank of Nigeria Statistical Bulletin and the Debt Management Office which covered 1970-2010. While the Cointegration test showed the existence of long run equilibrium relationship among the variables, findings from the error correction method showed a positive contribution of external debt to the Nigerian economy.

It was recommended that government should ensure economic and political stability, and that external debt should be required for economic reasons rather than for social or political reasons.

Ajayi and Oke (2012), investigated the effect of external debt burden on economic growth and development of Nigeria through the instrumentality of the regression analysis of Ordinary Least Squares (OLS) on secondary data sourced from Central Bank Of Nigeria and other relevant institutions. The study established that external debt burden had an adverse effect on the country’s income, as high level of external debt led to the devaluation of the national currency, increased retrenchment, industrial disharmony and poor educational system. The study, consequently, recommended that debt service obligation should be kept below foreign exchange earnings, and loan should be invested in productive sectors of the economy with a view to generating income for its repayment.

Mbah, Agu and Umunna (2016), investigated the impact of external debt on economic growth in Nigeria through the use of the ARDL bound testing approach to co-integration and error correction models, as well as the Granger Causality test for the period 1970-2013. A long run relationship was established among the variables. It was also established that external debt had a negatively significant impact on economic growth.

In addition, a unidirectional causality was established between external debt and economic growth. As a consequence, the study recommended that government embarks on prudent borrowing and encourages export-oriented growth.

Kudaisi (2015), examined the impact of foreign direct investment inflow and external debt on economic growth using the ARDL econometrics technique to investigate both the short and long term relationships among the variables. From the estimated results, it was espoused that Foreign Direct Investment (FDI) and External Debt had a positive and statistically significant effect on the economic growth of Nigeria. Among others, the study recommended that the government should be responsive enough to direct borrowed funds to capital and development projects.

Using data from 1970-2010 which were obtained from the statistical bulletin of the Central Bank of Nigeria and annual reports of the Debt Management Office, Hassan and Mamman (2013), investigated the contribution of external debt to the economic growth of Nigeria. The study used Real Gross Domestic Product (RGDP) as proxy for economic growth (dependent Variable) and External Debt, Debt Service Payment, Export, Inflation, and Exchange Rate as explanatory variables. While the Augmented Dickey-Fuller (ADF) test was used to ascertain the stationarity of the variables, the Johansen Cointegration test was deployed to evince the existence or otherwise of a long run relationship between the variables. On the other hand, the Ordinary Least Squares (OLS) technique was used for data analysis. Findings from the study showed a positive contribution to economic growth by external debt. It was consequently recommended that external borrowings should be channelled to the real sectors of the economy in order to have its impact felt.

Adeniran, Azeez and Aremu (2016), elucubrated the impact of External Debt on Economic Growth in Nigeria (1980 to 2014) using the Vector Error Correction Model. It was empirically found through the Impulse Response analysis and Variance Decomposition that External Debt Service payment negatively impacted growth of Real Gross Domestic Product per capita in Nigeria thereby connoting the existence of the debt overhang impact on economic growth. In addition the Granger Causality / Wald test showed a unidirectional causation from Real Gross Domestic Product to External Debt stock and from External Debt Service Payment to Real Gross Domestic Product. The study recommended that External Debt be discouraged since it could not be depended upon for the promotion of economic growth due to its negative influence on growth.

Ayadi and Agadi (2008) investigated the impact of the huge external Debt and the consequent servicing requirement on the economic growth of Nigeria and South Africa using both the Ordinary Least Squares (OLS) and Generalized Least Squares (GLS). The Study confirmed a negative impact of debt and its servicing requirement on growth in both Nigeria and South Africa. However, South Africa was seen to have performed better than Nigeria in the application of external loans to promote growth. Furthermore, it was espoused that External Debt contributed positively to growth in Nigeria up to a point after which its contribution turns negative. This showed the presence of non-linearity effect.

Chong, Lau, Liew and Puah (2010) studied the effect of different types of Debts on the Economic Growth of Malaysia from 1970 to 2006 through the instrumentality of the Cointegration test. It was shown that all components of debt had negative effect on economic growth in the long run. On its part, the Granger Causality test shows the prevalence of a short run causality linkage between all debt measures and economic growth in the short run.

Ahmed, Saeed and Saed (2015) sought to identify and analyse the negative impact of External Debt on Economic Growth currently and in the future in the case of Iraq through the ARDL approach to estimate the level of Cointegration and relationships between External Debt and Economic Growth. Empirical findings espoused that war, political and security instability impacted negatively on both the size of external debt and direction of economic growth of Iraq. The study also established that although external debt impacted negatively on Gross Domestic Product, the impact was more in the short run than in the long run. From its findings, the study recommended diversification of the Iraqi economy from oil to agricultural and industrial sectors.

Methodology

Sources of Data

Annual secondary time series data obtained from the statistical bulletin of the Central Bank of Nigeria (CBN), Debt Management Office (DMO), World Bank Report and the National Bureau of Statistics were used in the study. The data set covered between 1970-2016.

Method of Analysis

The study employed the use of descriptive statistics (trend analysis), Augmented Dickey-Fuller (ADF) Unit Root Test, the Johansen Cointegration test, the Error Correction Mechanism and the Granger Causality test.

Model Specification

This study employed a modified version of the model stated by Hassan and Mamman (2013).In studying external debt and economic growth nexus in Nigeria, Hassan and Mamman had stated their model as:

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However, to capture the relationship under study more accurately, this study modified the model stated above by removing the export variable and incorporating other variables such as Capital Expenditure and Interest Rate.

Thus the model for this study may be stated implicitly as:

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Figure 1: Trend of Real Gross Domestic Product and External Debt in Nigeria

Source: Researchers computation from appendix 1 using E-Views 9

The figure above shows the trend of External Debt (EXD) and Real Gross Domestic Product (RGDP) which is a proxy for economic growth in Nigeriafrom 1986 through2016.

From the graph it can be observed that External Debtsteadily increased from the year 1986 to 1996 but witnessed a slight drop in 1997 after which there was a more significant increase in External Debt in Nigeria. This increase continued through 2004 after which the debt relief was granted to Nigeria by Paris club which had very significant impact on Nigeria External Debt profile. Real Gross Domestic Product shows steady increase through the period of study. The most significant relationship between the two variables was shown by the corresponding increase in RGDP from 1998 through 2005.

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Source: culled from Appendix

Tables 1 above shows that all variables are stationary at first difference i.e integrated of the order one I(1). This means that the variables do not have unit root.

Table 2:Johansen Unrestricted Cointegration Rank Test

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Source: culled from Appendix

The trace tests the null hypothesis that there are at most r co-integrating relationships. In other words, a rejection of the null hypothesis means that there are more than r co-integrating relationships. Table 2 confirms that there exist three co-integrating equation at 5% level of significance.

The Long Run Model

The result of the Johansen co-integration shows the existence of long run relationship among the variables. The co-integrating equation will be chosen based on log likelihood ratio.

RGDP = 0.144218 –0.002770EXD –0.000811DSP -0.023474INF (0.08091) (0.00835) (0.00393) (0.00775)

Note the standard errors are stated in parenthesis and * denotes that the parameters are significant in the long-run.

From equation 1, represent the long run relationship among the variables. if all the explanatory variables are held constant RGDP will increase by 0.1 units in the long run this is an indication that not only the variables incorporated in the model affect economy growth in Nigeria. The coefficient Of External Debt is 0.002770 which is negatively signed implying a negative relationship between EXD and RGDP in the long run and this does not conform to a prior, because funds garnered from external sources in form of external debt when channeled to productive ventures can lead to increased economic growth. This negative relationship therefore suggests that the debt obtained did not yield the expected result as it was unproductive. Also the coefficient of DSP is 0.000811 which is negatively signed and conforms to Apriori. This is as a result of the fact that when the debt profile of a nation is very high she tend to spend resources that should be invested in productive venture on debt servicing. There the higher the debt profile of a nation, the higher the debt servicing and the lower the economic growth. Finally, the coefficient of INF is also negatively signed which conforms to a priori. When the general price level is too high it tend to reduce d frequency of economic activities in the country thereby discouraging investment.

Vector Error Correction Model (VECM)

When co-integration is achieved, the process is completed with the use of error correction model. The model in this study assumes a year lag in the variables; the vector error correction process helps to observe the convergence in the long-run as earlier revealed by the co-integration test. The error correction mechanism is the speed or degree of adjustment i.e the rate at which the dependent variable adjust to changes in the independent variables. The results are shown in the table below

Table 3: VECM RESULTS

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Source: culled from Appendix

Table 3 above reveals that the coefficient of the ECM(-0.691766) is significant with the expected sign. The VECM is correctly signed and in terms of magnitude it lies between 0 and 1. Precisely the error correction model reveals that about 69% of errors generated between each period are corrected in subsequent periods. Therefore the speed of adjustment of the dependent to any disequilibrium in the previous period is high.

The adjusted coefficient of determination is the most suitable measure of the movement in the dependent variable as explained by the independent variables in a multiple regression model. From table 3 above the adjusted coefficient of determination is 0.514498 this shows that the model has a good fit, as the independent variables were found to jointly explain 51.44% of the movement in the dependent variable

The above short run estimates in table 4.5 shows that RGDP in the current period (t) is influenced by -0.000208 units holding all other variables constant.

From the Error Correction Model, the coefficient of EXD is negatively and wrongly signed but statistically significant at 5% significance level in the period of study. This implies that a unit change in EXD in the previous year will lead to 0.002851 unit decrease in RGDP which is the proxy for economic growth in the current year. This negative relationship for the period may be due to corruption, investment in unproductive sectors of the economy or poor economic condition of the Nigerian economy at some point.

Granger Causality

To determine if there is a causal relationship between External Debt(EXD) and economic growth(RGDP) in Nigeria, we conducted a granger causality test and the result is shown in table 4 below. Table 4 Engle Granger Causality Test

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Source: culled from Appendix

From Table 4 there exist no causation between the dependent variable and the independent variables. Therefore, the null hypothesis of no granger causality is accepted.

References

Abubakar,S.(2011).“External Debt and Nigerian Economic Development: An Empirical investigation. "www.abu.edu.ng/publications/2012-04-11 (161305)

Adeniran, A.O., Azeez, M.I and Aremu, J.A (2016). “External Debt and Economic Growth in Nigeria: A Vector Auto-regression (VAR) Approach.”International Journal of Management and Commerce Innovations, vol.4, issue 1

Ajayi, S.I and Khan, M.S (2000).“External Debt and Capital Flight in Sub-Saharan Africa. International Monetary Fund.

Ajayi, L.B. and Oke, M.O. (2012).“Effect of External Debt on Economic Growth and Development of Nigeria. ”International Journal of Business and Social Science, Vol.3, No.12

Bayo, F.(2005). “Determinants of Inflation in Nigeria : An Empirical Analysis.” International Journal of Humanities sandSocialScience,Vol.1No.18

Ekperiware, M.C. and Oladeji, S.I (2012). “External Debt Relief and Economic Growth in Nigeria”. American Journal of Economics, 2(7).

Ezeabasili, V.N., Isu, H.O., and Mojekwu, J.N. (2011). “ Nigeria's External Debt and Economic Growth: An Error Correction Approach”. International Journal of Business and Management, Vol. 6, No. 5

Hassan,S.U.and Mamman, A.(2013). “External debt and Economic Growth: Evidence from Nigeria.”International Journal of Economics, Business and Finance,Vol.1, No.10

Ibi, E. E. and Aganyi, A. (2015). “Impact of External debt on Economic growth in Nigeria: a VAR approach. Journal of Business,3(1).

Krugman, P.(1988). “ Financingvs Forgiving a Debt Overhang: Some Analytic Notes."Journal of Development Economics, Vol.29

Kudaisi, B.V. (2015). “Foreign Direct Investment Inflow, External Debt and Economic Growth in Nigeria. ” Research Journal of Economics and Business Studies,Vol.5

Mbah, S.A, Agu, O.C and Umunna, G.(2016). “Impact of External Debt on Economic Growth In Nigeria: An ARDL Bound Testing Approach. Journal of Economics and Sustainable Development. Vol. 7, No.10s

Ogunmuyiwa, M.S.(2011). “Does External Debt Promote Economic Growth in Nigeria?” Current Research Journal of Economic Theory, 3(1)

Soludo,C.C.(2003).“Debt Poverty and Inequality.” In Okonjo-Iweala, Soludo, and Muhtr (eds). The Debt Trap in Nigeria, Africa WorldPress, NJ

Osinubi, T.S. and Olaleru, O.E (2006). “ Budget Deficits, External Debt and Economic Growth in Nigeria”. Applied Econometrics and International Development, vol. 6-3

Sulaiman, L.A and Azeez, B.A. (2012). “Effect of External Debt on Economic Growth of Nigeria.” Journal of Economics and Sustainable Development,"Vol.3,No.8

Appendix

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