CHAPTER ONE

INTRODUCTION

1.1  Background of the Study

Sustainable economic growth is a major concern for any sovereign nation most especially the Less Developed Countries (LDCs) which are characterized by low capital formation due to low levels of domestic savings and investment (Adepoju, Salau and Obayelu, 2007). It is expected that these LDC’s when facing a scarcity of capital would resort to borrowing from external sources so as to supplement domestic saving (Aluko and Arowolo, 2010; Safdari and Mehrizi, 2011; Sulaiman and Azeez, 2011). Soludo (2003) asserted that countries borrow for two broad reasons; macroeconomic reason that is to finance higher level of consumption and investment or to finance transitory balance of payment deficit and avoid budget constraint so as to boost economic growth and reduce poverty. The constant need for governments to borrow in order to finance budget deficit has led to the creation of external debt (Osinubi and Olaleru, 2006).

External debt is a major source of public receipts and financing capital accumulation in any economy (Adepoju et al, 2007). It is a medium used by countries to bridge their deficits and carry out economic projects that are able to increase the standard of living of the citizenry and promote sustainable growth and development. Hameed, Ashraf and Chaudary (2008) stated that external borrowing ought to accelerate economic growth especially when domestic financing is inadequate. External debt also improves total factor productivity through an increase in output which in turn enhances Gross Domestic product (GDP) growth of a nation. The importance of external debt cannot be overemphasized as it is an ardent booster of growth and thus improves living standards thereby alleviating poverty.

It is widely recognized in the international community that excessive foreign indebtedness in most developing countries is a major impediment to their economic growth and stability (Audu, 2004; Mutasa, 2003). Developing countries like Nigeria have often contracted large amount of external debts that has led to the mounting of trade debt arrears at highly concessional interest rates. Gohar and Butt (2012) opined that accumulated debt service payments create a lot of problems for countries especially the developing nations reason being that a debt is actually serviced for more than the amount it was acquired and this slows down the growth process in such nations. The inability of the Nigerian economy to meet its debt service payments obligations has resulted in debt overhang or debt service burden that has militated against her growth and development (Audu, 2004). The genesis of Nigeria’s debt service burden dates back to 1978 after a fall in world oil prices. Prior to this occurrence Nigeria had incurred some minor debts from World Bank in 1958 with a loan of US$28million dollars for railway construction and the Paris Club debtor nations in 1964 from the Italian government with a loan of US$13.1 million for the construction of the Niger dam. The first major borrowing of US$1 billion known as the ”Jumbo loan” was in 1978 from the International Capital Market (ICM) (Adesola, 2009).

External borrowing has a significant impact on the growth and investment of a nation up to a point where high levels of external debt servicing sets in and affects the growth as the focus moves from financing private investment to repayments of debts. Pattilo, Poirson and Ricci (2002) asserted that at low levels debt has positive effects on growth but above particular points or thresholds accumulated debt begins to have a negative impact on growth. Furthermore Fosu (2009) observed that high debt service payments shifts spending away from health, educational and social sectors. This obscures the motive behind external borrowing which is to boost growth and development rather than get drowned in a pool of debt service payments which eats up most of the nation’s resources and hinders growth due to high interest payments on external debt.

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. According to (Omotoye, Sharma, Ngassam and Eseonu, 2006) Nigeria is the largest debtor nation in sub Saharan Africa. When compared with other sub Saharan nations such as South Africa, Nigeria’s external debt stock follows an upward pattern over the years while the former is relatively stabilized (Ayad and Ayadi, 2008). Nigeria’s external debt stock rose from US$28454.8 million in 1997 to US$31041.6 and US$37883.1 million in 2001 and 2004 with 80.3, 64.67 and 52.58 percentages of GDP respectively. On the other hand South Africa’s external debt stock stood at US$25272.4 million, US$24050 million and US$27112.4 million in 1997, 2001 and 2004 with 16.98, 20.34 and 12.52 percentages of GDP respectively.

The unabated increase in the level of external debt service payments has led to huge imbalances in fiscal deficits and budgetary constraints that have militated against the growth of the Nigerian economy. The resultant effect of the debt quagmire in Nigeria could create some unfavourable circumstances such as crowding out of private investment, poor GDP growth e.t.c (Ngonzi Okonjo Iweala, 2011).

1.2  Statement of the Research Problem

“Huge external debt does not necessarily imply a slow economic growth; it is a nation’s inability to meet its debt service payments fueled by inadequate knowledge on the nature, structure and magnitude of the debt in question” (Were, 2011).

It is no exaggeration that this is the major challenge faced by the Nigerian economy. The inability of the Nigerian economy to effectively meet its debt servicing requirements has exposed the nation to a high debt service burden. The resultant effect of this debt service burden creates additional problems for the nation particularly the increasing fiscal deficit which is driven by higher levels of debt servicing. This poses a grave threat to the economy as a large chunk of the nation’s hard earned revenue is being eaten up. Nigeria’s external debt outstanding stood at US$28.35 million in 2001 which was about 59.4% of GDP from US$8.5 million in 1980 which was about 14.6% of GDP (WDI 2013). The debt crisis reached its maximum in 2003 when US$2.3 billion was transferred to service Nigeria’s external debt. In the year 2005 the Paris Club group of creditor nations forgave 60% (US$18 billion) of US$30.85 billion debt owed by Nigeria. Despite the debt relief of US$18 billion received by Nigeria from the Paris club in 2005 the situation remains the same (Bakare, 2010). The question then becomes why has external borrowing not accelerated the pace of growth of the Nigerian economy?

There are various empirical studies that have been conducted to investigate the impact of external debt burden on economic growth in Nigeria and have arrived at different results using the same scope of study (see Bhattarchanya & Nguyen, 2003; Fosu, 2007; Hunt, 2007; Ayadi, 2008). My research study will focus on these issues in external debt to determine the long run relationship between external debt and economic growth by expanding the scope of study beyond what has been done in times past.

1.3  Research Questions

This research seeks to investigate the impact of external debt on economic growth in Nigeria and therefore tries to answer the following research questions:

1.  Does a long run relationship exist between external debt and economic growth in Nigeria?

2.  Is there causality between external debt and economic growth in Nigeria?

3.  What are the causes of Nigeria’s external debt burden?

1.4  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:

1.  To determine long relationship between external debt and economic growth in Nigeria.

2.  To examine causality between external debt and economic growth in Nigeria.

3.  To identify the causes of external debt burden in Nigeria.

1.5   Research Hypotheses