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THE IMPACT OF EXTERNAL DEBT ON ECONOMIC GROWTH IN NIGERIA. BY ABUBAKAR SADIQ SALEH Department of Banking and Finance, University of Abuja abubakar008@yahoo. co. uk ABSTRACT Debt is borrowing that is either for the purpose of smoothening the consumption path in the face of transitory shocks or as a means of supplementing domestic savings in order to expand productive capacity and raise the long ??? run growth rate. The objective of this work is to link foreign borrowing with growth.
Whether debt could be used as a development strategy especially among low-income countries is the question of interest in this research. By using a simple open macro-economic model and focusing on the external balance of payment of a developing economy with rigidities, this work derives an empirically testable condition to show the impact of foreign borrowing on growth, i. e. as factor of growth and its negative impact on growth or when acting as a burden on growth.
It concluded that foreign debt could have negative relationship with growth if not managed prudently. It is recommended that for external debt to be of positive impact on growth there is the need for a comprehensive and effective debt management strategy. 1. 1INTRODUCTION Foreign debt is a situation of the indebtedness of one country to another or institutions of the world. Many developing countries have used the instrument of foreign borrowing for the purpose of promoting or meeting their economic growth.
It is a fact that many of today’s advanced industrial economies also resorted to foreign borrowing at one time or the other, especially after the Second World War (Farzin, 1988). The difficulties faced by many indebted developing countries led to a widespread and frequent debt reschedule which in turn raise serious concerns among policy makers culminating in clamours for debt cancellation for the poor indebted countries (World Bank, 2002).
This work focuses particularly on the consequence of external debts on Nigeria’s economic growth. Similar works have been going on for decades, especially since the 1980s where the happening in the Latin American countries became a global issue. The resultant stand that materialized from the crisis was the assertion that external debt can act as a “factor of growth” and sometimes as a “burden on growth” of a certain country (Farzin, 1988).
This was later seen to be an argument that might not necessarily hold valid for a low income country, particularly the highly indebted poor ones which could face an entirely different debt crisis and which might be affected differently by large external debts (Schclarek, 2004). 2. 0 LITERATURE REVIEW There was the traditional school view point which believed that an optimal balance between long term debt and equity existed and that at this optimal point share price (or equity) would be minimized and cost of capital minimized.
Here the argument is stating that debt especially long term has a positive impact on the growth of an organization or the net worth of the borrower (Brigham, 1975). The arguments of two other renowned financial academics in the persons of Modigliani and Miller which was published (1958) earlier disputed the so-called arguments of the traditional school and argued that the so called optimal capital structure did not exist at all. Impliedly the total value of the borrowing body remains constant with any level of change in leverage.
Given the argument above it is very important to see how phenomenon of debt impact on a borrowing nation. The question that arises out of this situation is, could debt have any positive impact on a country’s economic growth as held by the traditional school or zero impact as postulated by Modigliani and Miller? And hence the thrust of this work. 2. 2 EXTERNAL DEBT AND ECONOMIC GROWTH Presbitero (2005) argues that contrary to recent empirical studies there was no evidence of an inverse U-shaped curve representing the debt growth relation.
In his view external debt in the previous period is negatively associated with current economic growth, even controlling for policies and institutions. Schclarek (2004) argued that although the relationship between public (external) debt and economic growth is a major concern for policymakers, there is little empirical work investigating this relationship. Furthermore there is even less evidence on the specific channels through which debt affects growth. Although there are exceptions to he lack of empirical evidence by the works of Pattillo (2002, and 2004), which empirically studied the relationship between total external debt and the growth rate of GDP for developing countries, it was noted that the studies considered total external debts without distinguishing between public external debt and private external debt. In addition Alfredo (2004) tried to determine the channels through which debt affects economic growth, by considering its effects on total factor productivity, capital accumulation and private savings rates, respectively.
It was observed that for developing countries there was a negative and significant relationship between total external debt and economic growth, i. e. lower external debt levels are associated with higher growth rates. Farzin (1988) argued using a simple open macroeconomic model and by focusing on the external balance of a developing economy (Sudan) with structural rigidities, derived empirically testable conditions that showed when foreign borrowing can act as a “factor of growth” and when as a “burden on growth”.
Kretzmann and Nooruddin (2005) examined the relationship between oil and debt and concluded that there is a strong and positive relationship between oil production and debt burdens. According to the duo the more oil a country produces, regardless of oil’s share of the country’s total economy, the more debt it tends to generate. By focusing on Uganda the duo discovered that the international economic environment has an important impact on SSA economies. It drives the prices of African exports, the demand for those exports and the effective interest rates countries pay.
The terms of trade of developing countries are also indirectly affected by economic trends in industrialized countries (Mbire and Atingi, 1997). For Fosu (2000) the role of external debt in growth seems rather complicated. He first of all point out that the various measures of the debt burden may have different implications for growth. Secondly, the growth-debt relationship does not seem straightforward. Sachs and Warner (1995) using data drawn from 97 developing countries confirmed that there was indeed a negative relationship between a country’s dependence on natural resources exports and it’s later growth performance. 3. 0 METHODOLOGY . 1 SOURCE OF DATA The dataset for this work spans a period of thirty six years commencing 1970 to 2006. The major sources are the world development indicators and the Global development Finance of the World Bank. 3. 2MODEL SPECIFICATION The basic regression equation employed for the purpose of uncovering the relationship between debt and economic growth is of the following type Yt = ? Xt + ? Dt + ? t + ? t where Yt is the dependent variable, Xt represents the set of explanatory variables, Dt is the debt variable, ? t is an unobserved time-specific effect, ? is the error term and the subscript t represents the time period. 3. 3RESULT Nigeria’s external debt history started from the year 1970 with a total amount of $ 836. 68 million and by the year 2001 the amount outstanding stood at a total amount of $31. 04 billion, representing a growth of $30. 204 billion or 97. 31% in principal, interest, penalties on principal and interest payments over the years. Agitation for debt relief/cancellation was at its peak during the ensuing years and by the year 2006 the country’s total debt dropped after a down payment of $18 billion to the major creditors to a total of $7. 9 billion. This phenomenon is related to the country’s total exports and other growth indicators in the sections that follow. The total exports of the country from the year 1960 to 2007 was run as the regressand against a regressor of external debt in order to test the validity of the null hypothesis, whether there is a positive relationship between external debt and exports. Here exports is taken as an indicator of growth. H0: There is a positive relationship between Nigeria’s External Debt and growth in exports; H1: There is no positive relationship between Nigeria’s External Debt and growth in exports.
The test carried out as revealed by the analysis in appendix (ii) showed 0. 00 significance in both the anova and coefficient. Impliedly even though our adjusted R2 is significant at 0. 566 the actual relationship is not significant. Thus we reject the null hypothesis which states that there is a positive relationship between Nigeria’s external debt and changes in total exports. Given Nigeria’s monocultural nature of economy however portrays the positive R2 to be justifying the position that relates crude oil producing countries to higher external debts.
The indicator of Foreign Direct Investment is another growth variable that is measured against debt in this work. If Nigeria’s aggregate debt over the years is seen to influence positive changes in the inflow of foreign direct investment then our null hypothesis will be justified in favour of the alternative. For the purpose of clarity the statements are made below. H0: There is a strong positive relationship between Nigeria’s External Debt and the inflow of Foreign Direct Investment H1: There is no significant relationship between Nigeria’s External Debt and the inflow of Foreign Direct Investment
From the analysis in appendix (iii) we see that our R2 is very insignificant at 0. 088 and the adjusted R2 is equally weak at 0. 060. The overall significance given the p- value stood at 0. 088 against a minimum of 0. 05. This gives sufficient grounds for accepting HO although our R2 and its adjusted are both low confirming the insignificance of the correlation. Thus we reject the alternative hypothesis in favour of the null hypothesis that there is a positive relationship between the country’s level of external debt and economic growth as a result of foreign direct investment.
Although Nigeria is more of a monocultural economy where almost 90% of its revenue comes from proceeds from sales of crude oil, agriculture is the commonest means of employment. Thus the extent of land cultivation for agricultural production is considered as an indicator of growth and as such related to the country’s external debt. Where the correlation is seen to be significant the conclusion can be drawn that the level of the country’s external debt influences land cultivation.
In line with this the following hypothesis is hereby formulated and tested. H0: There is a relationship between external debts to agric land cultivation; H1: There is no relationship between external debts to agric land cultivation The analysis in appendix (iv) is the result of the test carried out which shows two variables of external debts and agricultural land. The R2 here is positive but insignificant at 0. 393, where the adjusted R2 remain close at 0. 375. Tested at 0. 05 significance our p-value of 0. 0 gives sufficient grounds for rejecting the null hypothesis in favour of the alternative hypothesis which states that there is no significant correlation between the extent of the country’s external indebtedness and agricultural land cultivation. GDP is by far the most important of all growth indicators. Consequently its choice as a yardstick to measure growth against external debt is paramount. And hence we formulate the following hypothesis. H0: There is a positive relationship between External debts and GDP; H1: There is no significant relationship between External debts and GDP.
The test result as shown in appendix (v) gives us a very low and insignificant R2 at 0. 020, adjusted R2 of 0. 008. This indicates a weak but positive relationship between Nigeria’s external debts and its gross domestic product (current). To consider our null hypothesis we need to have a significant p-value at 0. 05. Our result above however shows a p-value of 0. 000. As a result we reject H0: There is a significant relationship between External Debts and GDP, in favour of H1: There is no significant relationship between External Debts and GDP.
An alternative to GDP, gross domestic product, theoretically is the GNI, gross national income. We are all very much familiar with the process of determining our GNI in a particular period of time. All that is required is a summation of all goods and services produced by a nation over a period of one year. And hence the term gross national product or gross national income. The GNI like the GNP is a very important measure of growth. And hence our resolve to relate external debts to GNI. The following hypothesis is thus formulated for validation.
H0: There is a significant relationship between External Debts and Gross National Income; H1: There is no significant relationship between External Debts and Gross National Income. The test result in appendix (vi) shows a positive but weak relationship between the two variables with R2 of 0. 006 and an adjusted R2 of -0. 022. Impliedly this statistics shows that Nigeria’s quantum of external debts does not significantly influence the level of its gross national income. Given this result we take a decision based on a p-value of 0. 000 against a minimum of 0. 050 and reject the null hypothesis.
If the null hypothesis is rejected then we settle for the alternative hypothesis and thus conclude that there is no relationship between Nigeria’s external debt and its gross national income. Official development assistance are bilateral grants and technical assistances provided by the world bank group and other international donor bodies to member nations that show signs of sustained reforms and possible improvements in their balance of payment positions. Thus the official development assistance is here regarded as an equally important indicator of growth.
It is therefore regressed against total external debts over the years. Our hypothesis is thus postulated as, H0: There is a significant relationship between External Debts and the amount of Official Development Assistance; H1: There is no significant relationship between External Debts and the amount of Official Development Assistance. An analysis in appendix (vii) shows a positive though weak R2 at 0. 005 and an adjusted R2 of -0. 024 to disprove the correlation. Our p-value on the other hand is very significant at 0. 188 against a minimum of 0. 050.
This leads us to take a decision to reject the alternative hypothesis and maintain the status quo – (null) hypothesis ??? which states that there is a relationship between external debts and official development assistance. Given the non linear quadratic regression (appendix viii) result we can see that our R2 is positive though very low at 0. 10046 and its adjusted stands weaker but also positive at 0. 04755. This shows that there is an insignificant relationship between the two variables. However to take a decision we need to consider our p-value of 0. 0599 which makes the rejection of the null hypothesis next to impossibility.
We thus do not reject H0 but instead reject H1. And we conclude that there is a sort of non linear relationship (positive but insignificant) existing between external debts and growth, here represented by GNI. That is at lower levels of debts, where repayments equal its contributions; the impact on growth is positive but deteriorates as the figure grows. Like the gross national income gross domestic is the alternative indicator of growth as far as this work is concerned. Thus in order to see how external debts influences growth, we relate our total external debts to gross national product.
Note however that due to non availability of external debts data between 1960 and 1969, the data used started from 1970 to 2006. The same applies to the immediate preceding analysis. We thus formulate the following hypothesis. H0: There is a non linear relationship between External Debts and Economic Growth; H1: There is no non linear relationship between External Debts and Economic Growth. With the help of the test result (see appendix ix) we arrive at a decision. Firstly, we see that we have a positive R2 of 0. 05665 and an adjusted R2 of 0. 00116. This implies a positive but weak relationship between the variables.
However with a p-value of 0. 2006 against a minimum of 0. 050 we do not reject H0, the null hypothesis and instead reject H1: There is a non linear relationship between external debts and economic growth (See figure 2). 4. 0 CONCLUSION This work has investigated both the linear and nonlinear relationship between external debt and economic growth of Nigeria as a nation. Furthermore the work has tried to determine the channels through which external debts affects economic growth, by considering its effect on total factor productivity and capital accumulation.
To specify the growth regression seven alternative independent variables sets commonly used in empiric growth literature. The overall result show that for Nigeria there is no significant relationship between external debts and growth. Although total external debts seem to have a positive effect on two of the variables of Foreign Direct Investment and Official Development Assistance, the impact is quite understandable because the sources of foreign direct investments and official development assistance are always one and the same with that of the external debts.
Nigeria as an oil producing country is affected by the phenomenon that tend to relate increase in oil production to increase in external debts. This is because oil wealth tends to increase the ability of oil-exporting countries to finance their fiscal and balance of payment deficits by means of borrowing. In nutshell Nigeria’s debt over the years since independence had been a wasted effort and a colossal drain on the nation’s resources that led to the impoverish ness of the mass population through lack of infrastructures and general fall in standard of living. Where a total outstanding facility of $836. 8 million as at 1970 jumped to a total of $31. 04 by the year 2001, representing a growth of $30. 204 billion or 97. 31% is outrageous and retrogressive. And this was in spite of frequent negotiations, rescheduling and persistent repayments to the external creditors. The only respite in the name of “debt relief” came in 2006 with a down payment of $18 billion, an amount that was several multiples of all the nation’s borrowings throughout its external debt history. One can only imagine what impact $18 billion pumped into Nigeria’s economy will have on its growth and development. . 1RECOMMENDATIONS Given the foregoing scenario the following recommendations are hereby made for the purpose of external debts and its management in the country. 1. There should be an effective and foolproof debt management strategy that will guide in an efficient debt management in the country; 2. Debt must not be incurred except with a clear cut plan of its purpose and implementation; 3. Any debt implementation should follow a strict laid down plan of implementation that is both consistent and transparent; 4.
Conditionalities attached to externally debts from multilateral organizations must be in tandem with the overall short and long-term economic objectives of the country; 5. On no account should principal and or interest instalmental repayment be allowed to run into arrears in order to forestall cases of multiple repayments; 6. Debt should strictly be sourced for capital intensive and industrial related activities; and 7. A thorough periodic review of debts outstanding should carried out for a better reconciliation of the total figure. APPENDIX I YEAREXTERNAL DEBTSEXPORT FDIAGRICULTURAL GDP CURRENTGNI OFFICIAL DEV.
ASSISTANT 1960. 9. 24.. 4196174592. 32170000 1961. 9. 19. 75. 544467288064. 29640000 1962. 8. 27. 75. 654909399040468646502429320000 1963. 8. 78. 75. 765165590528520215398418120000 1964. 9. 2. 75. 885552931328550104883241970000 1965. 10. 89. 75. 995874422272570878208071870000 1966. 10. 41. 76. 066366792704578400102463230000 1967. 11. 08. 76. 145203136000516445747267670000 1968. 9. 93. 76. 145200896000526754252868800000 1969. 11. 39. 76. 586634187264659338342485110000 19708366780008. 4120500000076. 75125458493449433652224107540000 197196036300010. 8328600000076. 75918176972810323863552107110000 1972108176200010. 730500000076. 75122744156161166262681683000000 1973177897800015. 9237300000076. 75151628707841316329164876380000 1974188071900025. 18. 76. 75248466411522078052966472610000 1975168717200018. 34. 76. 86277789347842539383603281380000 1976133779200018. 22. 76. 97363088814083319223091251820000 1977314644400024. 87440514242. 577. 13360354078723766368665642010000 1978509117200019. 55210933271. 477. 1336527861763847222476840150000 1979624458100024. 82309598869. 277. 2472599101444570948812825740000 1980892140800029. 38738870004. 477. 28642017894405575397785634400000 19811142067800022. 53542327289. 177. 8599185367045726443110439250000 19821197160700016. 34430611256. 577. 46497634099205598498816034950000 19831756075500013. 61364434580. 277. 64349504593924308697907246750000 19841777053300014. 85189164784. 977. 82281825423363276614860832390000 19851864325600016. 1485581320. 977. 99284079308803035919769631710000 19862221193400017. 1193214907. 578. 35202107883522499130368058120000 19872902138000028. 61610552091. 578. 49234413342722316809216067620000 1988296210290023. 12378667097. 778. 742284772761625829279744118060000 19893012199900032. 69188424973978. 932384350822424855373824344000000 19903343892400043. 43587882970. 79. 142847247155225519552512255080000 19913352720500037. 22712373362. 579. 422731335270426556770304258320000 19922901871400042. 24896641282. 579. 563271036928029066799104258820000 19933073562300047. 12134536858779. 692135275929624833249280288420000 19943309228600041. 76195921985879. 822366338867223470204928189660000 19953409247100044. 29107927155179. 972810882662423588239360210900000 19963140660700048. 14159345922278. 133529915187228569958400188750000 19972845486900044. 95153944571876. 793622936985632203696128199750000 19983029449500033. 53105132621776. 793214381875231477866496203090000 19992912762000036. 9100491671976. 63477603942432726083584151800000 20003135492000053. 98114013766076. 914598360064033542492800173700000 20013104158800042. 99119063202477. 34799977472040122208256167820000 20023047599000031. 87187404213079. 275911684710445396021248294030000 20033470023600042. 7200539003379. 716765602406455622275072308060000 20043788308800043. 95187403299780. 158784542105673423224832578160000 20052217828200046. 54201336737881. 251. 12249E+11881551114246415780000 2006769305000043. 165445340524. 1. 46867E+111. 14771E+1111433920000 2007. 38. 99.. 1. 6569E+111. 37091E+11. APPENDIX II DEBT VS EXPORT APPENDIX III DEBTS VS FDI (BOP)
APPENDIX IV DEBTS VS AGRIC. LAND APPENDIX V DEBTS VS CURRENT GDP APPENDIX VI DEBTS VS GNI APPENDIX VII DEBTS VS OFFICIAL DEV. ASSISTANCE APPENDIX VIII REGRESSION Dependent variable. GNI Method.. QUADRATI Multiple R . 31695 R Square . 10046 Adjusted R Square . 04755 Standard Error20817192285. 3 Analysis of Variance: DF Sum of Squares Mean Square Regression 2 1. 6454928E+21 8. 2274640E+20 Residuals 34 1. 4734087E+22 4. 3335549E+20 F = 1. 89855 Signif F = . 1653 ——————– Variables in the Equation ——————–
Variable B SE B Beta T Sig T EXTDEBT 2. 446549 1. 256701 1. 507253 1. 947 . 0599 EXTDEBT**2 -6. 54702401E-11 3. 4719E-11 -1. 459949 . (Const) 24607701937. 140150 7852176048 3. 134 . 0035 APPENDIX IX REGRESSION Dependent variable.. GDP Method.. QUADRATI Multiple R . 23801 R Square . 05665 Adjusted R Square . 00116 Standard Error28283086344. 4 Analysis of Variance: DF Sum of Squares Mean Square Regression 2 1. 6332986E+21 8. 1664928E+20 Residuals 34 2. 7197721E+22 7. 993297E+20 F = 1. 02090 Signif F = . 3711 ——————– Variables in the Equation ——————– Variable B SE B Beta T Sig T EXTDEBT 2. 228220 1. 707406 1. 034694 1. 305 . 2006 EXTDEBT**2 -5. 44184535E-11 4. 7171E-11 -. 914663 . . (Const) 25603072625. 930190 10668286583 2. 400 . 0220 FIGURE 1 FIGURE 2 References: 1. Augustine K. F. 2000. ” The International Dimension of African Economic Growth”, CID Working Paper No. 34 2. Alfredo S. 2004. “Debt and Economic Growth in Developing and Industrial and Industrial Countries” . Andrea F. P. 2005. “The Debt-Growth Nexus In Poor Countries: A Reassessment” 4. Barbara M. and Michael A. (1997) “Growth and foreign debt: The Ugandan experience”, AERC Research Paper 68 5. Farzin, Y. H. 1988. “The Relationship of External Debt and Growth. Sudan’s Experience, 1975-1984”. World Bank Discussion Paper 24 6. Misan, R. 2007. “Overrated? The Impact of Oil Revenue on Nigeria’s Creditworthiness, Debt Profile and Sustainability, 1973-2004. ” 7. Stephen K. and Irfan N. 2004. “Drilling Into Debt: An Investigation Into the Relationship Between Debt and Oil”.