The effect of external debt on economic growth of nigeria(1981-2010)

Thesis Overview

<p> INTRODUCTION<br>1.0 BACKGROUND OF THE STUDY<br>It is generally expected that developing countries, facing a scarcity of capital, will<br>acquire external debt to supplement domestic saving (Malik et al, 2010; Aluko and<br>Arowolo, 2010). Besides, external borrowing is preferable to domestic debt because the<br>interest rates charged by international financial institutions like International Monetary<br>Funds (IMF) is about half to the one charged in the domestic market (Pascal, 2010).<br>However, whether or not external debt would be beneficial to the borrowing nation<br>depends on whether the borrowed money is used in the productive segments of the<br>economy or for consumption. Adepoju et al (2007) stated that debt financed investment<br>need to be productive and well managed enough to earn a rate of return higher than the<br>cost of debt servicing<br>The main lesson of the standard “growth with debt” literature is that a country<br>should borrow abroad as long as the capital thus acquired produces a rate of return that is<br>higher than the cost of the foreign borrowing. In that event, the borrowing country is<br>increasing capacity and expanding output with the aid of foreign savings. The debt, if<br>properly utilised, is expected to help the debtor country’s economies (Hameed et al,<br>2008) by producing a multiplier effect which leads to increased employment, adequate<br>infrastructural base, a larger export market, improved exchange rate and favourable terms<br>of trade. But, this has never been the case in Nigeria and several other sub-Saharan<br>African Countries (SSA) where it has been misused (Aluko and Arowolo, 2010). Apart<br>9<br>from the fact that external debt had been badly expended in these countries, the<br>management of the debt by way of service payment, which is usually in foreign<br>exchange, has also affected their macroeconomic performance (Aluko and Arowolo,<br>(2010); Serieux and Yiagadeesen, (2001).<br>Prior to the $18 billion debt cancellation granted to Nigeria in 2005 by the Paris<br>Club, the country had external debt of close to $40 billion with over $30 billion of the<br>amount being owed to Paris Club alone (Semenitari, 2005a). The history of Nigeria’s<br>huge debts can hardly be separated from its decades of misrule and the continued<br>recklessness of its rulers. Nigeria’s debt stock in 1971 was $1 billion (Semenitari, 2005a).<br>By 1991, it had risen to $33.4 billion, and rather than decrease, it has been on the<br>increase, particularly with the insurmountable regime of debt servicing and the insatiable<br>desire of political leaders to obtain loans for the execution of dubious projects<br>(Semenitari, 2005a).<br>Before the debt cancellation deal, Nigeria was to pay a whopping sum of $4.9<br>billion every year on debt servicing (Aluko and Arowolo, 2010). It would have been<br>impossible to achieve exchange rate stability or any meaningful growth under such<br>indebtedness. The effect of the Paris Club debt cancellation was immediately observed in<br>the sequential reduction of the exchange rate of Nigeria vis-à-vis the Dollar from 130.6<br>Naira in 2005 to 128.2 Naira in 2006, and then 120.9 in 2007 (CBN, 2009). Although the<br>growth rate of the economy has been inconsistent in the post-debt relief period as it<br>plunged from 6.5% in 2005 to 6% in 2006 and then increased to 6.5% in 2007 (CBN,<br>2008), it could have been worse if the debt had not been cancelled.<br>10<br>However, the benefits of the debt cancellation, which was expected to manifest<br>after couple of years, was wiped up in 2009 by the global financial and economic crisis,<br>which was precipitated in August 2007 by the collapse of the sub-prime lending market<br>in the United States. The effect of the crisis on Nigeria’s exchange rate was phenomenal<br>as the Naira exchange rate vis-à-vis the Dollar rose astronomically from about N120/$ in<br>the last quarter of 2007 to more than N150/$ (about 25% increase) in the third quarter of<br>2009 (CBN, 2009). This is attributable to the sharp drop in foreign earnings of Nigeria as<br>a result of the persistent fall of crude oil price, which plunged from an all-time high of<br>US$147 per barrel in July 2007 to a low of US$45 per barrel in December 2008 (CBN,<br>2008).<br>Available statistics show that the external debt stock of Nigeria has been on the<br>increase after the debt cancellation in 2005. The country’s external debt outstanding<br>increased from $3,545 million in 2006 to $3,654 million in 2007, and then to $3,720<br>million and $3,947 in 2008 and 2009 respectively (CBN, 2009). It is therefore imperative<br>to examine the effect of external debt of the country on her economy for us to appreciate<br>the need to avoid being back in the group of highly indebted nations.<br>1.1 STATEMENT OF THE PROBLEM<br>The huge external debt stock and debt service payments of African countries and<br>Nigeria in particular prevented the countries from embarking on larger volume of<br>domestic investment, which would have enhanced growth and development (Clements,<br>etal. 2003). External debt became a burden to most African countries because contracted<br>loans were not optimally deployed, therefore returns on investments were not adequate to<br>meet maturing obligations and did not leave a favourable balance to support domestic<br>11<br>economic growth. So, African economies have not performed well because the necessary<br>macro-economic adjustment has remained elusive for most of the countries in the<br>continent. The main interest of this study then is to empirically investigate the effect of<br>external debt on the economic growth of Nigeria.<br>1.2 OBJECTIVES OF THE STUDY<br>The study will focus on the following objectives:<br>(i) Empirically investigate the effect of external debt on the growth process of the<br>country;<br>(ii) To determine the impact of external debt service payment on economic<br>growth of Nigeria. <br></p>