CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

It is generally expected that developing countries, facing a scarcity of capital, will acquire external debt to supplement domestic saving (Pattillo, Poirson,  and Ricci , 2002; Safdari and Mehrizi, 2011). The rate at which they borrow abroad - the “sustainable” level of foreign borrowing - depends on the links among foreign and domestic saving, investment, and economic growth. The main lesson of the standard “growth with debt” literature is that a country should borrow abroad as long as the capital thus acquired produces a rate of return that is higher than the cost of the foreign borrowing. In that event, the borrowing country is increasing capacity and expanding output with the aid of foreign savings.

In theory, it is possible to calculate the sustainable level of foreign borrowing, based, on maturity and availability of foreign capital. In practice, however, the task is nearly impossible, since such information is not readily available. Thus, various ratios, such as that of debt to exports, debt service to exports, and debt to GDP (or GNP), have become standard measures of sustainability. Even though it is difficult to determine the sustainable level of such ratios, their chief practical value is to warn of potentially explosive growth in the stock of foreign debt. If additional foreign borrowing increases the debt-service burden more than it increases the country’s capacity to carry that burden, the situation must be reversed by expanding exports. If it is not, and conditions do not change, more borrowing will be needed to make payments, and external debt will grow faster than the country’s capacity to service it.

Countries in sub-Saharan Africa have generally adopted a development strategy that relies heavily on foreign financing from both official and private sources. Unfortunately, this has meant that for many countries in the region the stock of external debt has built up over recent decades to a level that is widely viewed as unsustainable. From a trivial debt stock of $1billion in 1971, Nigeria had towards the end of 2005 incurred close to $40 billion debt with over $30 billion of the amount owed to the Paris Club alone. Although Nigeria’s debt was more than the total of those of the 18 other poor countries (14 of them African Countries) classified as Heavily Indebted Poor Countries (HIPCs), it had been a herculean task convincing the creditors that debt cancellation was the most desirable option. Prior to Nigeria’s $18 billion debt cancellation deal, these 18 other poor countries i.e. Benin Republic, Bolivia, Burkina- Faso, Ethiopia, Ghana, Guyana, Honduras, Madagascar, Mali, Mauritania, Mozambique, Nicaragua, Niger, Rwanda, Senegal, Tanzania, Uganda and Zambia had secured a 100 percent debt cancellation totalling $40 billion (Semenitari, 2005).

The debt burden on less developed countries can be traced to the early 1980’s after the oil price increase of the 1970’s. It was the product of reactions by the international community to “oil price shocks”. One of the legacies of African Countries from the crisis has been an increasing debt burden, which constituted a major constraint to growth and development.

External debt became a burden to African Countries because contracted loans were not optimally deployed, therefore returns on investments were not adequate to meet maturing obligations and also hindering economic growth. African economies have not performed well, partly because of the increased outflow of resources to service debt obligations and partly because the necessary macro-economic adjustment has remained elusive for most of the countries in the continent.

1.2 OBJECTIVES OF THE STUDY

The main objective of this research is to determine the effect of an increasing external debt liability on the Nigerian economy. Other specific objectives are as follows;
(i) to examine the external debt trend of Nigeria

(ii) To explore the impact of the debt cancellation on the Nigerian economic growth

(iii) Proffering appropriate framework based on the policy recommendations made.

1.3 SIGNIFICANCE OF THE STUDY

The finding of this study will provide an econometric basis upon which to examine the effect of external debt on Nigeria’s economic growth. Hence, policy makers will be able to formulate an articulate and comprehensive policy with respect to debt management in Nigeria.  This research will also
provide an objective view to the relevance of the debt cancellation to Nigerian economy. The findings of this research will also serve as a good resource materials for those that in tend to carry out further research on the effect of debt liability on the Nigerian economy.

1.4 STATEMENT OF HYPOTHESES

The following hypotheses will be tested at the course of this study:

i.             Ho: the external debt stock did not affect the economic growth of Nigeria.

H₁:  the external debt stock affects the economic            

          growth of Nigeria.

ii.          Ho:  the external debt cancellation has no significant

            effect on the Nigerian economy    

             H₁:  the external debt cancellation has a significant

              effect on the Nigerian economy

iii.        Ho:  the external service payment did not impact on

            the economic growth of Nigeria.

            H₁:  the external service payment impacted on the  

             economic  growth of Nigeria.

1.5 SCOPE AND LIMITATIONS OF THE STUDY

The scope of this study shall cover the external debt trend in Nigeria and the effect external debt has on the growth of the Nigerian economy. This research will also focus on the effect of external debt cancellation and debt service payment on the economic growth in Nigeria.  Recent literatures will be reviewed with respect to the rationality behind the increasing debt liability in Nigeria. However, the empirical investigation of the effect of external debt on the economic growth of Nigeria shall be restricted to 1981 and 2010. This restriction is unavoidable because of the non-availability of some data.

The main limitation of this study is time constraint. The time allotted for the completion of this research is not adequate based on recent and contemporary happening  with respect to  the effect of external debt on the Nigerian economy.

1.6 METHODOLOGY

Secondary data shall be the basis for this study. The relevant data to be used would be sourced from the Central Bank of Nigeria’s statistical reports, annual reports and statement of accounts for the years under review.

The Ordinary Least Square Regression Technique will be employed in the analysis of the data. This econometric method would be used because it is very reliable and widely used in researches. Two simple regression models shall be adopted to capture the effect of external debt and the debt service payment on Nigerian economic growth. The effect of other macro-economic factors such as: exchange rate, inflation rate, interest rate and government expenditure would also be considered. This would enable us to judge the relevance of the debt cancellation. If the external debt stock and the debt servicing payment had adverse effect on the economy, then the debt cancellation would contribute the growth of the economy. 

1.7 DEFINITION OF TERMS

       The following words are operationally defined as they would be used in this research study.

i.             External Debt: The acquisition of foreign loan. That is the amount of money owing by country to another.

ii.            Economic Growth: The rate of expansion in the volume of production of goods and services of a country. That is the rate at which the Gross National Product (GNP) increases annually.

iii.           Inflation: A steady and progressive fall in the value of money, shown by the proportionate rate of increase in the general price level per unit of time.

iv.          Debt Conversion: This involves the practice of issuing new stocks and shares exchange for others. The transformation of repudiated loan stock into a new loan issue.

v.           Foreign Exchange:  currency or interest bearing bonds of another country. For example, holding by Nigerians of US Dollars. Euro - Dollars, Deutsche - Marks, Swiss - Francs or US Government bonds.

vi.          Fiscal Deficit: A situation where Government expenditure exceed income or where Government liabilities exceed assets at a specific point in time.

vii.         Economic Recession: A falling off in the progress of a country, which if it persists will lead to depression and to a slump.

viii.       Devaluation: A reduction in the official per-value of the legal unit of currency in terms of the currencies of other countries. Devaluation is used to correct a balance of payment deficits but only as a last resorts as it has major repercussions on the domestic economy.