external debt

Impact of External Borrowing on Nigeria Economy 1981-2016

The impact of external borrowing on Nigeria economic growth analysis the debt service burden incurred on on Nigeria economy as a result of continuous debt servicing. The work aim at ascertaining whether there is both long-run and short-run relationship between economic growth and external borrowing in Nigeria.



1.1 Background to the Study

The accumulation of external debt is a common phenomenon of the third World countries at the stage of economic growth and development where the supply of domestic savings is low, current account payment deficit is high and import of capital is needed to increase domestic resources. No government is an island on its own; it would require aid so as to perform efficiently and effectively. One major source of aid is foreign borrowing or external debt. The idea behind external debt is due to the fact that countries especially the developing ones lack sufficient internal financial resources and this calls for the need for foreign aid (Noko, 2016).

The dual-gap analysis provides the framework which shows that the development of a nation is a function of investment and that such investment which require domestic savings is not sufficient to ensure that development take place (Oloyede, 2002). Hence, the importance of external debt on the growth process of a nation cannot be overemphasized. Hameed, Ashraf, and Chaudhary (2008) stated that external borrowing ought to accelerate economic growth especially when domestic financial resources are inadequate and need to be supplemented with funds abroad. Many developing countries particularly Nigeria is found to be wallowing in debt. The external debt problem facing Nigeria has been receiving increasing attention in which adequate solutions are yet to be found. A clear and persistent lesson of the debt crisis has been that adequate debt management is essential if external resources are to be used efficiently. Many developing countries resort to external borrowing to bridge the domestic resource gap in order to accelerate economic development. It then means that any developing country can resort to external borrowing provided that the proceeds are utilized in a productive way that will facilitate the eventual servicing and liquidation of the debt.

The management of Nigeria’s external debt has been a major macroeconomic problem especially since the early 1980s. For many years now, the country’s debt has been growing in spite of the efforts being made by the Government to manage and minimize its crushing effects on the nation’s economy. Such efforts range from the various refinancing and restructuring agreements to debt conversion programme and the deliberate allocation of substantial resources towards servicing the debt. One particular concern to the authorities is the heavy debt burden it imposes when compared with the country’s debt service capacity. In recent years, however, some observers have held different perceptions about Nigeria’s capacity or otherwise to service her debt. This is largely because of the improved income to the country arising from export of crude oil, Nigeria’s major export.

Moreover others have argued that bad governance, especially during the military rule, largely accounted for the mismanagement of the Nigerian economy and therefore, the people should bear the brunt. Whatever position one holds, what appears undisputable is the increasingly large debt service requirement which imposes considerable stress on the Nigerian economy even when the improved resource inflow is factored into the country’s cash flows. Indeed, the issue of sustainability of Nigeria’s debt profile continued to be the focus of research and public debate until the recent initiative of the Paris Club of Creditors which appears to address the issue in a more meaningful way. Even then the conditions and adequacy of the debt relief have continued to generate further debate (Tonuchi, 2015).

However, during the late 70’s and early 80’s, commercial banks began playing a big role in international lending by recycling surplus OPEC ‘’petrodollars’’ and issuing general purpose loans to less developed countries to provide balance of payment support and expansion of export sectors. While foreign borrowing can be highly beneficial providing the resources necessary to promote economic growth and development, it has its cost. In recent years, these costs have greatly outweighed the benefits for many developing nations. The main cost associated with the accumulation of a large external debt is ‘’debt serving’’. Debt servicing is the payment of liquidation of the principal and accumulated interest. It is a contractually fixed exchange on domestic real income and savings as the debt grows or as interest rate raise. Debt service payment must be made with foreign exchange. In other words, debt service obligation can be met only through export earnings. However, should the composition of import change or should the composition of export change or should interest rate rise causing ballooning of debt service payment or should export earnings diminish, debt servicing difficulties are likely to arise. This has been the experience of most of the heavily indebted third World nations.

According to Omoleye, and Ezeonu (2006), Nigeria is the largest debtor nation in the Sub-Saharan Africa. The genesis of Nigeria’s external debt can be traced to 1958 when 28 million US dollars was contracted from the World Bank for railway construction. Between 1958 and 1977, the need for external debt was on the low side. However, due to the fall in oil prices in 1978 which exerted a negative influence on government finances, it became necessary to borrow to correct balance of payment difficulties and finance projects. The firstmajor borrowing of 1billion US dollars referred to as Jumbo loan was contracted from the international capital market (ICM) in 1978 increasing the total to 2.2 billion U.S dollars (Adesola, 2009).

The rate of borrowing increased thereafter with the entry of the state government into external loan contractual obligation. According to the Debt Management Office (DMO), Nigeria’s external debt outstanding stood at N17.3 billion. In order to solve the problem, several external debt-financing options were adopted under the Structural Adjustment Programme (SAP) in 1986. Since the introduction of this programme, Nigerians have been plunged into one hardship after another ranging from the devaluation of the naira through Second Tie Foreign Exchange Market (SFEM) now Foreign Exchange Market (FEM) to the rising prices of commodities, inflation etc. (Ayadi, 2008). The objective of this paper is to review Nigeria’s external debt and the burden it imposes, and use the various indicators and prevailing global economic circumstances to justify the need for substantial debt relief for the country.

The increasing fiscal deficits driven by the higher level of external debt servicing is a major threat to growth of the nation. The resultant effect of large accumulation of debt exposes the nation to high debt burden. Nigeria is about the richest on the continent of Africa, yet due to the numerous macro-economic problems, such as inflation, unemployment, sole dependency on crude oil as a major source of revenue, corruption and mounting external debt and debt service payment, majority of her citizen fall below the poverty line.

Prior to the $18 billion debt cancellation granted to Nigeria in 2005 by the Paris Club, the country had external debt of close to $40 billion with over $30 billion of the amount being owed to Paris Club alone (Semenitari, 2005). The history of Nigeria’s huge debts can hardly be separated from its decades of misrule and the continued recklessness of its rulers. Nigeria’s debt stock in 1971 was $1 billion (Semenitari, 2005). By 1991, it had risen to $33.4 billion, and rather than decrease, it has been on the increase, particularly with the insurmountable regime of debt servicing and the insatiable desire of political leaders to obtain loans for the execution of dubious projects (Semenitari, 2005).

Before the debt cancellation deal, Nigeria was to pay a whopping sum of $4.9 billion every year on debt servicing (Aluko and Arowolo, 2010). It would have been impossible to achieve exchange rate stability or any meaningful growth under such indebtedness. The effect of the Paris Club debt cancellation was immediately observed in the sequential reduction of the exchange rate of Nigeria vis-à-vis the Dollar from 130.6 Naira in 2005 to 128.2 Naira in 2006, and then 120.9 in 2007 (CBN, 2009). Although the growth rate of the economy has been inconsistent in the post-debt relief period as it plunged from 6.5% in 2005 to 6% in 2006 and then increased to 6.5% in 2007 (CBN, 2008), it could have been worse if the debt had not been cancelled However, the benefits of the debt cancellation, which was expected to manifest after couple of years, was wiped up in 2009 by the global financial and economic crisis, which was precipitated in August 2007 by the collapse of the sub-prime lending market in the United States. The effect of the crisis on Nigeria’s exchange rate was phenomenal as the Naira exchange rate vis-à-vis the Dollar rose astronomically from about N120/$ in the last quarter of 2007 to more than N150/$ (about 25% increase) in the third quarter of 2009 (CBN, 2009). This is attributable to the sharp drop in foreign earnings of Nigeria as a result of the persistent fall of crude oil price, which plunged from an all-time high of US$147 per barrel in July 2007 to a low of US$45 per barrel in December 2008 (CBN, 2008).

Available statistics show that the external debt stock of Nigeria has been on the increase after the debt cancellation in 2005. The country’s external debt outstanding increased from $3,545 million in 2006 to $3,654 million in 2007, and then to $3,720 million and $3,947 in 2008 and 2009 respectively (CBN, 2009). Therefore, the study seeks to thoroughly and empirically investigate the consequential effect of Nigeria’s external debt on her economy for us to appreciate the need to avoid being back in the group of highly indebted nations..

1.2 Statement of the Problem

It cannot be overemphasis that Nigeria’s huge external debt burden was one of the hard knots of the Structural Adjustment Programme (SAP) introduced in 1986 by the Babangida administration, knowing full well that the period 1985 through 1993 when the country embarked on Structural Adjustment Programme (SAP) only coincided with a period when external debt was at its peak.

The high debt profile of Nigeria despite cancellation of some external debt by London club, Nigeria still remain among the top most indebted countries in the whole world. It is unfortunate how successive government in Nigeria overlook the negative impact of domestic and especially external debt and focus only on the positive impact when contracting the loans.

According to Were (2001, cited in Noko, 2016) 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 that breed economic hardship and woes in a country.

It is no exaggeration that this is the major challenge faced by most developing countries, Nigerian inclusive. 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.

Countries like Japan has a very large volume of external debt profile but at the same time has large volume of external reserves in US dollar. It is the lack of precise definition of external borrowing that often leads to mismanagement of funds. Managing debt service burden entails reducing the burden of external and domestic debt in the country. According to DMO over 40% Nigeria budget are allocated to servicing her debt not even repaying the capital borrowing.

Nigeria debt burden profile keeps on rising but the economic growth and other major macroeconomic goals are falling this can be seen from Nigeria debt profile image. And this has raise many questions among the stake holders like:

  • How has Nigeria debt being expended?
  • Why has the huge Nigeria borrowing not accelerated the pace of growth of the Nigerian economy?
  • Is there any measure to reduce the debt service burden on Nigeria economy?

The debt burden of Nigeria economy over the years has some interrelated factors that contributed to it including:

  • Macroeconomic policy imbalances- conflicting policies,
  • Increases in the price of a number of primary commodities encouraging countries to borrow,
  • High prime lending rates discouraging private sector investment.
  • Poor economic planning or feasibility study.
  • Corruption or embezzlement of public funds by the policy makers.

This high debt serving burden resulting from improper management of the nation borrowing and wealth has led to:

  • To fall in aggregate demand in the nation overtime
  • Increase in poverty and hunger especially in the rural areas.
  • Increases in the profile of unemployment among the youths who are the most vulnerable.
  • Fall in the economic growth resulting to the current economic recession going on in the country.
  • Religion, Political and social – economics crisis in the country as every part of the country feels neglected.

This later stated fact propelled the researcher into carrying out this research on effect of external debt on the economic growth of Nigeria.

1.3 Research Questions          

In the course of the research the following question will be addressed;

  • To what extent does external debt have an effect on the economic growth of Nigeria?
  • Is there any long-run relationship between external debt and economic growth in Nigeria?

1.4 Objectives of the Study

The main objective of the study is to assess the effect of external debt in Nigeria and its role in returning the economy backs to equilibrium after budget imbalance.

The specific objectives of this study are to:

  • empirically investigate the effect of external debt on Nigeria’s economic growth.
  • evaluate the long-run relationship between external debt and Nigeria’s economic growth.

1.5       Research Hypotheses

The hypotheses to be tested in the course of this research work are:

  1. H0: That external debt does not have significant effect on economic growth in Nigeria
  2. H0: That external debt does not have any long-run relationship with economic growth in Nigeria.


1.6 Significance of the Study

The emphasis on economic and monetary integration among economic of the world may not be realized in face of rising external debt of developing countries including Nigeria. Even the current much talked about “Millennium Development Goals” may turn out to be an illusion if this fundamental problem of debt burden is not deal with properly. In order to justify further the critical importance given to external debt in Nigeria, the objective of this work is to examine empirically the relationship between external debt and economic growth and examine the impact of the level of debt servicing on economic growth using Nigerian data. The benefactors of this study will include;

  1. Central Bank: The central bank of Nigeria is responsible for debt management; this will serve as advisory tool for their choice of debt servicing.
  2. Scholars: Scholars will find the study relevant as it will form basis for further research and also a reference tool for academic works.
  • Government: This study will serve as an eye opener to government officials so that when policies are recommended to them (on external debt) having obtained idea from this work, will know the appropriate policy to choose from.

Lastly, this study will reveal the relationships and effect of external debt in Nigeria; a knowledge that will be beneficial to many stakeholders who will find relevance in it. It will in the long run, guide policy formulation and implementation for a better Nigeria.

1.7       Scope and Limitation of the Study

The project covers the structures of Nigeria’s external debt, its management techniques and some factors that contributed to the huge debt. The time frame of this project is 1981-2016 was chosen because it allows an analysis of the Structural Adjustment Programme (SAP) which was at this period, partly solve the debt crisis and partly foster sustainable economic growth. This study is basically restricted to the effect of external debt on the Nigeria economy growth. The research was not able to gather all the necessary materials from all the secondary sources needed for the study. Also as a student still dependent, he is limited by finance that would have ensured consistency.

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