ABSTRACT
In Nigeria, despite the huge expansion of public expenditure based on the budget deficit status over the years, the expected level of economic growth as a result capital formation has not been achieved and it is against this backdrop, that this study investigated the effect of deficit financing on capital formation in Nigeria for the period 1981-2019 with the help of the ARDL model of estimation. Based on the issues covered in the literature review, empirical investigations were carried out on the effect of deficit financing on capital formation in Nigeria. Results showed that External Debt Stock (LNEXDBT) had a positive relationship with GCF_GDP in the current year, 1st and 2nd lagsbut statistically insignificant in the long run, Domestic Debt Stock (LNDMDBT) had a negative relationship with GCF_GDP in the current year, 1st and 2ndyear lags and long run, Aggregate Gross Savings (LNADBTS) had a positive significant relationship with GCF_GDP in the current year and in the long run, Aggregate Debt Service (LNADBTS) had a positive relationship with GCF_GDP in the current year and in the long run while Total external reserves had a negative relationship with GCF_GDP in the current year and in the long run. Based on the findings, the study recommended that the Government should demonstrate a high sense of transparency in its monetary and fiscal operations to curb high prevalence of external and domestic borrowing, improved gross savings to reduce the incidence of inflation which will translate to economic prosperity.
TABLE OF CONTENTS
Title
Page i
Declaration
ii
Certification iii
Dedication iv
Acknowledgement v
Table
of Contents vi
List
of Tables vii
Abstract viii
CHAPTER 1: INTRODUCTION
1.1 Background of the Study 1
1.2 Statement of the Problem 2
1.3 Research Questions 5
1.4 Objectives of the Study 6
1.5 Research Hypotheses 6
1.6 Significance of the study 7
1.7 Scope of the Study 8
CHAPTER 2: LITERATURE REVIEW
2.1 Conceptual
Literature 9
2.1.1 Concept and nature
of deficit financing 9
2.1.2 External debt 10
2.1.3 Domestic 11
2.1.4 Debt Service 11
2.1.5 Implications of
fiscal deficit 14
2.1.6 Nature of fiscal
deficit in Nigeria 15
2.1.7 The Nigeria economy
and saving profile 16
2.1.8 Concept
of capital formation 17
2.1.9. Process of capital formation 20
2.1.10.
Roles of capital formation in economic growth of a country 22
2.1.11.
Nature of Nigeria's capital formation 23
2.1.12
External reserves 23
2.2 Theoretical
Literature review 25
2.2.1 Neoclassical theory 25
2.2.2
The Ricardian equivalent perspective 26
2.2.3
Keynesian economic theory 27
2.2.4
The Monetarist theory 28
2.3 Empirical
Literature Review 29
2.4 Gap in Empirical
Literature 31
2.5
Identified gap in empirical
Literature 33
CHAPTER 3: RESEARCH
METHOD
3.1 Research
Design 34
3.2 Model Specification
34
3.2.1
Definition of variables 37
3.3 Estimation
Technique 39
3.3.1
Stepwise regression analysis 39
3.3.2 Normality test 39
3.3.3
Unit root test 39
3.3.4 Cointegration test 40
3.3.4.1
Autoregressive distributed lag model (ARDL) approach to
cointegration testing or bound cointegration testing approach 41
3.3.4.2.
Requirements for the application of autoregressive distributed
lag model (ARDL) approach to
cointegration testing 42
3.4 Post-Estimation
Test 43
3.4.1. Error correction mechanism (ECM) 43
3.4.2
Toda and Yamamoto for granger causality
test 43
3.4.3. Breusch–Godfrey test for autocorrelation 44
3.4.4
Breusch–Pagan test for
heteroscadasticity 45
3.4.5
Stability test 46
3.4.5.1
Cumulative sum and cumulative sum of squares 46
3.4.5.2
Ramsey regression equation specification error test 46
3.5 Sources of
Data 45
3.6 Description of Data 45
3.6 Software
Application 47
CHAPTER 4: DATE PRESENTATION, ANALYSIS AND DISCUSSION
4.1. Pre-estimation Test 48
4.1.1
Stepwise regression estimates 48
4.1.2
Descriptive statistics 49
4.1.3 Unit root test 50
4.1.4 Selection of lag length criteria 51
4.1.5
Cointegration test 51
4.2 Dynamic Short Run
ARDL Error Correction Model and Discussion
52
4.3 ARDL Long Run Form
for deficit financing and capital formation in Nigeria 55
4.4
Diagnostic Test/Post Estimation Test 56
4.4.1Breusch-Godfrey
serial correlation LM test 56
4.4.2Breusch-Pagan-Godfrey
heteroskedasticity test 56
4.4.3 Stability test 57
4.4.3.1
Ramsey reset test 57
4.4.4.2
Cumulative and cumulative squares test 58
4.4.4
Toda and Yamamoto granger causality test 59
4.5.
Discussion of Findings 60
4.5.1
Effect of external debt stock on capital formation in Nigeria. 60
4.5.2
Effect of domestic debt stock on capital formation in Nigeria 61
4.5.3
Effect of aggregate gross savings on capital formation in Nigeria 61
4.5.4
Effect of aggregate debt service on capital formation 62
4.5.5 Effect of total external
reserves on capital formation in Nigeria. 62
CHAPTER 5: SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS
5.1 Summary
of Findings 64
5.2 Conclusion 65
5.3 Recommendation 65
Reference 67
Appendices 70
LIST OF TABLES
Page
4.1
Stepwise
regression estimates for selection of variables 48
4.2 Common sample descriptive
statistics 49
4.3 Summary
of stationarity test 50
4.4:
VAR lag
order selection criteria 51
4.5 Autoregressive
distributed lag bounds test for co-integration 51
4.6 Result
of dynamic short run ARDL error correction model for deficit
financing
and capital formation in Nigeria 52
4.7
Static Long Run Estimates of deficit
financing and capital formation in Nigeria 55
4.8 Result Breusch-Godfrey Serial Correlation
LM Test 56
4.9 Result of Breusch-Pagan-Godfrey
heteroskedasticity test 57
4.10 Result of Ramsey Reset Test 57
4.11 Result of Toda and Yamamoto granger
causality test 59
CHAPTER
1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Budget
Deficit as a means of financing was introduced in Nigeria after the civil war,
accompanied by the uncertainties in the oil market and further aggravated by
the current financial and economic challenges. Since independence, over 88
percent of Nigerian budget are on deficit (Momodu & Monogbe 2017) because the
government and the monetary authorities believes that one way of solving social
and economic problems is by increasing spending in the economy (Monogbe, Dornubari
and Emah 2015). Government as an agent of the people focuses more on capital
formation which requires revenue to provide education, employment, adequate
health services, infrastructures and good roads, but in the process of
discharging this enormous responsibility, the revenue or spending requirements
of the government may sometimes exceeds its availability, hence the resort to
deficit financing so as to fill the gap between expenditure needs and revenue
availability.
In
Acknowledging the Ricardian equivalence theorem, which posits that increases in
the deficit financed by fiscal spending will be matched by future increase in
taxes and so this will leave interest rates and private investment unchanged,
the implication of this is that in an attempt to repay the borrowed fund, tax
which was cut in the previous years will eventually be raised higher than what
was supposed to be paid earlier which means that the accumulated private
savings during the period of increase in government spending will be used in
setting off the borrowed fund in the future. The choice is therefore between
tax now and tax later. At this juncture, one wonders why empirical evidence and
theoretical underpinning justifies the fact that deficit financing stimulates
economic growth especially when an economy is facing persistence inflationary
pressures and high unemployment rate like in the Nigerian case.
In
Nigeria, regardless of the fact that the extended expansion of public
expenditure in Nigeria over the years, the expected level of economic growth as
a result capital formation and accumulation by the government has not been
achieved as greater percentage of the Nigeria citizens still wallow in absolute
poverty, persistent high mortality rate, low life expectancy due to inaccessibility
of standard medical facilities, poor road network, shortage of food and high
rate of unemployment (Momodu & Monogbe 2017),can we emphatically say that
deficit financing has stimulated Nigerian economic growth from 1986 till date?.
Series of studies have been carried out on this subject matter and quite a
number of results have also emerged in the process. Some researchers believe
that deficit financing has a significant effect on capital formation which in
turn translates to increase in economic growth while others believe that there
is no significant effect on the economy. Their findings are contradictory and
is on this background that the study was motivated to fill the knowledge gap on
the effects of deficit financing on capital formation in Nigeria.
1.2 STATEMENT OF THE
PROBLEM
In
Nigeria, despite the fact that actual revenues realized are often above the
budgeted estimates, huge budget deficits have been recorded over the years
(Anyanwu, 1997). This lack of fiscal discipline which have resulted in ever
increasing fiscal deficits have been blamed for some of the macroeconomic
problems that beset the country such as high and rising inflation rates, high
and rising unemployment, balance of payments problems, over indebtedness and
debt crisis, poor investment performance, etc (Onwiodiukit, 1999).
Figure 1: Trend of Budget
Deficit Financing in Nigeria 1981-2018
Source:
Researcher’s Compilation from World Bank data files.
In Nigeria,
considerable attention has
been focused on
the consequences of
deficit financing because
of the belief
that the presence
of these consequences in
the Nigeria economy
might have informed the
current thinking that
the government through
its deficit financing
has contributed greatly
to the country's
current economic problem.
Among the problems
confronting the Nigerian
economy are; pressure
on balance of
payment, declining growth
and heavy debt
burden in which
Nigeria had $18billion
that is about 60 percent
of the $30billion
owed the Paris
Club written off
(Debt Management Office,
2006). The concern is not about increased deficit
budget, this is because fiscal deficit is
not a crime
but when it
exceeds the international
bench mark of
3 percent of
Gross Domestic Product, it becomes worrisome, especially when it cannot
be said to promote economic activities (Anyanwu, 1997). For instance, from figure one above, it can be
seen that from 1981 to 1993, Nigeria budget deficit was relatively low to an
extent from 1989 to 1993, the Nigeria budget deficit declined absolutely to
negative values of 10.3, 7.43 and to its lowest value of 53.23 and rose
significantly to 244.98$ billion in 1996, falling again to 19.98$ billion in
2002 while attaining its highest peak in 2016 with an all-time high value of
1,044.84$ billion.
Figure 2. Trend of Gross Fixed Capital
Formation for the period 1981-2018
Source: Researcher’s
Compilation from World Bank data files
The
above chart on gross fixed capital formation shows that there has been a
neglect on the part of the government in the area of capital accumulation since
in recent year’s expenditure profile overtime has tilted more to recurrent
rather than on capital expenditures. Not much of her capital outlays were spent
on the acquisition of capital goods, such as machines, instruments, factories,
or on increasing the stock of raw materials, finished goods and improved
general investments and this can be seen in figure 2 above where, for example,
in the years 1981 and 1982, gross fixed capital formation averaged 89.4 and 86
percent of GDP respectively in Nigeria and continued declining to the lowest
average of 14.90 in 2013. That is certainly not good enough for a nation that
is striving to grow.
The
back and forth fluctuations in Nigeria deficit financing may be attributed to
the fact that Often times when projects are approved and money is disbursed,
there is no proper monitoring mechanism in place to ensure that the money is
judiciously used. This has created a cover for corrupt politicians and
government official to hide under and divert government funds. These projects
that are not carried out are then reinserted into the next budget for another
fiscal year and funds are again approved for them which creates an opening
through which government funds are continually siphoned.
Furthermore,
most of the studies conducted on the topic made use of variables like
government expenditure, government tax revenue, money supply, balance of
payments, etc as part of the explanatory variables (i.e., as measures of fiscal
deficits). Our argument here is that these variables do not adequately measure
budget deficit financing. To fill this gap therefore, the present study
investigating the effects of deficit financing on capital formation in Nigeria
to see how it translates to boast economic growth.
Another
justification for this study is the fact that the dynamic nature of the
structure of the Nigerian economy, and the emergence of new set of empirical
data (both occasioned by the passage of time) might have rendered the findings
of some of the previous studies obsolete. Hence the need to confront the issue
with fresh empirical data that will reflect current economic realities in the
country.
1.3 RESEARCH QUESTION
The
following research questions will be answered at the end of this study.
1.
What is the effect of domestic borrowing on capital formation in Nigeria?
2.
What is the effect of foreign borrowing on capital formation in Nigeria?
3.
What is the effect of aggregate savings on capital formation in Nigeria?
4.
What is the effect of aggregate debt service on capital formation in Nigeria?
5.
What is the effect of external reserves on capital formation in Nigeria?
1.4. OBJECTIVES OF THE
STUDY
The broad objective
of this study is to investigate the effect of deficit financing on capital
formation in Nigeria. The specific objectives of the study are as follows:
1.
To determine the effect of domestic borrowing on capital formation in Nigeria.
2.
To determine the effect of foreign borrowing on capital formation in Nigeria.
3.
To determine the effect of aggregate savings on capital formation in Nigeria.
4.
To determine the effect of aggregate debt service on capital formation in
Nigeria.
5.
To determine the effect of external reserves on capital formation in Nigeria.
1.5. RESEARCH HYPOTHESIS
HO1:
Domestic borrowing has no significant effect on capital formation in Nigeria at
5% level of significance.
HO2:
Foreign borrowing has no significant effect on capital formation in Nigeria at
5% level of significance.
HO3:
Aggregate savings has no significant effect on capital formation in Nigeria at
5% level of significance.
HO4:
Aggregate debt service has no significant effect on capital formation in
Nigeria at 5% level of significance.
HO5.
External reserves has no significant effect on capital formation in Nigeria at
5% level of significance.
1.6 SIGNIFICANCE OF THE
STUDY
This
research is inspired by the important functions of deficit financing in the
economy which determines to a large extent, the flexibility of the economic
system to meet present and future requirements for the objective of being
productive, efficient and achieving the set macro-economic goals that expressly
translate to better living standards for the populace. Empirical research on
budget deficit financing and capital formation especially in Nigeria has been
relatively scanty; a justification for this appears to be lack of credible and
adequate data, therefore, the present study will immensely be of great benefit to
the following:
1. Policy Makers: the study will stand to
enlighten them on the ways of finding the best policy to use when it comes to
the issue of the Nations deficit financing techniques.
2. Investors: the study will help them to
realize the actual state of the economy, especially when the country’s budget
is at deficit.
3. Researchers: they will find it rewarding as
it will add to the rich collection of work in available literatures due to the
expansion of years covered and modification of model.
4.
Economy: the study will helps to reveal the stand of the economy in the face of
deficit budgeting system.
1.7 SCOPE OF THE STUDY
The
study is basically for the economy of Nigeria. The study will dwell mainly on
the effect of deficit financing on capital formation in Nigeria and to
determine which of the determinants of deficit financing contributes more to
the Nigerian economy. The study will specifically cover the period of 1980-2019
as available data permits while making use of some selected variables of
interest such as Gross Fixed Capital Formation Percentage Contribution to GDP
(GCF_GDP) as the dependent variable while External Debt (EXDBT) Domestic Debt
(DMDBT), External Reserves (EXTRS) Aggregate Debt Service (ADBTS) Aggregate
Savings (AGGSV) and Private Consumption Expenditure (PCEXP) all coming in as
explanatory variables. The study will look at the concept of deficit financing and
conceptualize the determinants of deficit financing in Nigeria while reviewing
various theories that lays support to the importance of deficit financing in
Nigeria. The specified model will be estimated using the Autoregressive
Distributive lag Model (ARDL) and the Toda Yamamoto causality test to accurately
estimate and determine the level of impact that one variable has on another and
to determine the direction of causality among the variables of interest. The
study will make use of E-views 10 statistical software for estimation and
computation of results, while the available time series data of interest shall
be obtained from World Bank national accounts data and OECD National Accounts
data files.
.
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