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Product Code: 00007598

No of Pages: 100

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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.


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


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


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 Autoregressive distributed lag model (ARDL) approach to

cointegration testing or bound cointegration testing approach                                     41 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 Cumulative sum and cumulative sum of squares                                                       46 Ramsey regression equation specification error test                                                  46

3.5       Sources of Data                                                                                                           45

 3.6      Description of Data                                                                                                    45

3.6       Software Application                                                                                                  47


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 Ramsey reset test                                                                                                        57 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



5.1       Summary of Findings                                                                                                 64

5.2       Conclusion                                                                                                                  65

5.3       Recommendation                                                                                                       65

            Reference                                                                                                                    67

            Appendices                                                                                                                 70                                           









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











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.


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.


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?


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.


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.


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.


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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