ABSTRACT
This thesis investigated the effect of public borrowing on fixed capital formation in Nigeria. For the purpose of the study, data on domestic debt, external debt and gross fixed capital formation were collected from secondary sources - majorly the CBN statistical bulletin and World Bank online database. The collected data was analyzed using descriptive statistic, Auto-regressive Distributed Lag, Co-integration and Granger Causality method. However, the data analysis was preceded by a diagnostic test using ADF and PP methods to ensure that the data set was stationary. The findings showed that domestic borrowing has a positive effect on capital formation while external debt has a negative effect on formation capital development. The results also show that on the long run, domestic debt has a positive effect on formation capital while external debt has a negative effect. The results of the Granger causality test show that domestic debt has a uni-directional causality effect on formation capital. Finally, the findings indicate uni-directional causality between external debt and formation capital. Based on the findings, it was concluded that: Domestic borrowing helps to increase formation capital. However, external borrowing has done more harm than good to the Nigerian economy. Both domestic and external borrowing causes change formation capital. In view of the above, it is recommended that: Domestic borrowing should as much as possible be used in place of external borrowing to fund formation capital. Stringent measures must be put in place to ensure that all external borrowing are not only tied to specific projects but also that such projects are closely monitored from start to finish to forestall the problem of diverting funds.
TABLE OF CONTENTS
Title Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgement v
Table of Contents vi
List of Tables viii
List of Figures ix
Abstract x
CHAPTER 1: INTRODUCTION
1.1
Background
to the Study 1
1.2
Statement
of the Problem 5
1.3
Objectives
of the Study 7
1.4
Research
Questions 8
1.5
Research
Hypotheses 9
1.6 Significance of the Study 9
1.7 Limitations of the Study 10
1.8 Scope of the Study 11
1.9 Definition of Terms 11
CHAPTER 2: LITERATURE
REVIEW
2.1 Conceptual Framework 13
2.1.1 Concept of public debt 13
2.1.2 Debt management in Nigeria 14
2.1.3 Establishment of debt management office
(DMO) 18
2.1.4 Infrastructure 22
2.2 Theoretical Framework 24
2.2.1 Savings-investment gap theory 26
2.2.2 Capital accumulation in economic growth
theory 28
2.3 Review of Empirical Literature 31
2.3.1 Summary of empirical literature 42
2.4 Gap in Previous Studies 46
CHAPTER 3: RESEARCH
METHODOLOGY
3.1 Research
Design 47
3.2 Area of Study 47
3.3 Sources of Data 47
3.4 Model Specification 48
3.5 Description of Variables 51
3.5.1 Gross fixed capital formation 51
3.5.2 Domestic debt outstanding 51
3.5.3 External debt outstanding 52
3.6 Techniques of Data Analysis 52
CHAPTER 4:
DATA PRESENTATION, ANALYSES AND DISCUSSION
4.1 Data Presentation 54
4.2 Data Analysis and Interpretation 59
4.3 Test
of Hypothesis 66
4.4 Discussion
of Findings 69
CHAPTER 5: SUMMARY, CONCLUSION AND
RECOMMENDATIONS
5.1 Summary of Findings 75
5.2 Conclusion 76
5.3 Recommendations 77
5.4 Contribution to Knowledge 78
REFERENCES 79
APPENDICES 85
LIST OF TABLES
2.3.1 Summary of empirical literature 42
4.1: Dataset of study 55
4.2: Descriptive Statistics 60
4.3: Summary
of ADF and Phillip-Perron Unit Root Test 61
4.4: Auto-Regressive
Distributed Lag (ARDL) Test 62
4.5: ARDL
Bounds Test Results 63
4.6: ARDL
Co-integrating and Long Run Form Results 64
4.7: Granger Causality
Results 65
LIST OF FIGURES
4.1: Graph of Trend in Gross Fixed
Capital Formation 56
4.2: Graph of Trend in Domestic
Debt 57
4.3: Graph
of Trend in External Debt 58
4.4: Graph
of Trend in Total Savings 59
CHAPTER
1
INTRODUCTION
1.1 BACKGROUND
TO THE STUDY
Development
of infrastructure is part of the capital accumulation required for economic
development and lead to the enhancement of the socioeconomic measures of
welfare. Generally, investment in infrastructure plays a very important role in
expanding the nation's productive capacity, which leads to increase in a
country's wealth (Koh, 2018). The development of infrastructure has been
recognized as a prerequisite for economic development to take place. For
example, building roads will benefit agriculture as farmers will be able to
sell their produce in the location that offers competitive prices no matter the
distance. Just as the provision of
electricity will engender industrial growth beyond the primary and extractive
sectors to processing/manufacturing.
In
addition, infrastructure will boost productivity in the services sectors like
banking, education, telecommunications health etc. Infrastructure describes
essential facilities, organizational structures and services needed for a
country to operate efficiently. It includes roads, power systems bridges,
transport systems, airports, sea ports, utilities, water and sewage systems and
telecommunication systems among others. These facilities are essential for
enabling productivity in the economy and having the right infrastructure in
place also enhances the country’s global competitiveness.
Governments
especially in developing countries are faced with numerous challenges in the effort
to improve basic infrastructure and attain economic development. First, the provision
of infrastructure requires huge capital outlay and secondly, the gestation
period for large scale infrastructure projects is usually very long. Finally,
some infrastructure projects do not make any foreseeable financial returns. These
problems makes it difficult for governments to accumulate the necessary capital
needed to finance developmental projects
and also guarantee that the capital so accumulated is “sufficient in quantity”
in order to contribute significantly to the economic development objectives of
policy makers.
To
solve developmental problems including those involving fixed accumulation,
governments rely principally on revenue generated through economic activities
within the country. However this is hardly ever sufficient to generate the huge
amount of capital outlay that is required to achieve the government’s
development objectives. Thus, the inability of the government to accumulate sufficient
quantity of capital through internal revenue generation gives rise to the need
for governments to borrow. As noted in Ezirim (2005), when the government’s
actual revenue performance falls short of projected estimates, it resorts to
borrowing to finance projects of social and economic importance to the nation.
Gbosi (1998) also noted that the necessity to finance rising government
expenditure was majorly responsible for the sharp increase in the stock of
Nigeria’s public debt.
Gurley
and Shaw (1956) stated that the increasing volume of public debt is a necessary
feature of a strong and healthy financial structure in a market based economy.
But he also cautioned that such borrowing should as much as possible be
deliberate and within a framework. From the above, it can be deduced that for a
development oriented government in a market based economy, borrowing to finance
budgetary shortfalls is unavoidable.
As
noted by Onoh (2007), deficit budgeting is now a deliberate policy direction
employed by governments in developing countries. However, he also stated that
countries that resorted to borrowing especially from external sources to
finance budgetary shortfalls have recorded varying degrees of success or
failure in their use of this tool. While some recorded some measure of success
in improved production and consequently higher employment levels, others have
resulted in higher inflationary pressures, weak domestic currencies, capital
flight, chronic deficits in balance of payment and negative savings.
The
implication is that borrowing by government is a policy option that should be
used with utmost care in order not to trigger adverse economic conditions that
may not have been intended in the first place. With this in mind, it is
important to note that public debt consists of two components viz – domestic
and external debt. Both involve different mechanisms and interact differently
with the economy.
Domestic
debt implies the government issuing debt instruments such as treasury bills,
treasury certificates, development stocks and bonds locally and denominated in
the local currency. External debt by definition
denotes to the fraction of a country's debt liability that was borrowed from
foreign lenders including governments, development/commercial banks and/or
international financial institutions and organizations (Ajayi and Khan, 2000). These loans, including
interest, must usually be paid in the currency in which the loan was made or
any other agreed currency. Odozi (1996), further stated that domestic debt
involves the total liability of a government owed to individuals, institutions
and organizations within the country, and properly categorized should include Local, State and Federal
governments’ transfer obligations to the citizens, corporations and
institutions within the country.
According
to Rais and Anwar (2012), while external borrowing increases the country’s
access to new financial resources, domestic borrowing only transfers resources
within the country. In other words, domestic borrowing only change hands of
money holders while the volume of money within the country remains the same.
Nigeria
like numerous other developing countries have over the years relied heavily on
borrowing to finance huge projects that are capital intensive. A cursory observation
of the structure of Nigeria’s debt stock
both external and domestic indicates a
gradual increase in public debt from 1981 to 1998. In 1999 total debt spiked
upwards to N3.37 trillion from the previous year’s 1.19 trillion representing
about a 182% increase. It is also instructive to note that external borrowing
is largely responsible for this upward spike, increasing from 1998’s N688
billion to N2.57 trillion in 1999.
Nigeria’s
total public debt peaked in 2004 at N6.26 trillion before dropping to N3.18
trillion in 2006. Nigeria’s public debt data published by the CBN also
indicated that domestic debt constituted a whopping 82% of the total public
debt. But by 2004, domestic share of the total debt had dropped to about 21.89%
and rose again to about 86.84% of the total by 2010. Available data from the Debt Management Office
(DMO) shows that Nigeria’s total debt stock (addition of external and domestic
debts) as at December 31, 2011 stood at N6.510 trillion representing an
increase of 24.37% from the December 31, 2010 figure of N5.235 trillion. A
breakdown of the debt stock shows that external debt accounted for 13.64% of
the total debt stock at N887.95 billion, while domestic debt stock accounted
for 86.36% of the total debt stock at N5, 623bn.
In
2015, the total debt stock increased to N10.948 trillion consisting of 80.714%
domestic and 19.286% external and upward to N18.377 trillion in 2017 consisting
of 68.507% domestic debt. This shows that not only is the debt stock of the
country rising rapidly, the external component is gradually gaining on the
domestic component as a proportion of the total.
Data
on fixed capital formation (infrastructure) as published in the central bank statistical
bulletin (2018) showed that from inception gross fixed capital formation has
been on an upward trend except for a few intermittent years when it had shown a
reduction from the previous year. For example in 1981, Nigeria’s expenditure in
provision of fixed capital was N18.2 billion. This value dropped consistently
through the next few years until it reached its lowest value at N8.79 billion
in 1985. It rose to N11.35 billion in 1986, N15.22 billion in 1986 and N17.56
billion in 1987. The upward trend continued until it peaked in 2010 at N9.183
trillion before dropping to N8.425 trillion in 2011 and N8.641 trillion in 2012.
This increased to N10.432 trillion in 2015 and down to N9.631 trillion in
2017.
The
rest of the study is devoted to an in depth analyses of the reasons and
implications of the continual fluctuations in the composition of Nigeria’s
public debt. Issues concerning the management of external and domestic debt and
its implications on economic advancement by way of investment in fixed capital
formation will be given adequate consideration.
1.2 STATEMENT
OF THE PROBLEM
In
virtually every country of the world, Nigeria inclusive, public borrowing constitutes
a major and important source of additional financial resources for financing
capital projects. As noted by Nwakanma and Nnamdi (2010), debt accumulation is
beneficial to the extent that it promotes economic growth. Thus, borrowing for
development is an acceptable activity provided it follows a well-structured,
planned and managed process. In such a situation, borrowing would as
anticipated in theory and collaborated in empirical studies fill in the
saving/investment gap and hence higher growth rate in the economy would be
attained.
But
where public debt is incurred in an environment devoid of the necessary
regulatory and institutional framework that would help to streamline the
process from borrowing to repayment, the outcome could be quite catastrophic
for the country involved.
Previous
empirical publications on the subject of public debt are replete with forecasts
and commentaries on the likely relationships between public debt and economic
growth and development. On the one side are those that assert that government
borrowing can play a valuable source of capital formation. For instance by
raising funds for long-term development projects in physical infrastructure and
human capital. Market based borrowing is perceived to contribute meaningfully
to: macroeconomic stability, domestic savings and private investment. Indeed, as
noted by Gbosi (1998), public debt can provide necessary support for the
financial system in credit intermediation, or even act as a substitute for it
and in some cases, it can help the financial system to survive crises.
In
contrast, holding excessive stock of public debt will likely have long-term
negative consequences on the economy. As stated by Modigliani (1961), public
debt can also become an implicit tax on the revenue and resources generated by
a country and create a burden on future generations to come in the form of a
reduced flow of income from a lower stock of fixed capital. This, in turn, may result
in an increase in interest rates and crowding-out of private investments
necessary for productivity growth, and a reduction in capital accumulation. Significant
negative fallouts may also result from heavy public debt burden and threaten
fiscal sustainability and, ultimately, cause a severe stunting in economic
development (Kutivadze, 2011).
In
Nigeria, a lot empirical research has been conducted on the negative effect of
public borrowing on the economy (Isu, 1997; Nwakanma and Nnamdi, 2010; Isu,
Mojekwu and Ezeabasili, 2011; Adofu and Abula, 2010; Amassoma, 2011). For
example Isu, Mojekwu and Ezeabasili (2011) employed a prediction model to determine
the major determinants of Nigeria’s External and Domestic Debt problems. On the
other hand, Adofu and Abula (2010) focused on the impact of domestic debt on the
economy. While Nwakanma and Nnamdi
(2010) assessed the implication of Nigeria’s public debt structure on the
economy.
At
this juncture, it is imperative to state that the over-riding justification for
long-term borrowing by the government is to increase the stock of
infrastructure or fixed capital to act as a primer for economic growth and
development. Consequently, the aim of this research is to find out whether
public debt has significantly contributed to infrastructure development in
Nigeria.
This
research study contributes to previous empirical work in several important
respects. First, much of the previous empirical research on the subject has
focused almost entirely on the relationship/impact of public debt on the
economy via gross domestic product (GDP). The thesis diverge from the above
trend in that it provides new information/knowledge on a specific component of
gross domestic product (infrastructure) on which long-term public borrowing is
expected to affect directly. Thus, in this research, attention was focused on
how public borrowing has impacted on capital formation in Nigeria.
1.3 OBJECTIVES
OF THE STUDY
The major objective of
this thesis in general is to empirically investigate how public debt impacts on
fixed capital formation in Nigeria by providing new evidence regarding the
debt-infrastructure development relationship. In more specific terms, the
objectives of this study include to:
i. Determine
the extent to which domestic debt affect gross fixed capital formation in
Nigeria.
ii.
Determine the extent to which external debt
affect gross fixed capital formation in Nigeria.
iii.
Ascertain whether domestic debt has a long
term effect on gross fixed capital formation in Nigeria.
iv. Determine
whether external debt has a long term effect gross fixed capital formation in
Nigeria.
v.
Evaluate the direction of causality between
domestic debt and gross fixed capital formation in Nigeria.
vi. Evaluate
the direction of causality between external debt and gross fixed capital formation
in Nigeria.
1.4 RESEARCH
QUESTIONS
The
research questions formulated for the purpose of this study are as follows:
i.
To what extent does domestic debt affect
gross fixed capital formation in Nigeria?
ii.
To what extent does external debt affect
gross fixed capital formation in Nigeria?
iii.
How does domestic debt affect gross fixed
capital formation in the long term in Nigeria?
iv.
How does external debt affect gross fixed
capital formation in the long term in Nigeria?
v.
What is the direction of causality between
domestic debt and gross fixed capital formation in Nigeria?
vi.
What is the direction of causality between
external debt and gross fixed capital formation in Nigeria?
1.5 RESEARCH
HYPOTHESES
For the purpose of this study, the
following hypotheses were proposed:
Ho1: Domestic debt does not significantly affect
gross fixed capital formation in Nigeria.
Ho2: External debt does not significantly affect
gross fixed capital formation in Nigeria.
Ho3: Domestic debt does not have a long-run effect
on gross fixed capital formation in Nigeria.
H04: External debt does not have a long-run
effect on gross fixed capital formation in Nigeria.
Ho5: Domestic Debt does not Granger-Cause Gross Fixed Capital
Formation in Nigeria.
Ho6: External Debt does not Granger-Cause Gross
Fixed Capital Formation in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
A
series of academic research has been carried out on the relationship or the
lack thereof between economic growth and the public debt components of domestic
and External Debt. But, the bulk of existing literature has not given adequate
attention to the interaction between Domestic Debt and External Debt and how
they interact with infrastructure development. This is the gap this study has
filled. At the end of this study, it is hoped that the following groups will
find its contents valuable for their various uses.
Government Policy Makers:
the
study avails those in decision making position an opportunity to appreciate
better the simple and complex interactions between Domestic and External Debt
and infrastructure development. It will further enhance the ability of policy
makers to formulate policies on the optimal mix of Domestic and External Debt
that will contribute significantly to economic development.
Investors: both domestic and foreign
investors will find contents of this research study very useful. With a better
understanding of the public debt environment in Nigeria, investors will be able
to make better investment decisions to enhance their returns.
Scholars and Researchers: The
findings of this research notwithstanding, further research on public debt and
its impact on the economy will need to be carried out in the future. To this
end, the materials contained herein will serve as a good source of data and
information for further research.
1.7 LIMITATIONS OF THE STUDY
In
the course of this research work, numerous difficulties were encountered by the
researcher. Among these are: Well researched academic publications on public
debt and its linkages with the capital formation were in short supply. Another
issue was related to the difficulty in obtaining the necessary data on capital
formation (especially for earlier periods) needed to complete the research.
Where such data was available, the number of observation was found to be
inadequate.
One
of the methods adopted to deal with data insufficiency was the use of robust
analytical tools like the Auto-Regressive Distributed Lag Model for which lag
lengths can be adjusted to suit the data available. As regards the question of
difficulty in accessing relevant literature, it was necessary to combine both
materials from the physical libraries, online academic publication outlets and
also reaching out to senior colleagues and researchers in the area of public
finance in order to gain access to their private academic works on the subject
of the thesis.
1.8 SCOPE OF THE STUDY
The
study was restricted to information on the Nigeria financial system and
specifically to the public debt information. It also reviewed issues concerning
economic growth/development and infrastructure provision in Nigeria. The period
covered in the study is thirty seven (37) years from 1981 to 2017.
1.9 DEFINITION OF TERMS
For
proper understanding of this research study, a definition of the following
words and terms as they are used in the study are provided.
Public Debt: Also known as Government
debt or national debt is the debt owed by the government to investors who may
be individuals, institution or governments both local and foreign. It may also
refer to the debt of federal, state and local governments.
Domestic Debt:
Domestic debt implies the government issuing debt instruments including
treasury bills, treasury certificates, development stocks and bonds locally and
denominated in the local currency.
External Debt: External
debt by definition refers to the part of a country's debt that was borrowed
from foreign lenders including development and commercial banks, governments and
international financial institutions
Economic Growth: Is
the positive trend in the nation’s total output over a long period of time.
This implies a sustained increase in GDP for a long time.
Economic Development:
is the improvement in material welfare, especially for persons in the lowest
income bracket. Thus, the application of the products of economic growth to
provide roads, quality education/schools, quality and affordable healthcare
services and social amenities and services can be described as economic
development.
Deficit Financing: This means any expenditure that is in
excess of current public revenue. It also describes the process of financing a
deliberately created gap between public revenue and public expenditure. This is
also referred to as budgetary deficit.
Capital Formation: Implies
that the country does not apply the entirety of its current output to the needs
of immediate consumption, but targets part of it to the making or acquisition
capital goods that can be applied to increase production in the future.
Gross Fixed Capital
Formation: The central bank statistical bulletin
describes gross fixed capital formation as expenditure on fixed assets such as machinery,
facilities, buildings, etc. either for
replacing or expanding the stock of present fixed assets. Gross Fixed Capital
Formation is a component of the expenditure on GDP, and thus shows information
about how much of the new value added in the economy is reinvested rather than
consumed.
Infrastructure:
The large-scale public systems, services, and facilities in a country that make
living conditions better and are necessary for economic activities. These
include roads, and schools, electricity supply, water works and systems,
drainage systems, public transportation and telecommunication systems, ports
facilities etc.
Revenue Generation:
Revenue generation means government activities aimed at raising funds through
collection of all forms of taxation.
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