IMPACT OF PUBLIC DEBT ON CAPITAL FORMATION IN NIGERIA

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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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