CHAPTER ONE

INTRODUCTION

1.0 BACKGROUND OF THE STUDY

It is generally expected that developing countries facing a scarcity of capital will

acquire external debt to supplement domestic saving (Malik et al 2010; Aluko and

Arowolo 2010). Besides external borrowing is preferable to domestic debt because the

interest rates charged by international financial institutions like International Monetary

Funds (IMF) is about half to the one charged in the domestic market (Pascal 2010).

However whether or not external debt would be beneficial to the borrowing nation

depends on whether the borrowed money is used in the productive segments of the

economy or for consumption. Adepoju et al (2007) stated that debt financed investment

need to be productive and well managed enough to earn a rate of return higher than the

cost of debt servicing

The main lesson of the standard “growth with debt” literature is that a country

should borrow abroad as long as the capital thus acquired produces a rate of return that is

higher than the cost of the foreign borrowing. In that event the borrowing country is

increasing capacity and expanding output with the aid of foreign savings. The debt if

properly utilised is expected to help the debtor country’s economies (Hameed et al

2008) by producing a multiplier effect which leads to increased employment adequate

infrastructural base a larger export market improved exchange rate and favourable terms

of trade. But this has never been the case in Nigeria and several other sub-Saharan

African Countries (SSA) where it has been misused (Aluko and Arowolo 2010). Apart

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from the fact that external debt had been badly expended in these countries the

management of the debt by way of service payment which is usually in foreign

exchange has also affected their macroeconomic performance (Aluko and Arowolo

(2010); Serieux and Yiagadeesen (2001).

Prior to the $18 billion debt cancellation granted to Nigeria in 2005 by the Paris

Club the country had external debt of close to $40 billion with over $30 billion of the

amount being owed to Paris Club alone (Semenitari 2005a). The history of Nigeria’s

huge debts can hardly be separated from its decades of misrule and the continued

recklessness of its rulers. Nigeria’s debt stock in 1971 was $1 billion (Semenitari 2005a).

By 1991 it had risen to $33.4 billion and rather than decrease it has been on the

increase particularly with the insurmountable regime of debt servicing and the insatiable

desire of political leaders to obtain loans for the execution of dubious projects

(Semenitari 2005a).

Before the debt cancellation deal Nigeria was to pay a whopping sum of $4.9

billion every year on debt servicing (Aluko and Arowolo 2010). It would have been

impossible to achieve exchange rate stability or any meaningful growth under such

indebtedness. The effect of the Paris Club debt cancellation was immediately observed in

the sequential reduction of the exchange rate of Nigeria vis-à-vis the Dollar from 130.6

Naira in 2005 to 128.2 Naira in 2006 and then 120.9 in 2007 (CBN 2009). Although the

growth rate of the economy has been inconsistent in the post-debt relief period as it

plunged from 6.5% in 2005 to 6% in 2006 and then increased to 6.5% in 2007 (CBN

2008) it could have been worse if the debt had not been cancelled.

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However the benefits of the debt cancellation which was expected to manifest

after couple of years was wiped up in 2009 by the global financial and economic crisis

which was precipitated in August 2007 by the collapse of the sub-prime lending market

in the United States. The effect of the crisis on Nigeria’s exchange rate was phenomenal

as the Naira exchange rate vis-à-vis the Dollar rose astronomically from about N120/$ in

the last quarter of 2007 to more than N150/$ (about 25% increase) in the third quarter of

2009 (CBN 2009). This is attributable to the sharp drop in foreign earnings of Nigeria as

a result of the persistent fall of crude oil price which plunged from an all-time high of

US$147 per barrel in July 2007 to a low of US$45 per barrel in December 2008 (CBN

2008).

Available statistics show that the external debt stock of Nigeria has been on the

increase after the debt cancellation in 2005. The country’s external debt outstanding

increased from $3545 million in 2006 to $3654 million in 2007 and then to $3720

million and $3947 in 2008 and 2009 respectively (CBN 2009). It is therefore imperative

to examine the effect of external debt of the country on her economy for us to appreciate

the need to avoid being back in the group of highly indebted nations.

1.1 STATEMENT OF THE PROBLEM

The huge external debt stock and debt service payments of African countries and

Nigeria in particular prevented the countries from embarking on larger volume of

domestic investment which would have enhanced growth and development (Clements

etal. 2003). External debt became a burden to most African countries because contracted

loans were not optimally deployed therefore returns on investments were not adequate to

meet maturing obligations and did not leave a favourable balance to support domestic

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economic growth. So African economies have not performed well because the necessary

macro-economic adjustment has remained elusive for most of the countries in the

continent. The main interest of this study then is to empirically investigate the effect of

external debt on the economic growth of Nigeria.

1.2 OBJECTIVES OF THE STUDY

The study will focus on the following objectives:

(i) Empirically investigate the effect of external debt on the growth process of the

country;

(ii) To determine the impact of external debt service payment on economic

growth of Nigeria.

1.3 STATEMENT OF HYPOTHESIS

HYPOTHESIS I

The following hypotheses are tested in this study:

Ho: That the external debt stock does not have impact on the economicgrowth

of Nigeria.

HYPOTHESIS II

Ho: That the external debt service payment does not have an impact on

economic growth of Nigeria.

1.4 SIGNIFICANCE OF THE STUDY

This study is focused on providing alternative measures to tackling external debt

management problems. It will also serve as a tool in revamping government policies

towards loan procurement and debt servicing in Nigeria. This work may also serve as a

yardstick for further research and documentation on Nigeria’s external debt crisis.

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1.5 SCOPE AND LIMITATIONS OF THE STUDY

The scope of this study shall cover the external debt trend of Nigeria over the

years to date. The general overview of the debt cancellation shall be taken with certain

issues raised and discussed.However the empirical investigation of the effect of external

debt on the economic growth of Nigeria shall be restricted to 1981 and 2010. This

restriction is unavoidable because of the non-availability of some data.