CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Economic growth is one of the major macroeconomic goals, and any responsible government is obliged to secure growth, or at least avoid a decline, in its economy. Because immediate resources are usually scarce, a government's concern for growth naturally leads it to spend more than it earns. Development requires heavy investment, minimum standards of living must be met, poverty must be reduced, and employment, infrastructure and growth must be promoted, so governments sometimes run expenditure above revenue. When this happens, covering the gap by borrowing becomes unavoidable. The gap can be financed in several ways, including higher taxation, ways and means advances, the creation of debt and reduced expenditure. Whichever fiscal option is chosen, like any other element of economic planning, it needs adequate management if it is to achieve its purpose.

Debt financing has become one of the most widely used fiscal options, even though theories such as Ricardian equivalence, also called the Barro-Ricardo equivalence theorem, see no significant difference between financing by debt and financing by taxes. Debt financing has nevertheless attracted considerable attention from scholars and economic managers, possibly because a deficit financed by public borrowing shifts the IS curve to the right, which expands output and raises the nominal interest rate in the short run, when prices are assumed to be fixed. The creation of debt can therefore be regarded as a normal result of economic activity. Households, firms and government take decisions to spend, consume and invest. When an agent's income exceeds its consumption, it has a surplus. Conversely, when agents consume or invest more than their income, they must supplement it with borrowed funds. This shortfall has to be financed, and debt is created at that moment.

Debt, whether viewed from the standpoint of a sovereign or of a household, is often seen by non-economists as an evil to be avoided and not even mentioned. Ideally, however, debt is not bad in itself. Poorly managed debt is what is dangerous and injurious to the economy. Contemporary economic thinking does not treat public debt as a major problem in itself, and the real problems are its mismanagement and unsustainability. Blanchard (2019) makes the point forcefully by showing that when safe interest rates stay below growth rates, rolling over debt without later tax increases may be feasible and public debt may carry no fiscal cost, although it can still impose welfare costs by reducing capital accumulation. Debt creation and management form part of the management of the economic process, and many authors have justified the existence of government debt. Government domestic debt is commonly defended for three reasons. The first is to finance budget deficits. The second is to implement monetary policy, through the purchase and sale of treasury bills in open market operations. The third is to develop financial instruments and thereby deepen financial markets.

Although public debt is regarded as an inevitable instrument of economic management, poor use of it can lead to economic retrogression instead of growth, and to financial crisis. The empirical evidence on its effects is mixed. Eberhardt and Presbitero (2015) find some support across countries for a negative relationship between public debt and long-run growth. In Nigeria, however, Onuoha (2024), using data for 1981–2020, finds that domestic debt and public spending both have significant positive effects on growth, with public spending partly mediating the relationship, and Alenoghena, Aghughu and Odior (2023) find that domestic borrowing positively and significantly affected growth and industrial production, although it also affected inflation and trade openness. Udo Oji and John (2022), working from the crowding-out hypothesis and treating treasury bills, certificates and bonds as domestic debt, find that in the short run domestic debt largely determines economic growth in Nigeria. These results differ, but each study warns that borrowing must be kept under control and used productively. The importance of proper debt management therefore cannot be overstated.

Many papers have examined approaches to debt management, both external and domestic. At its ninth annual global forum on sovereign debt markets, held in May 2007 at its Paris headquarters together with the World Bank and the IMF, the Organisation for Economic Co-operation and Development (OECD) encouraged the use of derivatives for debt management and possibly for the development of domestic debt markets. Other approaches include government asset and liability management, Value at Risk (VaR) and debt sustainability assessment. Sustainable debt is a necessary condition for the achievement of macroeconomic goals, and debt is not a matter of major concern as long as it is manageable and sustainable.

Debt sustainability concerns whether a country can meet its debt-related financial obligations over a period starting from the present, and it has proved to be an elusive concept. Common assessments rely on threshold indicators, yet Eberhardt and Presbitero (2015) find no evidence of a similar, let alone common, debt threshold within countries. A country's public debt should therefore be assessed not only against the threshold indicators of international bodies but also against country-specific macroeconomic variables. For this reason, one focus of this study is to assess public debt sustainability using the primary fiscal balance and econometric techniques. Recent Nigerian work shows how far the answer can depend on the method. Nya and Onyimadu (2019), applying IMF and World Bank debt burden indicators and an error correction model to 1990–2017, found that the indicators pointed to sustainability, whereas Adeosun and Adedokun (2019), estimating fiscal reaction functions, found that the government's primary balances do not respond sufficiently to rising debt, so that the sufficient condition for sustainability is not met.

Before the 2005 debt repayment, the attention of Nigerian economists and debt managers was concentrated on external debt. Adeosun and Adedokun (2019) report that, over 1970–2016, Nigeria accumulated more external than domestic debt, and this focus is understandable given the rising external debt stock and the burden of its servicing. After the repayment, however, attention shifted to the domestic scene. Alenoghena et al. (2023) note that, once the country's foreign loans were repaid in 2006, borrowing came to be dominated by domestic loans, and that domestic borrowing grew by more than 800 per cent between 2006 and 2020. The trend of the debt profile gave impetus to a closer look at domestic debt management.

Official debt records show how fast domestic debt grew. Total domestic debt was N8,215.6 million in 1980, rose to N28,438.7 million in 1986 and to N36,789.1 million in 1987, an increase of N8,350.4 million in one year. It rose from N47,029.6 million in 1988 to N84,093.1 million in 1990, an increase of N37,063.5 million, which exceeds the 1986–1987 increase by N28,713.1 million. The reason was that government needed more money to finance its budget deficit. By 1996 domestic debt outstanding had risen sharply to N419,975.6 million, almost five times the 1990 figure. Analysis of total public debt outstanding for 2000–2010 shows that domestic debt began to rise sharply after 2005. The total debt stock was US$36,602.46 million in 2000, of which domestic debt accounted for about 22.48 per cent. In 2006, immediately after the external debt repayment, domestic debt had increased from US$8,228.78 million in 2000 to US$18,575.67 million, and its share of total debt stock had risen from 22.48 per cent to 79.57 per cent, an increase of 57.09 percentage points. The share of domestic debt in total debt continued to rise up to 2010.

1.2 Statement of the Problem

The continuous fiscal deficit of the Federal Government of Nigeria, together with the rise in domestic debt after the 2005 debt repayment, poses a serious threat to the sustainability of the country's domestic debt. Between 1980 and 2010, Nigeria recorded continuous and growing fiscal deficits, with the exception of 1995 and 1996, when surpluses of N1,000.00 million and N32,049.40 million respectively were recorded. The fiscal deficit stood at N1,975.20 million in 1980 and rose to N22,116.10 million in 1990, an increase of over 1,000 per cent in a decade. With the debt repayment in 2005, the deficit fell from N172,601.30 million in 2004 to N161,406.30 million in 2005, but by 2010 it had risen sharply to N1,105,439.78 million (CBN, 2010). Domestic debt stock rose from N11,192.60 million in 1981 to N116,198.70 million in 1991 and to N4,551,822.39 million in 2010 (DMO, 2010).

These increases in fiscal deficits, domestic debt stock and domestic debt service might not cause a serious economic problem in themselves if the economic growth rate exceeded the interest rate by a widening margin, a condition that Blanchard (2019) identifies as central to whether debt can be rolled over without fiscal cost. The trend analysis of interest rates and economic growth in Nigeria, however, shows that the interest rate has consistently been higher than the growth rate, which suggests that domestic debt is unsustainable. In 1980, GDP growth was about 5.3 per cent against an interest rate of 5.5 per cent. The interest rate remained above the growth rate between 2000 and 2010. In 2000, the interest rate was about 21.5 per cent against GDP growth of about 5 per cent. In 2009, GDP growth rose from about 5.9 per cent in 2008 to about 6.9 per cent, but the interest rate rose from 18.7 per cent to 22.9 per cent. By 2010, the interest rate stood at about 22.5 per cent and GDP growth at about 7.8 per cent.

To determine domestic debt sustainability, institutions such as the World Bank and the framework associated with the Maastricht Treaty set threshold values for debt indicators, and a country whose indicators exceed the thresholds is considered unsustainable. This approach seems simple and plausible, but it does not take account of country-specific circumstances, and Eberhardt and Presbitero (2015) support this concern by finding no common debt threshold within countries. Actual experience of debt problems shows the limits of the commonly used indicators, partly because of a lack of information about aspects of a country's position that bear on its capacity to meet its obligations. Nigeria illustrates the point. The debt-to-GDP indicator has consistently pointed to sustainable domestic debt, yet the gap between the interest rate and the growth rate has been positive, which suggests likely unsustainability.

A number of Nigerian studies have examined domestic debt. Recent ones fall mainly into two groups. The first examines the effect of domestic debt or borrowing on growth and other macroeconomic variables (Alenoghena et al., 2023; Onuoha, 2024; Udo Oji & John, 2022). The second examines the sustainability of public debt more generally, using fiscal reaction functions and debt burden indicators (Adeosun & Adedokun, 2019; Nya & Onyimadu, 2019; Otonne et al., 2019). These sustainability studies, however, treat total public debt rather than domestic debt as such. The earlier assessment dedicated to domestic debt sustainability was that of Rapu (2003), who concluded that, under a stance of primary deficit, the federal government's domestic debt was not sustainable and that primary surpluses of at least 0.9 per cent of GDP were needed. That work was done before the 2005 external debt repayment, when domestic debt did not appear to be a problem, and its method did not make full use of econometric techniques.

This study therefore intends to analyse the sustainability of Nigeria's domestic debt by comparing the era before the debt repayment with the era after it, and by analysing sustainability separately for the military era and the democratic era. Using the present value budget constraint together with econometric techniques to evaluate domestic debt sustainability is a further advantage of the study over earlier work.

1.3 Research Questions

The study is guided by the following research questions:

1. Can the current course of fiscal policy be sustained without an explosion of debt?

2. Is Nigeria's domestic debt sustainable, not only on the basis of the threshold criterion?

3. Is it necessary to re-assess the sustainability of Nigeria's domestic debt?

1.4 Research Hypotheses

The null and alternative hypotheses of the study are stated below.

1. H0: The current course of fiscal policy cannot be sustained without an explosion of debt.

H1: The current course of fiscal policy can be sustained without an explosion of debt.

2. H0: Nigeria's domestic debt is not sustainable only on the basis of the threshold criterion.

H1: Nigeria's domestic debt is sustainable only on the basis of the threshold criterion.

3. H0: Re-assessing the sustainability of Nigeria's domestic debt is not necessary.

H1: Re-assessing the sustainability of Nigeria's domestic debt is necessary.

1.5 Objectives of the Study

Many standard debt sustainability assessments focus on the threshold criterion. A major concern is whether such ratios can capture the present and future level of sustainability, because they are computed from historical data. Using a common threshold for virtually all countries, without real regard to country-specific features, may also give a misleading indication of sustainability. Against this background, the study specifically intends to:

1. Ascertain whether the current course of fiscal policy can be sustained without an explosion of domestic debt.

2. Ascertain whether Nigeria's domestic debt is sustainable, not only on the basis of the threshold criterion.

3. Re-assess the sustainability of Nigeria's domestic debt.

1.6 Scope of the Study

This study focuses on the analysis of domestic debt sustainability in Nigeria. It re-assesses sustainability using the balanced budget constraint of the accounting approach, an econometric technique and the present value budget constraint methodology. Using the OLS econometric method, it will draw valid conclusions on domestic debt sustainability from time series data on public debt dynamics. The study uses annual data, a lower frequency, covering 1980 to 2010. This period includes the period of full democratic rule in Nigeria and a period of heavier domestic debt, so it should give a clearer picture of domestic debt dynamics. It also covers the 2005 external debt repayment, which makes the analysis of domestic debt especially relevant.

1.7 Justification of the Study

At the time of the study, the domestic debt profile had risen to about 16.4 per cent of GDP, approaching the 20 per cent of GDP benchmark of sustainability adopted in this study, and this adds to the motivation for the work. Carrying out the research while domestic debt is rising so rapidly is timely and justifiable. The last known assessment dedicated to domestic debt sustainability, that of Rapu (2003), was made when domestic debt accounted for a very small share of total public debt, about 22 per cent. A study of this kind, undertaken some nine years after that attempt, is therefore pertinent. Moreover, the 2005 external debt repayment left domestic debt as the larger part of Nigeria's total public debt, which makes it imperative to evaluate its sustainability.

Primary data would be time-consuming and of little use for a study of this nature, and might well give unrealistic results. Secondary data are therefore used, relying on the accuracy and quality of data from the Central Bank of Nigeria (CBN), the Debt Management Office (DMO), the Budget Office of the Federation and the Federal Ministry of Finance.

1.8 Significance of the Study

The study is significant to the stakeholders of the economy in several ways. First, the Debt Management Office will benefit from an analysis of how domestic debt sustainability can be assessed by alternative and econometrically acceptable methods. Second, investors in financial instruments such as treasury bills and government bonds will be better guided in their decisions by the results of the analysis. Third, researchers and other academics will find the results useful as a reference point. Fourth, the work will be a valuable input to the body of knowledge, especially in economics, accounting, finance, management and administration. Finally, the study is significant to the researcher, since it is a requirement for the award of the Master of Science (MSc) degree in Economics.

References

Adeosun, O. A., & Adedokun, S. A. (2019). Fiscal reaction functions and public debt sustainability in Nigeria: An error correction mechanism approach. International Journal of Public Policy and Administration Research, 6(2), 116–132. https://doi.org/10.18488/journal.74.2019.62.116.132

Alenoghena, R., Aghughu, A. A., & Odior, E. S. (2023). Domestic borrowing and the Nigerian economy: A Bayesian VAR analysis. Journal of Developing Areas, 57(3), 65–77.

Blanchard, O. (2019). Public debt and low interest rates. American Economic Review, 109(4), 1197–1229. https://doi.org/10.1257/aer.109.4.1197

Eberhardt, M., & Presbitero, A. F. (2015). Public debt and growth: Heterogeneity and non-linearity. Journal of International Economics, 97(1), 45–58. https://doi.org/10.1016/j.jinteco.2015.04.005

Nya, I., & Onyimadu, C. O. (2019). Fiscal policy and public debt sustainability in Nigeria. Journal of Economics and Sustainable Development, 10(19). https://doi.org/10.7176/JESD/10-19-02

Onuoha, N. E. (2024). Domestic debt, public spending and economic growth in Nigeria: A mediation analysis. African Journal of Economic and Management Studies, 16(1), 112–126. https://doi.org/10.1108/AJEMS-10-2023-0400

Otonne, A., Emmanuel, Z., & Asogwa, O. J. (2019). Public debt sustainability in Nigeria after the exit from Paris Club: The role of structural breaks. Acta Universitatis Danubius. Œconomica, 15(7).

Rapu, S. C. (2003). Assessment of Nigeria's domestic debt sustainability. Economic and Financial Review, 42(2), 41–66. Central Bank of Nigeria.

Udo Oji, G., & Emmanuel John, C. (2022). Domestic debt effect on Nigeria's economic growth. International Journal of Business Management, 5(3), 1–15.