CHAPTER ONE

INTRODUCTION

1.1         Background of the Study

One of the major macroeconomic goals is economic growth. Any responsible country or government will be under obligation to ensure the growth (or at least a non-decreasing state) of her economy. The concern of a nation for economic growth, in the absence of immediate resources, naturally necessitates a government’s expenditure being greater than her revenue. Given the resources required in development, the need to achieve minimum standards of living, the urgency to alleviate poverty and the importance of creating employment, infrastructure and fostering growth, governments may at times run up expenses that is greater than her revenue. At such time the need to cover the gap by borrowing becomes inevitable. Financing such a gap could be done in so many ways like increased taxation, ways and means, debt creation and/or reduction in expenditure. Whatever fiscal alternative adopted, like every other economic planning concept, needs adequate management to achieve the desired goal.

Debt financing has become one of the most used fiscal alternatives, even though such theory like Ricardian equivalence (also known as the Barro-Ricardo equivalence theorem) does not see any significant difference between debt financing and tax financing. Yet debt financing seems to have received much attention among many scholars and economic managers, possibly because deficit financed by public borrowing shifts the IS curve to the right, resulting in output expansion together with a higher nominal interest rate in the short run when prices are supposedly fixed. Hence it is observable to state that the creation of debt is a normal and usual result of economic activity. The different agents in an economy: households, firms and government take decisions to spend, to consume and to invest. Whenever the income of one of the agents is greater than its consumption they have a surplus. And exactly the opposite, in a similar way, when some of the agents decide to consume and/or invest in excess of their income, they have to complement their income with borrowed financial resources. This shortfall or deficit has to be covered or financed, and it is then, at that moment, that debt is created. Debt (whether from a sovereign point of view

chijioke.okogbue @unn.edu.ng; +234 806 583 6554                                                            Okogbue, C. 2012

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Domestic Debt Sustainability in Nigeria: Evidence from Evaluation of Alternative Methodologies

or from household point of view) is always perceived from non economists as ‘evil’ and as such should be avoided and not mentioned. However, and ideally, debt is not bad but poorly managed debt is dangerous and injurious to the economy. Contemporary economic wisdom does not consider public debt as a major problem; rather problem is the mismanagement and unsustainability of the public debt.

Debt creation and its management is part of the management of the economic process and many authors have justified the essence of government’s debt. Singh (1999) while investigating the relationship between domestic debt and economic growth observes that sovereign debts have been incurred with the main objective of enhancing planned investment for economic development. Alison (2003) revealed three theoretical reasons often advanced for government domestic debts. The first is for budget deficit financing, secondly, it is for implementing monetary policy (buying and selling of treasury bills in the open market operation) and the third is to develop the financial instruments so as to deepen the financial markets.

Though public debt has been seen as an inevitable tool of economic management, poor utilization could result to economic retrogression, rather than economic growth, and financial crisis. Some studies have shown negative relationship between economic growth and public debt. For instance (Adofu and Abula, 2010), found a negative relationship between domestic debt and economic growth in Nigeria, analyzing time series data from 1986 to 2005. Therefore, the importance of proper debt management cannot be over emphasised. So many papers have researched on the different approaches to debt management, both external debt management and domestic debt management. The Organisation for Economic Co-operation and Development (OECD 2007) in May at her ninth OECD/World Bank/IMF annual global market forum, held in the OECD headquarters in Paris, encourage the use of derivatives for debt management and possibly for domestic debt market development. Bohn (1998) examines the use of government asset and liability management in public debt management. Other debt management approaches include the use of Value at Risk (V@R) and debt sustainability assessment, amongst others.

Sustainable debt is sine qua non for achievement of macroeconomic goals. Hence, debt is not a matter of major concern as long as it is manageable and sustainable. As observed by Conford (2009), debt sustainability which concerns the feasibility for a country meeting its debt-related

chijioke.okogbue @unn.edu.ng; +234 806 583 6554                                                            Okogbue, C. 2012

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Domestic Debt Sustainability in Nigeria: Evidence from Evaluation of Alternative Methodologies

financial obligations during a period beginning with the present, has proved an elusive concept. There is therefore the need to assess a country’s public debt sustainability not only in the light of the threshold indicators of the international bodies but also in some country-specific macroeconomic variables. Hence one of the focuses of this study is to assess the public debt sustainability employing the rigors of primary fiscal balance and econometric technique.

Prior to the 2005 debt repayment in Nigeria, attention of many economists and public debt managers in Nigeria, were focused on the external debt issues. For instance, Ajayi (1991) wrote “Macroeconomic Approach to External Debt: The Case of Nigeria”, a research paper series of the African Economic Research Consortium (AERC). Iyoha (1999) did a work on External Debt and Economic Growth in Sub-Saharan African Countries, including Nigeria. Ajisafe et al (2006) investigated the causal relationship between external debt and foreign private investment in Nigeria between 1970 and 2003. Oduh (2004) took an econometric analysis of the sustainable (external) debt and human resources development in Nigeria between 1980 and 2000. This is understandably due to the rising external debt stock and the implication of the rising external debt stock and its servicing to the economy. However, the pendulum of debt management in Nigeria swung to domestic scene after the debt repayment. The trend of Nigeria’s debt profile gave impetus for an incisive domestic debt management. For instance total domestic debt was N8, 215.6 million in 1980. The figure rose to N28, 438.7 million in 1986 and further increased to N36, 789.1 million in 1987, showing an increase of N8, 350.4 million between 1986 and 1987. Similarly, in 1990 domestic debt increased to N84, 093.1 million from N47, 029.6 million in 1988, showing an increase of N37, 063.5 million between the two periods. It is pertinent to note that the increase in domestic debt between 1989 and 1990 is greater than that in the period 1986 and 1987 by N28, 713.1 million. The reason for this increase is that more money was needed by the government to finance its deficit budget. In 1996, domestic debt outstanding arose astronomically to N419, 975.6 million, increasing by almost five – fold to N84, 093.1 (Adofu and Abula 2010).

The recent analysis of Nigeria’s total public debt outstanding (2000-2010) reveals that after 2005, domestic debt outstanding began to rise sharply. See figure 1 below.

chijioke.okogbue @unn.edu.ng; +234 806 583 6554                                                            Okogbue, C. 2012

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Domestic Debt Sustainability in Nigeria: Evidence from Evaluation of Alternative Methodologies