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1.1      Background of Study

It is generally expected that developing countries facing a scarcity of capital, will acquire domestic debt to supplement domestic saving (Pattillo, et al., 2002; Safdari and Mehrizi, 2011). Ajayi and Oke (2012) posits that the rate at which developing countries borrow, that is, the “sustainable” level of domestic borrowings depend on the links among foreign and domestic saving and investment. Ajayi and Oke (2012), suggest that the main lesson of the standard “growth with debt” literature is that a country should borrow home and abroad as long as the capital thus acquired produces a rate of return that is higher than the cost of the domestic and foreign borrowings. In that event, the borrowing country is expected to increase capacity and expand output with the aid of domestic debt.

In Nigeria, treasury certificates, which were first issued in 1968, constituted one of the largest securities between 1983 and 1988. It even surpassed treasury bills issued to further deepen the domestic money market by increasing short – term investment options available. In 1989, the monetary authorities initiated the action bid system for flotation of treasury bonds as obligation on domestic debt arising from the liberalization policies thus in 1989, N20 million worth of treasury bills representing 58.6% of treasury bills outstanding were converted to treasury bond. Treasury certificate was therefore abolished in 1996 (Audu and Abula, 2001)

According to Mukolu and Ogodor (2012) deficit usually occurs as a result of government inability to match the tax revenue and expenditure. The deficit is financed either through borrowings (domestically or foreign) or use of foreign reserve to settle the deficit. By borrowing it means the government has to agree on the terms payments which usually are attached with strange regulations. Hence, this will perpetrate the deficit as more money will be spent by government on servicing the debt which creates more expenditure and deficit. Persistence of this may result to high and variable inflation, debt crisis, with crowding out of investment and macroeconomic imbalance in general.

High extension debt stock and debt burden have also been shown to have a dampening effect on investment mainly through the “debt overhang” effect, the crowding out effect and credit rationing. The “debt overhang” effect refers to a situation in which a high debt burden


discourages investment by the private sector since the new accumulated debt stock is a tax on future income and production. The crowding out effect on the other hand arises from the consideration that resources which could have been used for investment are often deviated to service foreign debt. Credit rationing refers to situation in which a highly indebted country is likely to face credit constraint in international capital market and this would lead to reduction in investment (Ogidan, 2010).

In Nigeria, since the early 1960s, the ratio of domestic debt to Gross Domestic Product (GDP) increased to 6.1%. A decade later by 1974 this ratio went up slightly to 6.9% of GDP. But by 1984, the domestic debt to GDP ratio was over 40%. Although it declined slightly in the 1990s, it has since 2000 moved upward, (Asogwa 2005). The study further opined that, Nigeria has not been alone in experiencing escalating levels of government domestic indebtedness, but in comparison to other countries in sub-Saharan Africa, Nigeria’s domestic debt to GDP ratio is clearly on the high side.

One can analyze the evolution of the domestic debt from its size/structure or by considering its different components. The stock of government debt is measured relative to national output. This is shown by the size of the domestic debt structure both in nominal terms as a percentage of total debt. Domestic debt structure has grown tremendously from N0.23 billion at inception (1960) and it stood at N1.86 billion as at 1980. It was in 1986, at the inception of the Structural Adjustment Programme (SAP) that the level of external debt for the first time becomes larger than the level of domestic debt. Ever since then, the stock of external debt has consistently been larger than domestic debt (Ajisafe et al, 2006).

Alison et al (2003) revealed three theoretical reasons often advanced for government domestic debts. The first is for budget deficit and investment financing, secondly, 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.

In Nigeria, several factors have been advanced to explain the changing domestic debt profile between the1960s to date. The major factors include – high budget deficits, low output growth (as a result of low investment), large expenditure growth, high inflation rate and narrow revenue base witnessed between the 1980s and 1990s. Output growth declined as it recorded annual


average values of 5.9% in 1980-1984, 4% in 1990–1994 and 2.8% in 1998–1999 periods respectively (Semenitari, 2005).

It is usually expected that as countries expand their output, they also tends to rely more heavily on domestic public debt issuance to finance growth. Public expenditure as a percentage of GDP increased from 13% in the 1980 – 1989 periods to 29.7% in the 1990–1994 periods. This increased public expenditures to GDP ratio resulted from fiscal policy expansion embarked upon during the oil boom era of the 1970s. However, as the oil boom declined in the 1980s, priorities of government expenditure did not change.

Consequently, the fiscal operations of the federal government resulted in large deficits from the average of 0.8% of GDP in the 1970 – 1979 period, the level of deficit increased persistently averaging 5.1%in 1980 – 1989 and 10.0 in 1990 – 1994. A very remarkable feature of the government fiscal expansion was the financing of the excess expenditures from domestic sources averaging 79.2% between 1980 and 2002, since foreign loan was difficult to obtain (Mukolu and Ogodor 2012).

Nwankwo (2011) found that Nigerian domestic debt has attained 86.71% of the total debt as at 2011. He further emphasized that most of the internal debt was incurred through federal government bonds with maturity ranging from 3-20 years issued by Debt Management Office (DMO) on a monthly basis. In the light of this escalating and disturbing domestic debt growth rate and given the priority of current government at making Nigeria one of the largest 20 economies in the world by the year 2020 in line with the vision 2020 objectives, it is important to investigate the effect of domestic debt on private investment in Nigeria.

1.2  Statement of the Problem

Details of the domestic debt indicate that Federal Government of Nigeria (FGN) bonds accounted for N3.67tn or 61.44 per cent of the money borrowed by the federal government from internal sources. Nigerian Treasury Bills account for N1.95tn or 32.63 per cent, while Treasury Bonds account for N353.73m or 5.93 per cent. As of March 31, 2011, the nation’s external debt stood at $5.23bn, while the domestic debt stood t N4.87tn. This means that within one year, the external debt stock rose by 13 per cent, while the domestic debt stock rose by 22.59 per cent. Most of the domestic debts were not tied to any specific investment projects, but were raised to


finance budget deficits. The World Bank and other reputable institutions have continued to raise concern over this, saying that unless the country checks the rising debt profile, it may hinder private sector investment growth (Obinna 2012). The situation of Nigeria domestic debt shows that treasury bills constitute the main component of government debt accounting for 77.4% of total domestic debt in 1960, decline to 51% by 1970 but went up to 62% 2003. The decline in the percentage share of treasury bills in the mid-1970s happened as revenue from the oil sector improved substantially, Okunronmu (1992). The growth in the level of treasury bill also reflected the practice of roll over of matured securities and continuous recourse to conversion of ways and means advances outstanding at the end of the year to treasury bills as a way of funding the fiscal deficits. Total domestic debt was N28,440.2 million in 1986 but, rose to N36,790.6 million in 1987, showing an increase of N8,350.4 million between the two periods. Similarly, in 1990, domestic debt increased to N84,093.1 million from N47,031.1 million in 1989, showing an increase in N37,062.0 million between the two periods. It is pertinent for us to note that the increase in domestic debt between 1989 and 1990 is greater than that in the period 1986 and 1987 by N28,711.6 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 N343,674.1 million, increasing by almost five – fold to N84,093.1 million in 1990. By 2000 domestic debt had grown to N898,253.9 million showing an increase of N554,579.8 million between 1996 and 2000. The high rate of domestic debt continue to increase to the tune of N1,016,994.0 billion, N1,166,000.7 billion, N1,329,692.7 billion and N1,370,325.2 billion in 2001, 2002, 2003 and 2004 respectively, (Ezirim, Anoruo, and Muoghalu, 2006). In absolute terms, since 2007, Nigeria’s domestic debt has sky – rocketed with the effect that her domestic debt consumes a larger chunk of her Gross Domestic Product (GDP) thereby tending to decline total output of goods and services.

Generally, declines in government revenue were met by borrowing from the Central Bank through the instrument of ways and means advances. These advances were never defrayed by the federal government but refinanced by the floatation of treasury bills and treasury certificates are rolled over by issuing new ones to pay holders of maturing debt instrument contributing to the continued growth of the debt stock, (Falegan, 2012).


The stock of federal government domestic debt as at December 2010 was N4,551.8 billion, representing an increase of 41 percent over the level in 2009. The development reflected the substantial borrowing through the issuance of federal government of Nigeria (FGN) bonds and treasury bills. The banking system remained the dominant holder of the outstanding debt instruments with, 67.9 percent, and the non-bank public accounted for the balance of 32.1 percent. Disaggregation of the banking system’s holdings indicated that N2,605 billion or 84.2 percent, was held by the deposit money banks and discount houses, and N487.5 billion, or 15.8 percent by the CBN and the sinking fund. Analysis of the maturity structure of the domestic debt showed that instruments of two years and below accounted for N2,850.7 billion or 62.6 percent, followed by instruments of two to five years at N501.7 billion, or 11 percent; those with tenors of between five and ten years totaled N481.1 billion or 10.6 percent, and tenors of over ten years at N718.3 billion, or 15.8 percent (CBN annual report, 2010).

In the last few years (since, 2007) there had been alarming signals on the rising level of Nigerian domestic debt, which in the absence of appropriate measures might result to a looming catastrophe.

There is therefore the need to examine the effect of domestic debt on private investment in Nigeria, to enhance proper policy recommendation to the government. Against this background, this study is poised to answer the following research questions:

1.      What is the impact of domestic debt on domestic private investment in Nigeria?

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