The Debt Servicing Capacity Of

This study examines the interaction between external debt and economic growth, and analyses the sustainability of Nigeria’s foreign debt. Given the several reschedulings and persistent accumulation of the debt arrears, and consistently high debt burden ratios, it is doubtful if the debt burden can be judged as sustainable. This study employed analytical method and the findings from the analysis show that the effect of external debt on growth is negative. The role of debt overhang in precipating debt crisis is crucial. Moreover, to a greater extent the Nigerian debt situation is highly unsustainable. This unsustainability of Nigeria’s external debt could be associated with high initial debt stock, high interest rate, lower real GDP growth, and large trade deficits. It is difficult to stabilize the debt ratio when interest rates is rising, growth rate is falling and the initial levels of the debt ratios are high. The paper submits that debt relief would have positive impact on investment and growth. Furthermore, government needs to step-up its growth performance and use concessional debt with lower interest rate in order to keep the debt at sustainable level. Furthermore, as long as revenue (export income) continue falling, the external debt strategy becomes highly unsustainable because it constraints import capacity and hence lower growth. 1.1 Problem Statement/Relevance of Study Nigeria’s foreign debt profile received unparalleled attention in year 2005, when the President announced the write off of about US$18.0bn from the $30.0bn owed our foreign creditors, particularly the Paris Club. The foreign debt crises in many LDCs have necessitated much concern on its management, review of debt portfolio and conducting a sustainability analysis. An erratic and uneven debt demands and repayments can undermine a long-term development strategy of a nation. Large debt service payment imposes a number of constraints on a country’s growth prospect. It drains a country’s limited resources and curtails financial resources for domestic developmental needs. Large debt servicing obligations and debt burdens can depress investment, and hence economic growth through its illiquidity and disincentive effects. The illiquidity effect results from the fact that there are only limited resources to be divided among consumption, investment, and external transfers to service existing debt. The disincentive arises because expectations of future tax burdens tend to discourage current private investment. This is so because new investors are reluctant to resume activity for the fear that they will soon share in defaults with creditors on old debt. Furthermore, the debt overhang hypothesis provides a link between capital flight and external debt, this is based on the fear that the tax liability of domestic investors will rise in the future, thereby creating capital outflow, instead of saving domestically (Ajayi, 1995; Hajimicheal et al., 1995). This raises the question of whether a debtor country can continue to service its debt, and at the same time, achieve sustainable growth. The past two decades were characterised by a proliferation of research on and increasing concern about the foreign debt crisis of Nigeria. Nigeria has acquired substantial amounts of external debt during the past two decades, which is posing serious problems to the nation’s development. The country’s debt servicing burden reached critical proportions as reflected in the high record number of debt reschedulings, the sharp rise in external payment arrears and continuous recourse to more credit facilities. For instance, external debt during the early 1980s increased Nigeria’s official debt from US$4.1 billion at end of 1980 to US$24.6 billion by the end of 1986. In 1999, Nigeria had an outstanding foreign debt of US$28.4 billion, debt service payments amounted to US$1.72 billion and payment arrears of US$19 billion. Foreign debt stock stood at US$32.92 billion at the end of December, 2003($35.94b. in 2004) while external debt service payment was about US$2.0 billion during the same year. By 2004, it dropped to $1.757 billion. The severity of Nigeria’s debt problem is forcefully demonstrated by movements in certain debt ratios. At 13.3 per cent in 1980, the debt stock to export ratio rose to 404.2 per cent in 1986 and fell to 200.4 per cent in 1996 and again fell to 147.8 per cent in 2000, rose to 176.9 per cent in 2003. The ratio of debt stock to national output rose continuously from 8.9 per cent in 1980 through 50.5 per cent in 1986 to 148.8 per cent in 1995, and later fell to 93 per cent in 2000 and 64.4 in 2003. Similarly, the debt burden as measured by the ratio of debt service to exports rose rapidly from 4.2 per cent in 1980 through 69.5 per cent in 1986 and fell to 16 per cent in 1996 and further fell to 4.3 per cent in 2000 but rose to 9.8 in 2003. The debt burden indicators would have exceeded their current levels but for payment defaults (accumulation of arrears) and subsequent debt restructuring and refinancing. Similarly, the ratio of external reserves to external debt which averaged 337.2 per cent between 1975 and 1980 fell to 3.1 per cent in 1988 and was 26.6 per cent in 1997 and fell to 18 per cent in 2000. This devastating impact of the debt burden manifested in negative/marginal growth of GDP, large scale unemployment, capacity under-utilisation, drastic reduction in consumption and capital formation, growing interest payments on foreign debt, and a general fall in the living standards. For instance, real GDP growth averaged -5.7 per cent between 1981 and 1985, it averaged 2.2 per cent between 1991 and 1997 and moved to 3.3 per cent between 1998 and 2002(CBN, 2004). Fiscal deficit to GDP ratio increased from 4 per cent in 1985 through 10 per cent in 1989 to 15.3 per cent in 1993 and fell to 5.1 in 2002. Inflation rose to over 50 per cent in 1993 and moved to 73 per cent in 1995 but fell to 12.9 per cent in 2002. The investment/GDP ratio dropped from 26 per cent in 1981 through 16 per cent in 1985, to 5.2 per cent in 1996 and was 7 per cent in 2002. The inherent weakness in the structure of the economy is reflected in the over-dependence on imports for its productive base in the face of declining foreign exchange earnings and volatile terms of trade. This is how macroeconomic indicators present a problem of debt servicing like the declining growth rate, rising and persistently high imports and debt ratios and the costs of policies that may have to be undertaken to generate foreign exchange for debt servicing. The debt service payments are a charge on domestic income, savings and export income. Since the external debt situation worsened, the amount of resources required for debt service payments has gone up. The situation has become an impediment to growth and poverty reduction. The urgent need to restore the creditworthiness of the nation, amidst declining export receipts and foreign capital inflow, forced the Nigerian government to adopt the Structural Adjustment Programme (SAP) in 1986. Measures taken to limit the growth of Nigeria’s foreign debt include embargo on new loans, directive to state governments to minimize external borrowings, as well as concessional refinancing, debt restructuring, etc. However, experience has shown that these measures including restructuring are at best stop-gap measures, and do not offer lasting solutions. In many of the reschedulings, the provisions for additional financing have been eliminated or are not forthcoming. For example, Nigeria has had four rescheduling agreements with the Paris Club of creditors (1986, 1989, 1991, and 2000) yet the debt stock has not reduced and debt owed to this group has actually increased without the country contracting new loans. Despite the rescheduling, Nigeria’s total projected annual debt service payment for the years 2001 2005 is still high, above US$2 billion which she is still finding difficult to pay. Therefore, it is important to explore the repayment strategy that is compatible with sustainable long-term economic growth. Given these several reschedulings and yet persistent accumulation of arrears, and consistently high debt burden ratios, it is therefore obvious that the nation’s current debt burden can not be judged to be sustainable. The fact that a large proportion of the debt that is not eligible for rescheduling is rising fast, and the rescheduled debt will still require large debt repayment, makes it difficult for Nigeria to sustain its targeted investment and growth rate. Similarly, interest payments on the debt have been growing faster than the economy (GDP) and if this difference in growth rates were to continue for a very long time, the government will continue to borrow to service existing debt. The problem is that large continuous increases in debt service payments retard investment, economic growth, and lower the standard of living. Moreover, inadequate debt-servicing capacity tends to reduce creditworthiness, hence external credit availability. In Nigeria, studies on foreign debt have largely been devoted to describing the origin, causes, magnitude and sustainability of the debt problem. Some of these studies include: Raheem (1988; 1994), Ajayi(1991; 1995), Nyatepe-Coo(1993), Chhibber and Pahwa(1994), Uwatt (1995), and Iyoha(1997). While all the above studies have looked into one aspect or the other of foreign debt, they are limited in scope, nature and analysis of foreign debt sustainability through long-term economic growth process. Methodologically, most of them employ single equation framework, which is inadequate in analysing the long-term intertemporal relationship between debt and growth, thus making it difficult to capture the dynamic behaviour of the economy being modelled. This is the gap that the present study intends to fill. The research questions are: how much external debt is consistent with sustained growth or how much debt accumulation is advisable? Are future exports, savings and output growth prospects strong enough to bring to an end debt servicing difficulties? Similarly, has past foreign borrowing slowed growth and investment performance in Nigeria? Another question is whether the large debt burden is one of the factors contributing to weak economic performance and slow adjustment effort. It is against this background that this study is motivated. Consequently, the objectives of the study are to: a) examine the interactions between foreign debt and growth in Nigeria b) analyze the debt servicing capacity of Nigeria’s economy within the context of a sustainable long-term economic growth process and; c) draw policy implications for external debt management. 2.1 An Overview of the Nigerian Economy In analysing foreign debt problem, the structure of the economy inevitably matters. Nigeria with a current population of over 120 million, is the most populous country in Sub-Saharan Africa (SSA), with nearly 20 per cent of the region’s population and the continent’s second largest economy. Its wealth of natural and human resources including major oil and gas deposits, a vibrant private sector, and a large labour force endow her with considerable potentials for growth and development (World Bank, 1996). Petroleum production constituted about 49 per cent of GDP in 1995 – over 97 per cent of exports, and 83 per cent of budget revenues. Agriculture employed two-thirds of labour force and accounted for 28 per cent of GDP. Manufacturing accounted for less than 5 per cent of GDP, while the services sector, dominated by trade, accounted for about 18 per cent of 1995 GDP(Table 2.1). Table 2.1: Economic Performance by Sectors, 1960 – 2004 (Average Annual Growth) Sector 1960-7