The Impact of External Debt on the Nigerian Economy

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Journal of Sustainable Development in Africa (Volume 10, No.3, 2008) ISSN: 1520-5509 Clarion University of Pennsylvania, Clarion, Pennsylvania

THE IMPACT OF EXTERNAL DEBT ON ECONOMIC GROWTH: A COMPARATIVE STUDY OF NIGERIA AND SOUTH AFRICA Folorunso S. Ayadi University of Lagos Felix O. Ayadi Texas Southern University

Abstract This paper investigates the impact of the huge external debt, with its servicing requirements, on economic growth of the Nigerian and South African economies. The external debts of Nigeria and South Africa are analyzed in a new context utilizing traditional, but innovative, models and econometric techniques. The Neoclassical growth model, which incorporates external sector, debt indicators, and some macroeconomic variables, is employed in this study to explore a linear, as well as non-linear, effect of debt on growth and investment. Both ordinary least squares (OLS) and generalized least squares (GLS) are employed in the analysis. Among other test results, the negative impact of debt (and its servicing requirements) on growth is confirmed in Nigeria and South Africa. However, South Africa performs better than Nigeria in the application of external loans to promote growth. In addition, external debt contributes positively to growth up to a point after which its contribution becomes negative in Nigeria (reflecting the presence of non-linearity effects).

Introduction External debt is one of the sources of financing capital formation in any economy. Adepoju et al. (2007) note that developing countries in Africa are characterized by inadequate internal capital formation due to the vicious circle of low productivity, low income, and low savings. Therefore, this situation calls for technical, managerial, and financial support from Western countries to bridge the resource gap. On the other hand, 234

external debt acts as a major constraint to capital formation in developing nations. The burden and dynamics of external debt show that they do not contribute significantly to financing economic development in developing countries. In most cases, debt accumulates because of the servicing requirements and the principal itself. In view of the above, external debt becomes a self-perpetuating mechanism of poverty aggravation, work over-exploitation, and a constraint on development in developing economies (Nakatami & Herera, 2007). Like most developing countries of the world, Nigeria relies substantially on external funds for financing its development projects – iron and steel mills, roads, electricity generation plants etc. Such external funding usually takes the form of external loans. In the early years of political independence (i.e. 1960 through 1975), the size of such loans was small, the rate of interest concessionary, the maturity was long-term, and the source was usually bilateral or multilateral in nature. For instance, Nigeria’s external debt in 1960 was about $150 million; however, beginning in the year 1978, the situation changed. Nigeria, at the lure of the international financial centers, started to borrow huge sums from private sources at floating rates and with shorter-term maturities. The 1978 “jumbo loan” alone was estimated at some US $1 billion. By 1982, the value of Nigeria’s external indebtedness was US $18.631 billion, which represented over 160% of Nigeria’s gross domestic product (GDP) for that year. The situation precipitated a debt-crisis that progressively worsened over time. By 1986, Nigeria had to adopt a World Bank/International Monetary Fund (IMF) sponsored Structural Adjustment Program (SAP), with a view to revamping the economy and making the country better-able to service her debt. Loan capital was readily available to South Africa during the 1970s, and both the public and the private sectors borrowed heavily, often in the form of trade credits. However,

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in the early 1980s, foreign investments declined relative to the value of foreign loans needed to finance...
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