Domestic Debt and Private Investment: The Case of a Small Open Economy

Abstract

According to the Debt Management Office (DMO) Nigeria's total debt stock (foreign and domestic) as at June 2020 stood ₦31.01 trillion (US$85.9 billion), 8.31 percent increase when compared with ₦28.63 trillion (US$79.3 billion) recorded in March 2020. A breakdown reveals that total external debt stood at ₦11.36 trillion (US$31.47 billion), accounting for 36.65 percent of the total debt stock while domestic debts stood at ₦19.65 trillion (US$54.42 billion), represented 63.35 percent of the total debts. A cursory look at the historical trend shows that Nigeria's public debt increased by US$22.09 billion between June 2015 and June 2020. Nigeria spent a whopping US$1.3 billion to cover external debt obligations in 2019 as external debt service payment accumulated to US$3.5 billion in the last five years. In general, the unprecedented increase in the public debt is a source of anxiety for stakeholders in Nigeria. The study investigates the relationship between domestic debt and private investment in Nigeria for the period 2000: Q1–2019: Q2. The paper uses the Augmented Dickey Fuller (ADF) and Philp Perron (PP) tests to examine the statistical properties of the data and determine the appropriate model for the analysis. Also, Autoregressive Distributed Lag (ARDL) methodology to uncover the short and long run relationship between public debt and private investment. The time series data were found to exhibit mixed order of integration, I(0) and I(1), thereby necessitating the choice of the Autoregressive Distributed Lag (ARDL) methodology that allows for data with mixed integration order in modelling the relationships among economic variables. The model was tested for cointegration and the results of the Bounds test showed the existence of a long-run relationship among the variables. From the long-run equation, domestic debt, real GDP and prime lending rate were statistically significant and maintained a priori expectation. The study affirms that domestic debt has a significant negative effect on private investment in Nigeria, confirming the crowding-out hypothesis. On the basis on the empirical findings, the study recommends minimizing public borrowing (especially from domestic sources) in Nigeria. In addition, funds sourced through borrowing should be judiciously utilized to improve the investment climate in the country.