External Debt Affecting The Banking System

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CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

It is generally expected that developing countries, facing a scarcity of capital, will incure debt to supplement domestic saving (Pattillo et al, 2002; Safdari and Mehrizi, 2011). The rate at which they borrow abroad – the “sustainable” level of foreign borrowing – depends on the links among foreign and domestic saving, investment, and economic growth. The main lesson of the standard “growth with debt” literature is that a country should borrow as long as the capital thus acquired produces a rate of return that is higher than the cost of the borrowing. In that event, the borrowing country is increasing capacity and expanding output with the aid of the debt thus, making the debt productive and justifiable.

In theory, it is possible to calculate the sustainable level of foreign borrowing, based, for example, on the terms, maturity, and availability of foreign capital. In practice, however, the task is nearly impossible, since such information is not readily available. Thus, various ratios, such as that of debt to exports, debt service to exports, and debt to GDP (or GNP), have become standard measures of sustainability. Even though it is difficult to determine the sustainable level of such ratios, their chief practical value is to warn of potentially explosive growth in the stock of foreign debt. If additional foreign borrowing increases the debt-service burden more than it increases the country’s capacity to carry that burden, the situation must be reversed by expanding exports. If it is not, and conditions do not change, more borrowing will be needed to make payments, and external debt will grow faster than the country’s capacity to service it.

Countries in sub-Saharan Africa have generally adopted a development strategy that relies heavily on foreign financing from both official and private sources (Ajayi and Oke, 2012). Unfortunately, this has meant that for many countries in the region the stock of external debt has built up over recent decades to a level that is widely viewed as unsustainable. From a trivial debt stock of $1billion in 1971, Nigeria had towards the end of 2005 incurred close to $40 billion debt with over $30 billion of the amount owed to the Paris Club alone. Although Nigeria’s debt was more than the total of those of the 18 other poor countries (14 of them African countries) classified as Heavily Indebted Poor Countries (HIPCs), it had been a herculean task convincing the creditors that debt cancellation was the most desirable option. Prior to Nigeria’s $18 billion debt cancellation deal, these 18 other poor countries i.e. Benin Republic, Bolivia, Burkina- Faso, Ethiopia, Ghana, Guyana, Honduras, Madagascar, Mali, Mauritania, Mozambique, Nicaragua, Niger, Rwanda, Senegal, Tanzania, Uganda and Zambia had secured a 100 percent debt cancellation totaling $40 billion (Semenitari, 2005).

The debt burden on less developed countries can be traced to the early 1980’s after the oil price increase of the 1970’s (Ezike and Mojekwu, 2011). It was the product of reactions by the international community to “oil price shocks”. One of the legacies of African countries from the crisis has been an increasing debt burden, which constituted a major constraint to growth and development. Osuji and Ozurumba (2013) revealed that between the period of 1950-1960, Nigeria had a magnificent growth in its economy due to her huge investment in agriculture which was a major source of revenue for the country; this brought about reduction in both internal and external debt. However, in the eighties Nigeria’s external debt rapidly escalated as a result of declining oil export earnings.

Public  debt became a burden to African countries because contracted loans were not optimally deployed, therefore returns on investments were not adequate to meet maturing obligations and also hindering economic growth (Erhieyovwe and Onovwoakpoma, 2013). African economies have not performed well, partly because of the increased outflow of resources to service debt obligations and partly because the necessary macro-economic adjustment has remained elusive for most of the countries in the continent.

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