University of Ilorin

Ilorin, Nigeria

IMPACT OF PUBLIC DEBT ON

FINANCIAL DEVELOPMENT IN
NIGERIA

By

Tolani Olowoleni
B.Sc (Economics), M.Sc (Finance)

October, 2019

1
INTRODUCTION

Financial development is a non-negligible factor in the drive to achieve economic development

(Kablan, 2010).It is believed that Nigeria has a target to become one of the 20 largest economies

by 2020.Even though the attainment of this vision is highly unlikely, she needs a well-developed

financial system if any meaningful progress is to be made. Financial sector development takes

place when financial instruments, markets and intermediaries work together to reduce the cost of

information, enforcement and transactions. The main task of the financial system is to channel

funds from sectors that have surplus to sectors that have a shortage of funds. This means that no

profitable investment would be neglected due to lack of financial resources. In doing so, the

financial sector performs the task of reducing information and transaction costs, and facilitating

the trading, diversification, and management of risk (Mandiefe, 2015). The government plays a

very important role in the development of the financial sector. The government uses debt as one

of the sources of revenue to cover a part of public expenditure. The government can therefore

through fiscal policies determine when and to what extent to use public debt to cover its

expenditures and this can be a way of achieving financial development.

Government revenue is an important tool of fiscal policy of the government and it is the opposite

factor of government spending. Revenues earned by the government are received from sources

such as taxes levied on the incomes and wealth accumulation of individuals, corporations and on

the goods and services produced, exports and imports, non-taxable sources such as government-

owned corporation’s incomes, central bank revenue and capital receipts in the form of loans and

debts. When there is no possibility to finance government expenditure through taxes due to

2
various reasons such as when tax revenues are less than expected, war and recession. The

government obtains additional revenue through borrowing. This borrowing of revenue for

financing government expenditure is referred to as public debt and this can either be internal or

external. According to the Debt Management Office (2017), on the average the proportion of

domestic debt to total debt was 85% between 2012 and 2015, but reduced to 78% between 2016

and 2017. The federal government of Nigeria has set what it believes to be an optimal domestic

debt to external debt ratio at 60:40. The current domestic to external debt ratio stands at 70:30.

As a matter of fact, existing literatures (Emran & farazi, (2009) and Phillip, Victoria, Azharul,

Omankhanlen, Oluwaseun & Temiloluwa, (2017) have linked domestic debt and financial

development when they revealed that private sector can be crowded out by uncurbed domestic

debt, interest rate will be driven up due to the competition for limited financial resources by

government and private sector. These researchers therefore argued that when banks hold a large

proportional asset in public debt, it will reduce the amount of bank credit available to private

sector and restrict private investments. Credit to private sector is often used as a measure of

financial development.

On one hand, the public debt (total of domestic and external debt) in Nigeria has been on the rise

over the last five years and the general question provoked by these figures becomes ‘what is then

the impact of these figures on the development of the financial sector’? Available data from

DMO (2017) shows that Nigeria’s total public debt stock as at 31st December 2014 stood at

₦11.23 trillion, which comprises of ₦1.63 trillion external debt for federal and state

governments, ₦7.90 million domestic debt stock for federal government and, ₦1.71 million

3
domestic debt stock for state governments. By 2017, the total debt stock had increased to ₦21.73

trillion, which comprises of ₦5.79 trillion external debt for federal and state governments,

₦12.59 trillion domestic debt stock for federal government and, ₦3.35 trillion for domestic debt

stock for state governments. The Federal Government of Nigeria’s Domestic Debt Outstanding

by Instruments, 2015 and 2016 shows that as at December, 2016, the FGN’s domestic debt stock

comprised mainly FGN bonds (68.41per cent), Nigerian Treasury Bills (29.64 per cent) and

Treasury Bonds (1.95 per cent) CBN (2017).

On the other hand, statistics shows that indicators of financial development have reduced.

According to National Bureau of Statistics (2017), the value of domestic credit granted to private

sector which stood at 15.39% of GDP in 2010 reduced to 12.46% in 2011. The figures further

reduced to 11.79% in 2012. The figures stood at 12.59% and 14.49% in 2013 and 2014

respectively. By 2015, it had reduced to 14.19% and 14.15% in 2017. This represents 0.28%

decline. More worrisomely, the total market capitalization of GDP which stood at 13.9% reduced

to 9.5% in 2011. The figures increased to 12.2% in 2012 and 15.7% in 2013. By 2015, it had

reduced to 10.1% and 9.9% in 2017. This represents 1.08% decline. Notably, domestic credit to

private sector and market capitalization are commonly used indicators of financial development.

The above stimulates the interest to know whether the decline recorded in the financial

development indicators is as a result of rising public domestic debt. To achieve this, the study

focuses on domestic public debt because of the proportion of the total debt it accounts for and its

importance. According to Anyanwu and Erhijakfor (2004), the importance of domestic debt

cannot be downplayed as it is an alternative way of filing domestic savings gap in the face of

4
reducing government revenue from domestic sources. It is conspicuously so in the face of

fluctuating oil prices. There is a growing number of empirical studies on the relationship

between domestic public debt and financial development (Altayligil, 2013; Kativadze, 2011;Mun

& Ismail, 2015). This study differs from most existing studies because most of the studies did not

consider country specific level and the studies that considered country specific level focused on

the banking aspect of financial development. The non-bank aspect cannot be neglected because

49.68% which is equivalent to ₦5, 493.54 billion of the total domestic debt (Federal Government

only) in 2016 was sourced from non-bank sources. (CBN 2016) Thus, there is still a gap since

other aspects of financial development have not been examined on a country specific level.

Therefore, this study seeks to examine the impact of domestic public debt on financial

development in Nigeria. The study will add to prior studies on public debt in Nigeria and it will

help government and policy makers in making decision concerning the debt structure of the

country. The result of this study will provide insights into how domestic debts affects specific

indices of financial development, which will enable government to undertake measures that will

place the country in a position to achieve economic growth. This study covers the period

spanning 1984 to 2017. The start period was selected based on when the domestic debt-GDP

ratio reached the all-time highest of 40.71 per cent. (CBN, 2017)

The study is divided into 5 sections; section two highlights relevant literatures; section three

presents the data and methodology; section four reports the results and the last section

summarizes our conclusion and recommendation.

5
1. Literature Review

1.1 Conceptual Review

Financial Development

Financial development occurs when there is an improvement in the volume of financial services

rendered by banks and other financial intermediaries as well as financial transactions of capital

markets (Hussain & Charborty, 2012). The financial sector development includes but not limited

to having a well-organized monetary arrangement, a large banking sector, sustainable public

finances, independent central bank and developed securities market (Rosseau & Sylla, 2013)

Financial development is a multidimensional concept. Therefore, various indicators have by used

to measure this concept. The World Bank’s Global Financial Development Database (GFDD)

developed a framework to measure financial development worldwide. This framework

recognizes four sets of proxy variables indicating a well-functioning financial system; financial

depth, access, efficiency and stability. However, these four dimensions are broken into two

major components in the financial sector namely financial institutions and financial markets.

Empirically, financial development has been measured using different indicators. For instance,

ratio of financial institutions’ assets to GDP, ratio of liquid liabilities to GDP, ratio of deposits to

GDP, ratio of private credit to GDP and ratio of stock market capitalization to GDP have been

commonly used.

However, this study makes use of stock market capitalization as a percentage to GDP because

49.68% which is equivalent to ₦5, 493.54 billion of total domestic debt (Federal Government

only) in 2016 was sourced from non-bank sources (CBN Statistical bulletin, 2016).

6
Domestic Public Debt

The act of borrowing creates debts and debt can either be domestic or external. The focus of this

study is on domestic debt which refers to the part of a nation’s debt which is owed to creditors

within the country. The government turns to domestic debt to avoid the troubles associated with

external borrowing, to supplement internal savings and to manage macroeconomic conditions of

the country (Adofu &Abula, 2010).

According to Okunrounmu (2012), Nigeria’s domestic debt is made up of treasury bills, treasury

certificates, treasury bonds and development stock. In terms of source, Nigeria’s debt has been

largely generated through the banking system. For example, the average banking system holding

between the period 2000 and 2015 stood at 60%. However, the non-banking system accounted

for almost 50% in 2016 .Hence, the interest of the research to use the total market capitalization

as an indicator for financial development. The Debt Management Office (DMO) is the

government agency established to centrally coordinate the management of Nigeria’s debt.

According to the Debt Management Office, the domestic debt of Nigeria can be calculated as the

debt incurred by the Federal government alone or in addition to the debts incurred by the states.

However, this study calculates public domestic debt as the total of domestic debts of federal

government because the data on debts incurred by the states were unreliable because debt figures

for some states were not available.

1.2 Theoretical Review

The crowding -out and crowding- in theory are the relevant theories for the study. These theories

are discussed as follows

7
Crowding out and crowding in Theory

Although the studies on crowding out versus crowding in remains ambiguous. These theories

take root in the works of Bailey (1971) and Buiter (1977) where the relationship between private

and public spending was examined. In theory, crowding out occurs when increased government

involvement in a sector of the economy affects the remainder of the market, either on the supply

or demand side of the market. This theory argues that rising government spending drives down

or even eliminates private sector spending when the federal government increases its borrowing.

The scale of this borrowing can lead to a substantial increase in the interest rate. The crowding

out theory posits that if interest rates are rising because of government spending, the demand for

funds in the private sector falls as a result of the higher interest rate. The credit available to

private is an indicator of financial development. Although, it can be argued that the fall in

aggregate demand is as result of the reduced levels of private credit-financed spending.

Nonetheless, the theory opines that government borrowing tends to push interest up and this

might discourage many categories of private borrowing. This shows that as the interest rate

increases as a result of domestic borrowing, then the indicators of financial development will be

reduced i.e. there is an inverse relationship between domestic debt and financial development.

In complete reversal of the crowding out theory, some macroeconomic theories hold that in a

modern economy operating significantly below capacity, government borrowing can actually

increase demand by generating employment, thereby stimulating private spending as well. This

process is known as the crowding in effect. It advances a counter argument against the crowding

out hypothesis. The Keynesians maintain that domestic debt will lead to little or no increase in

8
the interest rate and instead an increase in output and income and hence a crowding-in rather

than crowding-out. This shows that as domestic borrowing increases, the indicators of financial

development increases i.e. there is a positive relationship between domestic debt and financial

development.

1.3 Empirical Review

Review of Single Country Studies

This section attempts a relevant review of previous empirical studies on the impact of public

domestic debt on financial development in order to provide a cogent context of debate. There

exist a number of studies on the impact of public domestic debt on financial development.

Different studies have shown that a positive relationship exist between public domestic debt and

financial development (Kalidze 2011; Kumhof & Tanner 2005). In contrast, some studies that

used credit to private sector as proxy for financial development (Altayligil & Akkay, 2013;

Fyed, 2012) finds a negative relationship between domestic debt and financial development.

Altayligil and Akkay (2013) investigates the relationship between domestic debt and financial

development for the Turkish economy between 2002Q1-2012Q2. The results which are based on

time-series analysis however criticize the generalization of the results provided by other studies

because each country has different responses due to its own peculiar conditions. Fyed, (2012)

used a cointegration approach to investigate the relationship between public debt and private

credit in Egypt. The paper concludes that government borrowing from the domestic banks leads

to a more than one to one crowding out of private credit. Fyed, (2012) also opines that

government borrowing is not the sole reason behind crowding out effect on private credit. The

9
author argues that the preference of domestic banks to invest excess liquidity in a low risk high

return investment such as treasury bills is also a factor.

Claeys, Moreno and Surinach (2012) opines that the crowding out effects of increasing public

debt have usually been found to be small or non-existent. The paper tests crowding out and

measures the degree of integration of government bonds market using spatial modeling

techniques. The authors conclude that a 1% increase in the debt ratio pushes up domestic interest

rates by 2% at most.

The literature on the relationship between government debt and stock market development is

still quite lean. Nonetheless, Aigheyisi and Edore (2013) argue that public debt adversely affects

the stock market development measured as market capitalization percentage of GDP. The study

posits that higher borrowing cost discourage investment and reduces corporations’ profit which

in turn adversely affects the development of the stock market since the profitability of quoted

firms is positively related to stock market returns and development. However, the study focuses

on the external proportion of public debt.

Literature provides evidence that other factors also affect financial development. Empirical

studies show that there is a negative relationship between inflation and financial development

(Alimi, 2014; Kim, lim & Suen, 2010; Odhiambo, 2012). These studies provided ample support

for the argument that inflation negatively affects financial development. These authors further

argued that one of the most important criteria for financial development is price stability. Kim et

al (2010) emphatically argued that inflation can have negative effect on financial development

by eroding the usefulness of money and by leading to policy decisions that distort the

entire
10
financial structure. However, Bittencourt (2011) finds a positive relationship between inflation

and financial development.

Irungu (2015) examined the effect of fluctuations in exchange rate on financial development at

the Nairobi Securities Exchange. This study noted that the fluctuations in the exchange rate are

major determinants of the financial development. It further asserted that a unit increase in

monthly exchange rate fluctuations would lead to an 18.359 increase in financial development.

On the other hand, Olugbenga (2012) examined the long-run effects of exchange rate on stock

market development in Nigeria over 1985-2009 using the Johansen cointegration tests. A bi-

variate model was specified and empirical results showed a significant positive stock market

performance to exchange rate in the short-run and a significant negative stock market

performance to exchange rate in the long-run. However, the study concluded that the negative

influence of the exchange rate on Nigeria stock market performance could have been as a result

of heavy devaluation of the currency since the introduction of the structural adjustment

programme in 1986.

Review of Country-Group Studies

Different studies have examined the effect of domestic debt on various indicators of financial

development (Christensen, 2005; De-Bonnis & Stacchini, 2010; Emran & Farazi, 2009) These

studies all found that government debt crowded out private sector lending. They further argued

that the crowding out effect were due to the fact that domestic debt markets in the countries were

generally small, highly short-term and had a narrow investor base. They opined that due to the

11
problem of non- performing loans, banks were becoming more risk –averse as reflected by the

reduction in private credit and investment in more liquid and less risky assets, such as treasury

bills and government bonds. Christensen (2005), examined role of domestic debt market in 27

sub-saharan African countries emphatically stated that an increase in domestic debt of 1%

relative to broad money causes the ratio of private sector lending to decline by 0.15%.

Research Gap

In Nigeria, it was found that little has been done on the impact of domestic public debt on

financial development as most studies have focused on the impact of domestic public debt on

economic growth. (Anyanwu & Erhijakfor, 2004; Adofu & Abula, 2010 ; Onyeiwu, 2012).While

the few studies that exist used credit to private sector as an indicator for financial development.

(Akpansung, 2018; Phillip et al., 2017). Furthermore, the generalization of the results provided

by cross-country studies on the impact of public domestic debt may not apply to Nigeria as each

country may have different responses against the changes in domestic public debt due to its own

peculiar economic and financial conditions. Empirically, the most commonly used financial

indicators are domestic credit to private sector to GDP ratio, broad money to GDP ratio,

commercial banks asset to GDP, valued traded stock to GDP ratio. To the best of the author’s

knowledge, studies specifically investigating the effects of domestic debt on financial

development using the total market capitalization to GDP as an indicator of financial

development in Nigeria remains relatively unexplored, a gap that the current study has bridged.

As mentioned earlier, the non-bank aspect cannot be neglected because 49.68% which is

12
equivalent to ₦ 5, 493.54 billion of the total domestic debt (Federal Government only) in 2016

was sourced from non-bank sources.

13
2. Methodology

This study employed secondary data sources, which were sourced from the Debt management

office reports and CBN statistical bulletin using the period 1983-2017. The Domestic debt- GDP

ratio was over 40% in 1983. The complete data for 2018 was not available as at the time of

carrying out this study. This study period ends in year 2017. Ex- post facto was used because of

its peculiar feature in examining how an independent variables present in prior study affect

dependent variable.

The econometric analysis was performed using the Autoregressive Distributed Lag (ARDL)

model which captures the short-run dynamics and long-run relationship between the variables of

this study. The ARDL model is the most useful method of determining the existence of

cointegration in small samples (Ghatak & Siddiki, 2001). More so, the ARDL approach has been

used even when other cointegration techniques require all of the regressors to be of the same

order, therefore, the ARDL approach can be applied whether the variables in the regression are

purely I(1) and/or purely I(0) or a mixture of both. The approach also avoids the pre-testing

problem associated with standard co-integration, which requires that the variables be already

classified into I(1) (Pesaran et al., 2001). Third, the ARDL approach to co-integration is

preferable to other approaches (such as the Johansen approach) because it avoids the problem of

too many choices that are to be made in such methods. These include the treatment of

deterministic elements, the order of Vector autoregression and the optimal lag length to be used.

Finally, unlike other methods, the ARDL approach allows variables to have different lag length.

Prior to the use of the Autoregressive Distributed Lag (ARDL), descriptive statistics was used to

14
provide a brief summary of the samples and the Augmented Dickey- Fuller (ADF) Unit Root

Test was used to test the stationarity of the series and order of integration.

2.1 Model Specification

Prior to empirical studies and theories used, the model is stated as follows

SMGDP= F (FGDDO, RIR, INF, RGDP, OPEN, REER)

The model is expressed econometrically as:

SMGDPt= λ0 + λ1FGDDOt + λ2RIRt + λ3INFt + λ4RGDPt + λ5OPENt + λ6REERt + Ut

The error correction model is specified as:

∆lnSMGDPt = λ0 + λ1∆FGDDOt + λ2∆RIRt + λ3∆INFt + λ4∆RGDPt + λ5∆lnOPENt +

λ6∆lnREERt + λ6ECM-1

Where: ∆ is the first difference operator

λ1….λ6 are the parameters to be estimated

ECM-1 is the residual of the result of equation 2 lagged one period.

Table 3.1 Measurement of variables

S/N Variables Symbol Measurements/Proxy Backup literature

01 Financial SMGDP It is calculated as the total Mogaka & Ochieng

Development stock market capitalization (2018)

to GDP

15
02 Public domestic FGDDO It is the total sum of the A l t a y l i g i & A k

debt Federal government debt as k a y ( 2 0 1 3 ) ;a n d

published by debt Kutivadze (2011)

management office
03 Real interest rate RIR Real Interest rate is the M o g a k a &

lending interest rate adjusted Ochieng(2018) and

for inflation as measured by E m r a n & F a r a z i

the GDP deflator (2009)

04 Inflation INF Inflation rate measured as A l i , A h m a d &

Consumer Price Index Rahman(2016) and

deflated by GDP Anyanwu, Gan & hu

(2013)
05 Real GDP RGDP Inflation adjusted GDP Mun & Ismail (2015)

and Janda and

Kravtov (2017)
06 Trade Openness OPEN Exports plus imports divided Ho & Iyke (2018) and

by GDP Ilgun (2016)

16
07 Real exchange rate REER The weighted average of Olugbenga (2012)

nominal exchange rates

(Naira as against USA

Dollar) , a d j u s t e d f o r

inflation

Source: Author’s compilation, (2019).

17
3. Data Estimation and Discussion of Results

3.1 Descriptive Statistics

The descriptive statistics of all the variables of the model are reported in Table 1. It shows the

mean, minimum value, maximum value, and standard deviation of the explained variable

(financial development) and each of the explanatory variables (domestic public debt, interest

rate, inflation rate, real GDP, trade openness and real exchange rate) used in this study.

Table 1. Descriptive Statistics

statistics SMGDP FGDDO RIR INF RGDP OPEN REER
Mean 9.814 2500.449 2.349 19.720 263929.4 33.847 132.630
Maximum 30.800 12578.80 18.180 72.835 385227.6 53.277 531.824
Minimum 0.161 25.672 -31.453 5.3822 198919.5 9.136 48.924
Square Dev. 7.234 3432.989 10.215 18.095 67077.19 11.961 109.436
Observations 34 34 34 34 34 34 34
Source: Author’s Computation, (2019).

From Table 1, the standard deviation of domestic public debt (FGDDO) is higher than its mean

value implying that public domestic debt increases more rapidly as a result of the need to

augment the revenues available to finance public expenditures. The mean value of real interest

rate (RIR) falls largely below its standard deviation indicating that interest rate is volatile; this

can affect the borrowing cost and investment earnings of economic units. The mean value of

inflation (INF) is almost 20%; this double digit inflation rate discourages savings. The mean

value of Real GDP (RGDP) is 263929.4 billion; according to World Bank (2016), developed

economies are those with a GNI per capita of $12, 055 (N4351855)or more. Therefore, this is

still low for a country that aims to be one of the largest economies by 2020. The value of the real

18
exchange rate (REER) peaks at 531.824; the high real exchange rate makes the relative price of

goods at home higher than the relative price of goods abroad. In this case, import is likely

because foreign goods are cheaper, in real terms than domestic goods.

3.2 Test for the Stationarity of Variables

This study employs the performs the Augmented Dickey-Fuller (ADF) Unit Root Test to

determine the stationarity of series as well as their order of integration -I(d). Therefore, the study

test the null hypothesis that the variables examined have a unit root.

Table 2. Results of Augmented Dickey-Fuller (ADF) Unit Root Test

Variable Level First Difference Order Of
Integration I(d)
T. Statistics p-value T-Statistics p-value
SMGDP -2.532 0.117 -5.833 0.000*** I(1)
FGDDO 9.612 0.139 -6.669 0.000*** I(1)
RIR -3.430 0.001*** - - I(0)
INF -4.075 0.016*** - - I(0)
RGDP -1.887 0.638 -2.933 0.003*** I(1)
OPEN -2.794 0.070* - - I(0)
REER -3.822 0.000*** - - I(0)
* and *** imply the rejection of the null hypothesis at 10% and 1% significance levels respectively.
Source: Author’s Computation, (2019).

Table 2 shows that financial development (measured as stock market capitalisation as a

percentage of GDP), domestic public debt, and real GDP are non-stationary at 5 percent

significance level and this means that they have a unit root. The implication is that OLS

regression could not be used on the non-stationary data as the result will be spurious. Real

interest rate, inflation rate, trade openness, and real exchange are stationary at level. However,

19
the order of integration for financial development, domestic public debt, and real GDP was

confirmed to be I(1) when the series became stationary after their first differencing. This implies

that no short-run relationship could be established between the independent variables and the

dependent variable. As a result, the co-integration test was conducted with the aid of the

Autoregressive Distributed Lag (ARDL) bounds test to assess the possibility of a long-run

relationship among the variables in the model.

3.3 ARDL Bound Testing Approach to Co-integration

The ADF unit root results in Table 2 show that the variables in the model are a combination of

I(0) and I(1) series. According to Pesaran, shin and Smith (2001) and Pesaran and Shin (1999),

ARDL Bound testing approach is the best estimator for series of I(0) and I(1) when checking for

long-run relationship. This is because it involves a single equation set up and that different

variable can be assigned different lag length. Based on the Akaike information criterion (AIC),

the AIC is preferred to the Bayesian information criterion because the BIC cannot handle

complex collections of models as in the variable selection problem in high- dimension. The

optimal lag order of 4 is automatically selected for the ARDL specification. The procedure is

used to determine the presence of a long-run relationship between variables. The bounds test

result conducted is shown in Table 3.

Table 3. Results of the ARDL Bounds Testing for Co-integration

F. Stat Significance Lower bound Upper bound Decision
level
7.245750 10% 2.26 3.35 Rejection of the null
5% 2.62 3.79 hypothesis of no co-
integration
1% 3.41 4.68
Source: Author’s Computation, (2019).

20
Table 3 shows the bounds test result computed with the assumption that all the variables are I(0)

for the set of lower bound and that all the variables are I(1) for the set of upper bound. Since the

F-statistics value of 7.245750 lies above the upper bound critical value of 3.79 at 5% level of

significance, the joint null hypothesis of no co-integration is rejected, which means that there is

evidence of co-integration and there is a need to conduct the long-run relationship among the

variables together with the short-run dynamic estimates from the ARDL co-integration

technique.

3.4 The ARDL Lag Determination

The optimal lag length for each variable was selected based on the Akaike information criterion

and the result obtained as shown in Table 4. One of the major advantages of using ARDL is that

it test for the optimal lag length that is suitable for each of the variables. In line with the

information criteria, the lag length for the variables is revealed in Table 4.

Table 4. Results of the ARDL Lag Selection

Variables Lag Selection
SMGDP 1
FGDDO 4
RIR 1
INF 2
RGDP 1
OPEN 1
REER 1
Source: Author’s Computation, (2019).

21
3.5 ARDL Regression Estimates
Having established a long-run co-integration relationship among variables, the model was

estimated using the following ARDL specification (1, 4, 1, 2, 1, 1, 1).

Table 5. Results of the ARDL Long-run Regression Estimates

Variable Coefficient Std. Error t-Statistics p-value
FGDDO 0.005 0.002 2.144 0.069*
RIR -2.087 0.419 -4.984 0.002***
INF 0.067 0.200 0.336 0.7471
RGDP 0.000 0.000 1.683 0.1363
OPEN 0.582 0.164 3.539 0.009***
REER 0.031 0.016 1.905 0.099*
CONSTANT -17.972 13.185 -1.363 0.2151
Note: * and ***implies the significance of the variables at 10% and 1% significance levels
respectively.
Source: Author’s Computation, (2019).

Taking into consideration that the main aim of this study which is to assess the effect of domestic

public debt on financial development in Nigeria. Table 5 demonstrates the results of the

estimated ARDL long-run relationship between the explained variable (financial development)

and explanatory variables (domestic public debt, real interest rate, inflation rate, trade openness,

real exchange rate, and real GDP).

In terms of the sign of the variables, it can be seen that most of the explanatory variables have a

positive association with financial development; this implies that there is a direct relationship

between domestic public debt, inflation rate, real exchange rate trade openness, real GDP and

financial development as revealed by their positively signed coefficients. The coefficient of real

interest rate indicated a negative association with financial development implying that an

22
increase in real interest rate slows down financial development. Therefore, it is observed that all

the variables concur with the a priori expectation. In terms of the significance of the variables,

all the variables except inflation rate and real GDP are statistically significant in explaining

financial development as evidenced by their p-values which are less than the 10% threshold level

of significance.

In terms of the coefficient’s magnitude (size), a unit increase in public domestic debt will boost

financial development by 0.005 units. A unit increase in real interest rate will cause a decline in

financial development (measured as the ratio of stock market capitalisation to GDP) by 2.086

unit. Meanwhile, in the long-run estimation, a unit increase in the inflation rate will enhance

financial development 0.067 unit. Similarly, it is noted that financial development will be

enhanced by 0.000095 unit due to a unit increase in real GDP. A unit increase in trade openness

swill spur financial development by 0.582 unit. On the same note, it is found that a unit increase

in the real exchange rate will cause 0.031 unit increase in financial development.

It may be very tough to draw a reliable and accurate conclusion about reality from data that

suffer from non-normality, heteroscedasticity, serial correlation, and instability.In order to

validate the correctness and reliability of the result, the post-estimation test was carried out after

the main estimation.

Table 6 shows the summary of post-estimation test conducted for the research.

23
Table 6. Results of the Post Estimation Tests
Test Instrument Statistics Decision
Normality Jarque Bera 0.72144 Residuals are
p-value 0.6972 normally
distributed
Heteroscedasticity Breusch-Pagan-
Godfrey Obs *R-squared 23.27001 No
Heteroscedasticity p-value (Chi-square) 0.3866 heteroscedasticity
test
LM Serial
correlation Breusch-Godfrey Obs *R-squared 13.83893
Serial correlation p-value (Chi-square) 0.1201 No serial
Stability test correlation
CUSUM and
CUSUM of Lies within between No structural
Squares critical boundaries at a change
5 percent level of
significance.

Source: Author’s Computation, (2019).

Table 6 revealed the ARDL model has passed all the diagnostic tests successfully since there is

the absence of heteroscedasticity and serial correlation as demonstrated by their p-values which

are statistically non-significant at the 5% level of significance. It was also concluded that the

model residuals are free from non-normality since the probability values are greater than the 5%

significance level. The stability tests indicated that there is no problem of structural change in the

model since the plots of the test lie within critical boundaries at the 5 percent level of

significance. The results of the error correction model (ECM) which allows a variable to be

dynamic in the short-run while remaining at equilibrium, in the long-run, are displayed in Table

7.

24
Table 7. Results of the ARDL Short-run Regression Estimates
Variable Coefficient Std. Error t-Statistics p-value
D(SMGDP(-1)) -0.879 0.256 -3.439 0.011**
D(FGDDO) -0.013 0.006 -2.205 0.063*
D(FGDDO(-1)) -0.027 0.012 -2.275 0.057*
D(RIR) -0.267 0.129 -2.060 0.078*
D(RIR(-1)) 1.012 0.211 4.806 0.002***
D(INF) -0.209 0.099 -2.098 0.074*
D(RGDP) 0.000 0.000 2.254 0.056*
D(RGDP(-1)) -0.000 0.000 -0.136 0.895
D(OPEN) -0.000 0.000 -0.864 0.415
D(REER) 0.000 0.000 2.936 0.0218**
CointEq(-1) -1.103 0.274 -4.029 0.0050***
Note: *, **, and ***implies the significance of the variables at 10%, 5%, and 1% significance
levels respectively.
Source: Author’s Computation, (2019).

Cointeq = SMGDP - (0.0049*FGDDO -2.0868*RIR + 0.0673*INF + 0.0001*RGDP +

0.5818*OPEN + 0.0311*REER -17.9719)

In the results of the ARDL short-run model, [Δ(SMGDP(-1)), Δ(FGDDO), Δ(FGDDO(-1))

Δ(RIR),Δ(INF), Δ(RGDP(-1)), and Δ(OPEN)] have negative coefficients. From the foregoing, it

implies that an increase in any of these independent variables and their lags will lead to a

negative change in financial development up to the value of each of their coefficients, while

other variables such as Δ(RIR(-1)),Δ(RGDP), and Δ(REER) have positive coefficients.

The short-term results of the ARDL model also show that all the variables in the short-run

estimates except (ΔRGDP(−1)) and Δ(OPEN) are statistically significant. Precisely, the

coefficients of ΔRGDP(−1)) and Δ(OPEN) show p-values that are higher than the 10 percent

threshold level. The value of R-squared and adjusted R-squared were estimated to be 0.958

25
and0.827 which implies the model of this study is strongly good fitted, hence the explanatory

power of the independent variables regarding the behaviour of financial development is

satisfactory. The F-statistics which has an exact p-value of 0.006 implies that the overall

significance of the short-run ARDL model. Based on the rule of thumb, the Durbin Watson

statistics falls within the acceptable limit with a value of 2.42, hence there is no presence of first-

order serial correlation in the model.

The lagged error correction term (CointEq(-1)) refers to the series of OLS residuals which are

derived from the long-run model. The lagged error correction term has a negative coefficient as

expected, the term is also highly statistically significant at 1% level. The ECM term validates the

existence of a long-run relationship between the variables of this study. This implies that the

disequilibrium can be adjusted to the long-run with higher speed, having any prior-year shock in

the explanatory variables.

3.6 Discussion of Findings

In the results of the ARDL Long-run regression shown in Table 5, the coefficient of domestic

public domestic debt is found to be positively related and significant at 10 percent level. This is

consistent with the crowding in theory of the Keynesians which argues that an increase in

domestic debt will lead to an increase in the indicators of financial development. This result is

consistent with the studies of Kumhof and Tanner ( 2005) and Kutivadze (2011) but differs from

the negatively signed coefficients reported by Altayligil and Akkay (2013) and Mogaka and

Ochieng(2018). However, public domestic debt is negatively related in the short-run at 5%

significance level and this is consistent with the crowding out theory. It is negatively signed in

the short run because as public domestic debt starts to increase, investors will lose confidence in

26
the government’s ability to pay back borrowed funds. Investors would demand a higher interest

rate to compensate for the increased risk, and at some point rates could rise sharply and

suddenly, creating broader financial consequences. Consequently, public domestic debt becomes

positively signed in the long run because by issuing bonds on a massive scale, the government

effectively make a way to put funds in the hands of investors which has a positive effect on

financial development. Therefore, this shows a crowding out effect in the short run and crowding

in effect in the long run.

The estimated coefficients of real interest rate is found to be negative and significant at 1% in

the long run. This means 1% change in the interaction term will bring about a negative change in

stock market capitalization/GDP by 0.021 unit. This result is in line with the study of Mogaka

and Ochieng (2018). In the short run, it is also negative and significant at 10%. The possible

cause of the negative coefficient in the short and long run is because government will continue to

see a rise in borrowing costs.

The estimated coefficient of trade openness is positive and significant at 1% in the long run. This

means that 1 percent change in trade openness is associated with a positive change in stock

market capitalization/GDP by 0.006 unit. This result is similar to the submission of Ho and Iyke

(2018). This implies that that in the long -run, the openness to trade further increases the

exposure of a country to external shocks, the financial sector intermediaries help to diversify the

associated risk. However, trade openness has negative coefficient in the short- run, this can be

attributed to the fact that Nigeria lack the institutional machinery needed for effective imposition

of income or corporation taxes.

27
The estimated coefficient of real exchange rate is positive and significant in the short and long

run. This study is consistent with the finding of Irungu (2015) but contradicts the negative result

showed by Olugbenga (2012). The positive relationship implies that when the naira depreciates

and local firms become more competitive which leads to an increase in their exports. This will

result in an ultimate increase in stock prices.

28
4. Conclusion and Recommendation

This study investigated the impact of public domestic debt on financial development in Nigeria

over the period 1983- 2017 using the ARDL regression model. It showed that public domestic

debt has a directly significant impact on financial development. The study concludes that Nigeria

can benefit from the increase in domestic debt by ensuring the development of her financial

sector considering the vital role which the sector plays in efficiently directing the flow of savings

and investment in the economy in ways that facilitate the accumulation of capital and the

production of goods and services. It also enables firms and households to cope with economic

uncertainties by hedging, pooling, sharing and pricing risks.

Against the core findings of this study, the following recommendations are put forward: First, the

government should ensure proper accountability of all borrowed fund while they are tied to

significant project that will serve the interest of the country. Second, the government should

enhance trade openness by improving infrastructure for logistics and communications needed for

trade and removing distortions in trade restriction. Third, the government should move against

the effect of increasing exchange rate by making the official foreign exchange available to

importers of industrial inputs, mostly importers of essential raw materials and plant and

equipment. Lastly, as a way to further emphasize the positive effect of public domestic debt on

financial development; the Nigerian government should integrate the Nigerian capital market

master plan into the country’s Economic Recovery and Growth Plan (ERGP).

29
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