CHAPTER ONEINTRODUCTION1.0 BACKGROUND OF THE STUDYIt is generally expected that developing countries, facing a scarcity of capital, willacquire external debt to supplement domestic saving (Malik et al, 2010; Aluko andArowolo, 2010). Besides, external borrowing is preferable to domestic debt because theinterest rates charged by international financial institutions like International MonetaryFunds (IMF) is about half to the one charged in the domestic market (Pascal, 2010).However, whether or not external debt would be beneficial to the borrowing nationdepends on whether the borrowed money is used in the productive segments of theeconomy or for consumption. Adepoju et al (2007) stated that debt financed investmentneed to be productive and well managed enough to earn a rate of return higher than thecost of debt servicingThe main lesson of the standard “growth with debt” literature is that a countryshould borrow abroad as long as the capital thus acquired produces a rate of return that ishigher than the cost of the foreign borrowing. In that event, the borrowing country isincreasing capacity and expanding output with the aid of foreign savings. The debt, ifproperly utilised, is expected to help the debtor country’s economies (Hameed et al,2008) by producing a multiplier effect which leads to increased employment, adequateinfrastructural base, a larger export market, improved exchange rate and favourable termsof trade. But, this has never been the case in Nigeria and several other sub-SaharanAfrican Countries (SSA) where it has been misused (Aluko and Arowolo, 2010). Apart9from the fact that external debt had been badly expended in these countries, themanagement of the debt by way of service payment, which is usually in foreignexchange, has also affected their macroeconomic performance (Aluko and Arowolo,(2010); Serieux and Yiagadeesen, (2001).Prior to the $18 billion debt cancellation granted to Nigeria in 2005 by the ParisClub, the country had external debt of close to $40 billion with over $30 billion of theamount being owed to Paris Club alone (Semenitari, 2005a). The history of Nigeria’shuge debts can hardly be separated from its decades of misrule and the continuedrecklessness of its rulers. Nigeria’s debt stock in 1971 was $1 billion (Semenitari, 2005a).By 1991, it had risen to $33.4 billion, and rather than decrease, it has been on theincrease, particularly with the insurmountable regime of debt servicing and the insatiabledesire of political leaders to obtain loans for the execution of dubious projects(Semenitari, 2005a).Before the debt cancellation deal, Nigeria was to pay a whopping sum of $4.9billion every year on debt servicing (Aluko and Arowolo, 2010). It would have beenimpossible to achieve exchange rate stability or any meaningful growth under suchindebtedness. The effect of the Paris Club debt cancellation was immediately observed inthe sequential reduction of the exchange rate of Nigeria vis-à-vis the Dollar from 130.6Naira in 2005 to 128.2 Naira in 2006, and then 120.9 in 2007 (CBN, 2009). Although thegrowth rate of the economy has been inconsistent in the post-debt relief period as itplunged from 6.5% in 2005 to 6% in 2006 and then increased to 6.5% in 2007 (CBN,2008), it could have been worse if the debt had not been cancelled.10However, the benefits of the debt cancellation, which was expected to manifestafter couple of years, was wiped up in 2009 by the global financial and economic crisis,which was precipitated in August 2007 by the collapse of the sub-prime lending marketin the United States. The effect of the crisis on Nigeria’s exchange rate was phenomenalas the Naira exchange rate vis-à-vis the Dollar rose astronomically from about N120/$ inthe last quarter of 2007 to more than N150/$ (about 25% increase) in the third quarter of2009 (CBN, 2009). This is attributable to the sharp drop in foreign earnings of Nigeria asa result of the persistent fall of crude oil price, which plunged from an all-time high ofUS$147 per barrel in July 2007 to a low of US$45 per barrel in December 2008 (CBN,2008).Available statistics show that the external debt stock of Nigeria has been on theincrease after the debt cancellation in 2005. The country’s external debt outstandingincreased from $3,545 million in 2006 to $3,654 million in 2007, and then to $3,720million and $3,947 in 2008 and 2009 respectively (CBN, 2009). It is therefore imperativeto examine the effect of external debt of the country on her economy for us to appreciatethe need to avoid being back in the group of highly indebted nations.