This study has attempted to investigate the relationship between fiscal deficit and private domestic investment using Nigerian data from 1981 – 2014. The study employed OLS technique to estimate the relationship and the Engel and Granger two step methods to establish the long run dynamics. It was discovered that private domestic investment is positive and statistically significant in explaining government fiscal deficit and there exist a long run relationship between both variables. It was thus recommended that Government should encourage domestic investors through giving incentives like lower interest rate in order to boost investment as this will lead to improvement in the fiscal deficit position in Nigeria.
1.1 BACKGROUND OF THE STUDY
According to Faith and Yunus (1990, as cited in Sayan and Abiola, 2015) the term of fiscal deficit can be defined as the difference between budget revenue and budget expenditure. Budget revenue includes three important components which are tax revenue, tax-exempt revenues and private revenues. Budget deficit is an economic technique of overcoming depression; it represents the government’s expenditures which exceed the revenue generated (Awe and Folanyo, 2014).Fiscal deficit arise because public spending rises while revenue remains unchanged, or tax revenue falls while public spending remains unchanged, or tax revenue falls while public spending rises (Onwioduokit, 1994, as cited in Sayan and Abiola, 2015). Deficit financing seems to present a negative impact on investment in developing economies especially Nigeria. When there is a budget deficit, government finds ways of financing the deficit through borrowing from commercial banks or from non-banking public and through the issue of short term bonds and monetary instrument. The use of these forms of deficit financing for the pursuit of fiscal policies often leads to crowding out of private investment, inflation and increase in debt (Paiko, 2015).
Deficit usually occurs as a result of government inability to match the tax revenue and expenditure. The deficit is financed either through borrowings (domestically or foreign) or use of foreign reserve to settle the deficit. By borrowing it means the government has to agree on the terms payments which usually are attached with strange regulations. Hence, this will perpetrate the deficit as more money will be spent by government on servicing the debt which creates more expenditure and deficit. Persistence of this many result to high and variable inflation, debt crisis, with crowding out of investment, growth and macro – economic imbalance in general (Paiko, 2012).
In the less developed countries including Nigeria, budget deficits have been blamed for much of the decrease in private investment that retarded economic activities in the 1980’s, the financing of budget deficit through the sale of bonds which increased public debt and caused the debt crisis in the 1980s; high inflation and the poor economic performance (Asogwa and Okeke, 2013). Whether the borrowing is external or internal, it has both beneficial and catastrophic effect on certain macroeconomic variables and the overall economic performance. This twin effect makes budget deficit a major issue of strident concern to both developed and developing nations (Rock, 2001).
For a period of over four decades (1970 – 2014), the fiscal operations of the Nigerian government resulted in surplus in only six (6) years. Specifically, these surpluses occurred in 1971, 1973, 1974, 1979, 1995 and 1996. As at 1986, the federal nominal fiscal deficit stood at N8.3billion or 11.3 per cent of GDP. The deficit/GDP ratio was 5.4 per cent in 1987, 8.4 per cent in 1988, and 6.7 per cent in 1989. The ratio jumped to 11.0 per cent in 1991 and 15.5 per cent in 1993. The fiscal deficit grew by 58 per cent between 1985 and 1986. Between 1991 and 1992, the deficit grew by 60.9 per cent, increasing to 86.2 per cent in 1998. Between 1999 and 2006 (CBN, 2006), the deficit/GDP ratios were 8.4, 2.9, 4.7, 5.6, 2.9, 1.7, 1.1 and 0.6 per cent, respectively and from 2010 to 2014 the deficit/GDP ratio were -2.04, -1.83, -1.37 0.00, -1.10 respectively (CBN, 2014).
The crowding out effect of budget deficit on private investment has been fuelled to a large extent by government policies that have resulted in a persistent overshooting of the budget deficits and also by the measures employed to finance the growing deficits (Asogwa and Okeke, 2013). The Nigerian government has a bad record of fiscal discipline and has been addicted to fiscal deficits since the period of independence. It is generally agreed in the literature that investment stimulates growth within a market economy; as a result private sector investment no doubt remains the engine of growth with the public sector providing the enabling environment (Kalu and Mgbemena, 2015). It is worth noting that it is argued that public capital expenditure crowds out or crowds in private capital investment, depending on the relative strength of two opposing forces: (1) as a substitute in production for private capital investment, public capital expenditure tends to crowd out private capital investment; and (2) by raising the return to private capital investment, public capital expenditure tends to crowd in private capital investment (Saleh, 2003).
It is against this background that this study sets to investigate the relationship between fiscal deficit and domestic investment in Nigeria.
1.2 STATEMENT OF THE PROBLEM
Chronic government budget deficits and escalating government debt have become major concerns in both developed and developing countries (Saleh, 2003).There have been a theoretical debate regarding the relationship between private investment and increasing public expenditure, the neoclassicist considers individuals planning their consumption over their entire life cycle. By shifting taxes to future generations, budget deficits increase current consumption and also assuming full employment of resources the neoclassical school argues that increased consumption will lead to decrease in savings, increase in interest rate to equilibrate the capital markets and thus a decline in private investment. In contrary there are Keynesians who provide a counter argument to the crowd-out effect by making reference to the expansionary effects of budget deficits. They argue that usually budget deficits result in an increase in domestic production, which makes private investors more optimistic about the future course of the economy resulting in them investing more. This is known as the “crowding-in” effect. Finally, there is the Ricardian equivalence approach advanced who argues that an increase in budget deficits, say due to an increase in government spending, must be paid for either now or later, with the total present value of receipts fixed by the total present value of spending. Thus, a cut in today’s taxes must be matched by an increase in future taxes, leaving interest rates, and thus private investment, unchanged
Some literature, as cited in Saleh (2003) [e.g. Bailey (1971); Buiter (1977); David and Scadding (1974); Premchand (1984); Yellen (1989); Barro (1990); among others]asloPaiko (2012) and Asogwa and Okeke (2013) has focused on the relationship between private investment and public expenditure mainly because of the crowding out effect of public spending. Some of these studies, such as Premchand (1984), assert that financing the budget deficit by borrowing from the public implies an increase in the supply of government bonds. In order to improve the attractiveness of these bonds the government offers them at a lower price, which leads to higher interest rates. The increase in interest rates discourages the issue of private bonds, private investment, and private spending. In turn, this contributes to the financial crowding out of the private sector.
Thus to investigate which of this is the Nigerian case the study investigate impact of fiscal deficit on private investment using Nigerian data.
1.3 RESEARCH QUESTIONS
The above problem statement gave rise to the following research questions;
- Does fiscal deficit have any relationship with domestic investment in Nigeria?
- What is the long run effect of domestic investment on fiscal deficit in Nigeria?
1.4 RESEARCH OBJECTIVES
The broad objective of this study is to determine the relationship of between fiscal deficit and domestic investment in Nigeria. The specific objectives are thus stated as;
- To empirically establish a relation between fiscal deficit and domestic investment in Nigeria.
- To evaluate the long run effect of domestic investment on fiscal deficit in Nigeria.
1.5 RESEARCH HYPOTHESES
The hypotheses to be tested in the cause of this study are stated as;
- HO: there is no relationship between fiscal deficit and domestic investment in Nigeria.
- HO: there is no long run effect of domestic investment on fiscal deficit in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
Every research work is expected to be of relevance to a set of people or group of persons. Thus for this work, it is expected to explain the relationship between government fiscal deficit and domestic investment in Nigeria thus will be very useful to the government since it will enable them to know how well or how bad their fiscal policy affects the activities of private investors and the domestic investment of the nation.
To the investor it will be of help since it will expose to them the dangers and the benefits of a government fiscal deficit and enable them make investment decisions for economic growth. It will act as a yardstick to make investment plans, analyses and economic cum financial investment plans as well as decisions that will boost the GDP and encourage private domestic investment.
To students and researchers, it will stimulate further research and act as a research reference material.
1.7 SCOPE OF THE STUDY
This research is expected to encompass the relationship between Government fiscal deficit and private domestic investment in Nigeria for the period of 34 years (1981-2014).
1.8 DEFINITION OF TERMS
DEFINITION OF TERMS
BUDGET: this is a plan of action for the whole organization, a state or an establishment. It is a financial or quantitative statement prepared and approved prior to a defined period of the policies to be pursued by the government.
PUBLIC DEBT: this is the totality of debt owed both internally and externally by the government of a country.
INTERNAL DEBT: these are debt owed by the government to the resident of a country.
EXTERNAL DEBT: these are debt owed to overseas government and international institutions.
FISCAL DEFICIT: this is the excess of government planned expenditure over its expected revenue as is being stated in its proposed budget.
DOMESTIC PRIVATE INVESTMENT: this is the total investment made by local investors of a given country.