External debt, institutional quality and economic growth in Nigeria

Abstract

The study examined the effect of external debt on economic growth; evaluate the role of institutional quality; determine the direction of causality; and establish the threshold of external debt relative to GDP for the Nigerian economy. Secondary annual time series data with key variables like economic growth (proxied by GDP), external debt (proxied by external debt outstanding), and institutional quality (proxied by six World Governance Indicators, including Voice & Accountability and Control of Corruption), financial development, human capital, and trade openness were included. The data were sourced from the CBN, World Bank, and World Governance Indicators, and were analyzed using advanced econometric techniques, specifically the Vector Error Correction Model (VECM) and a Nonlinear Threshold model. The analysis revealed that external debt has a positive and significant effect on economic growth in both the short and long run in Nigeria. Additionally, institutional quality also has positively impacts on economic growth. Causal analysis showed unidirectional causality running from economic growth to external debt, from institutional quality to external debt, and from economic growth to institutional quality. Crucially, a critical external debt-to-GDP ratio of 5.4822% was established as the threshold for the Nigerian economy. From the results, external debt can stimulate growth in Nigeria, particularly when combined with improved institutional quality (e.g., better rule of law and corruption control). However, to achieve rapid and sustainable economic development while avoiding debt servicing burdens that constrain future investment, the Nigerian government should explore alternative infrastructure financing mechanisms. It is recommended to shift reliance from huge external debt to Public-Private Partnership (PPP) models such as Build-Operate-Transfer (BOT) and similar arrangements.