Root Causal Effects of Federal Government Bond on the Negativeness of Budget Balances

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Published on International Journal of Economics & Business
Publication Date: August, 2019

Sarah Eno Effeh
X-Vone Ltd.
Wusasa, Zaria, Nigeria

Journal Full Text PDF: Root Causal Effects of Federal Government Bond on the Negativeness of Budget Balances.

The objective of this paper is to explain that politico – economic factors usually influences macro-economic decisions in the Nigerian economy. Some of these factors were discussed theoretically. They are corruption, general public opinions on government debts and investing plans. The data employed for five two-stage-least-square analyses were the five bond rate types. These are 3-year, 5-year, 7-year, 10-year and 20-year bond rates. Other data used are budget deficit, federal government bond and a dummy to represent debt management office’s (DMO) existence. DMO is a federal management office for all bond issues and repayment strategies. The analytical tools employed here were, 2-stage-least-square, permutations and combinations. The decisions that occur here may or may not be supported by the private sector and the investing public. The Ricardian equivalence proposition was used to also explain what most members of the populace are more concerned about, their welfare and that of their descendants. Currently, DMO assists the federal, state and corporate big names to float bonds as far as New York and The United Arab Emirates. The findings are the federal budget deficits is an insignificant factor when deciding when or when not to float more bonds. The permutation and combination analysis showed that even welfare of the Nigerian populace do not constitute a good reason for choice of bonds to float at any time. The private investing public will support bond policies that favor them too not just the federal, state government and corporate big names only.

Keywords: Bond rates, Investing Public & Nigeria.

According to Alison et al (2003) in Onyeiwu (2012), the main reason for government internal borrowing is to finance budget deficits. Other reasons are for implementing government policy and to deepen the financial sector. Despite the purposes for internal borrowing, public debts as a whole, according to Kumar and Woo (2010) in Presbitero (2010) reduces annual per capita GDP growth. Their analysis involved 38 advanced and emerging economies where financial markets are developed with strong macroeconomic policies. Thus Reinhart and Rogoff (2010b) in Presbitero (2010) concerns about the growing public debt in several low and middle income countries cannot be over emphasized.
Nigeria falls into the category of low income countries and with an economy that is mono-cultural, she is susceptible to price shocks in the international market. This is because her exports are dominated by primary products. The structure of the Nigerian public debt has changed because domestic debt is now higher than the external debt which led to the series of discussions on debt forgiveness. As at 2006 public domestic debt was N1.75trillion. By 2010 and 2011 it had risen to N4.55trillion and N5.62trillion respectively. In December 2012, the value of public domestic debt was N6.5 trillion. However external debt as at 2004 (when foreign debt crisis was really eminent thus attracted favorable response from the Paris Club Creditors) was N4.89trillion which is lower than the current level of domestic debt. Debts, whether domestic or external, have similar effect on the economy.
The main difference is that external debt is from foreign sources and can lead to capital flight during repayment periods and domestic debt leads to redistribution of income to holders of debt instruments within the economy. Domestic debt is considered more dangerous than foreign debt because (according to the current Finance Minister, Dr Okonjo-Iweala in Thisday, (2012) in the case of a default, the economy could be adversely affected since the bond holders would not have the needed cash to invest in the economy and create opportunities for the people. Thus it does not matter which type of debt is being exploited over the other since they are both sovereign debt and can lead to problems of debt over-hang. Despite the vast increases in the value of government debt it is still considered to be less than the international borrowing threshold of 40% for developing countries, Eromosele (2012).
Also, Chiraerae (2010) in Kaara (2010) mentioned that domestic debt borrowing leads to the crowding out of domestic investors, reduces banks drive to mobilize deposits and lending to other sectors and enhances liquidity risks. Thus increased government borrowing from the domestic debt market can spell doom for the economy even though the country is still within the borrowing threshold earmarked by the International Monetary Fund (IMF).
In addition, Onyeiwu (2012) observed that economic growth does not support domestic debt growth. This implies that economic growth can be achieved in Nigeria without high dependence on internal borrowing. However, Rahaman (2012) observed that Nigerians see borrowing as inevitable and sacrosanct to economic growth. Thus no matter the envisaged benefits of domestic borrowing, internal debts has a deleterious effect on citizens through the crowding out of the real sector and the equities market. Furthermore, the government’s high expenditure of borrowed funds on consumption causes interest rates and inflation to rise to the detriment of the economy.
Despite all this, the Debt Management Office still encouraged the Federal Government to sell FGN bonds to Nigerians in diaspora because, according to them this will diversify investor base. One of the major objectives of the DMO is to create and implement a sustainable plan for efficient management of Nigeria’s external and internal debts obligations at levels that are compatible with the desired economic activities for growth and development. With the current levels of internal debt (N 6.5 trillion as at December 2012) the economy is clearly unstable, with poor private sector performance and escalating rates such as exchange, inflation and interest rates. In the light of all this issues at stake, the main thrust of this paper is to show that, political reasons affect macro-economic decisions bordering on the time and reason for floating federal government bonds.

The Ricardian Equivalence proposition, postulates that increases in debt financed government spending does not influence consumption in the economy. This is because consumers will not increase spending with the extra income at their disposal from current tax cuts. They will rather save the excess and leave bequests to their children against future rise in taxes. Thus this proposition assumes that agents are rational and foresighted and will prefer to take care of their descendants’ utilities as well as their own thus they will not increase consumption in the current period. It also assumed that there is free access to the credit market, therefore agents will decide their consumption based on permanent income which is not affected by the timing of taxes (Barro, 1974 in Mueser and Kim, 2003).
These key points emphasize the existence of Ricardian equivalence between taxes and debt implying that in a perfect Ricardian equivalence case, a reduction in government saving due to tax cuts is fully offset by increased private saving- causing aggregate demand to remain unchanged. Therefore, interest rates, consumption, investments and all other variables associated with growth will not be affected. Thus increase in government domestic debts will leave the economy in the same situation as it was before the introduction of debt financed government expenditure.
Based on the frame-work upon which the Ricardian equivalence proposition is analyzed, it could be rejected or accepted. Generally, according to Riccuiti (2001) the Ricardian equivalence proposition is usually rejected when tested on the frame work of the life cycle hypothesis and accepted when examined under optimizing models. For instance, Modigliani and Jappelli (1987) in Riccuiti (2001) tested the Ricardian equivalence proposition against the life-cycle hypothesis which was re-formulated for inflation between 1860 and 1982.
Based on the estimated savings function it was possible to reject the Ricardian proposition and accept the other despite the fact that they shared similar consumption functions. Nicoletti (1988) in Riccuiti (2001) estimated the growth rate of consumption as a function of the expected real interest rate, the wealth to consumption ratio and the income to wealth ration both lagged one period, both the expected and the unexpected growth of net labor income, and the growth rate of public consumption. The main result, for the period 1961-1985, is that the debt neutrality hypothesis could not be rejected and there is a virtually complete discounting of future taxes. The main ground for critics of this theory is that the proposition is workable only when the agent will live forever. Also, critics argue that if parents know that the taxes will be increased after they die they will reduce their savings and expend more. Barro (1974) in Mueser and Kim (2003) contradicts this by emphasizing that parents are more concerned about their children’s welfare when taxes will be increased to cover the deficits and thus will save more in the present, for that period.
There are issues that could result in the general populace losing confidence in the federal government borrowing strategies. The proactive integrity reviews to safeguard bank funding commented that, “Investigations conducted by PIAC – African Development Bank, office of Integrity and Anti-Corruption, into allegations of fraud, corruption and other sanction-able practices in Bank-financed projects and useful insights for strengthening the preventive mandate of the department. One such example is the existence of red flags in project implementation which, had they been addressed, could have prevented the act under investigation from occurring”. Bossman (2015/2016).
According to PIAC – African Development Bank, office of Integrity and Anti-Corruption, report from the desk of the Director in person of Anna Bossman, “Corruption remains a threat to development tin Africa and poses a risk to achieving the Bank’s High Five priorities. It diverts resources away from the provision of public services, reinforces discrimination and hinders sustainable economic development. To mitigate the risks of corruption, PIAC remains committed to prevent, detect and investigate acts of corruption and misconduct towards ensuring that Bank resources are properly safeguarded and used for their intended purposes.”
Menocal et al (2015) noted that the following facilitates corruption, “A variety of economic, political, administrative, social and cultural factors enable and foster corruption ; Corruption is collective rather than simply individual, going beyond private gain to encompass broader interests and benefits within political systems; Corruption is a symptom of wider governance dynamics and is likely to thrive in conditions where accountability is weak and people have too much discretion ; It is this collective and systemic character of corruption that makes it so entrenched and difficult to address ; Democracy does not in itself lead to reduced corruption”. Based on the findings of Bossman (2015/2016) funded by African Development Bank and Menocal et al (2015) funded by United Kingdom Department for International Development (DFID), it is necessary to mention some possibilities that could be theorized within economies of the world.
This theoretical issue has to do with how private investment is regarded – as the main key to growth. The argument here is that individuals will go to any length they can afford to secure their funds for the reason they chose them for, irrespective of what the government chose to do with theirs; as postulated by the Ricardian equivalence supporters. That is why private firms are in court over stolen patents, funds, personalities. Apple and Samsung were in court for over 10 years due to adjudged stolen patent design of one of apples’ most successful wireless products, Apple i-3(nytimes com).
According to Bakare (2011) “…policy makers believe that private investment has a stronger and more favorable effect on growth than public investment…”. Theoretically let us assume that corruption clause can be represented by a basic surd, . This type of surd, stands for the simplest form a surd that cannot be broken down further, Talbert, Godman, Ogum (2008). This can be used to signify that some problems within the society and economy at large cannot be eradicated but can be reduced to the particular minimum it can be over looked, till time of discovery elapses.

PuB → BeD { is contained in BeD} (1)

where, PuB is public Borrowing and BeD is Budget Deficits. If < PuB, corrupt officials could cause unfinished projects to be dominant across the economy. When > PuB then BeD > Y where, Y is productive output from the economy. What happens if ≈ PuB is determined by the delay associated with getting away with the whole loot. Two of the factors Bakare (2011) mentioned as a determinant of private domestic investment (PDI) are savings rate and the inflation rate as a proxy for macroeconomic instability. In addition to this, based on the analysis of the fiscal, monetary and growth process, PDI is given by:
PDI = f (CPS, MLR, PLR, INF) (2)
MLR = Maximum lending rate
PLR = Prime lending rate
INF = Inflation Rate
Credit to private sector (CPS) is a major factor determining private investment within the country because it is the amount of net credit that is available to the private sector to borrow for investment. Also, the rate at which savings is incurred within the economy also affects private investment due to the fact that it also determines net domestic credit (NDC). The rates of interest on loans are also a key determinant to private investment. The two key rates are the maximum lending rate (MLR) and the Prime lending rate (PLR). Prime lending rate is the rate at which banks lend to prime customers while the maximum lending rate is the rate at which banks extend credit to perceived risky customers (Alawiye, 2012). Thus factors determining these rates are:
PLR = f (CPS, M2, MPR, INF) (3)
MLR = f (PLR, M2, INF, MPR) (4)
MPR = Monetary Policy Rate
The above discussion and equations show that it is risky to be a borrower in Nigeria as a private investor. Thus, avenues for the general public to invest into bond issues with their own savings should be encouraged, first. A different theoretical inclination has to do with the factors that affects Y in the Nigerian economy. The inflation rate in the country has a powerful influence on growth because it erodes the purchasing power of money in the hands of everybody within that geopolitical area. Fatukasi (2004) explained that the main determinants of inflation in Nigeria were fiscal deficits (BeD < 0), money supply (M2), maximum lending rates (MLR) and exchange rate (EXR). The exchange rate is also influenced by high Inflation rate and Interest rate differentials. Obi (2010) in his analysis, also concluded that increased productivity (Y), foreign exchange reserve (FER), investment to GDP ratio and the degree of openness of the economy are also determinants of exchange rate. Thus the factors influencing exchange rate and inflation rate can be represented below to show the relationship monetary policy rates (MPR) has with these two variables as: INF = f (BeD, M2, MPR, MLR, EXR) (5) EXR = f (Y, INF, MPR, M2) (6) Equations 2 to 6 above, are guided by the findings of (Garba 1995a and Garba 1995b). These issues counteract the purchasing power of borrowed funds after corruption factors have stolen, misappropriated and hedged up monies belonging to the federal government and the total populace. Investing with borrowed funds means contending with the corrosive power of inflation and the limiting influence of the current interest rate on borrowing.

The application of secondary data is paramount here and the chosen econometric analysis is 2-stage least square regression. As agreed in Effeh and Dangiwa (2019), the dataset chosen for the analysis have been subjected to relevant tests to ascertain their characteristics and have been found to be qualified for this type of analysis. They are federal government bonds, budget deficits, 3year bond rate, 5year bond rate, 7year bond rate, 10year bond rate and 20year bond rate. The inclusion of a dummy is to show the significance of the institutional efforts and changes within the Nigerian Financial sector as argued out by Garba, Njiforti and Effeh (2019). The two-stage-least-square analytical models can be represented below as follows: – FGB = a0 + a1BR03 + a2BuD + a3FGB-1 + a4DMO + Ut0 (7) FGB = b0 + b1BR05 + b2BuD + b3FGB-1 + b4DMO + Ut1 (8) FGB = c0 + c1BR07 + c2BuD + c3FGB-1 + c4DMO + Ut2 (9) FGB = d0 + d1BR010 + d2BuD + d3FGB-1 + d4DMO + Ut3 (10) FGB = e0 + e1BR020 + e2BuD + e3FGB-1 + e4DMO + Ut4 (11) The a priori expectations for all the coefficients of key explanatory variables within equations 7 through to 11, will be greater than or less than zero. To be more precise than this is affected by socio economic dispensation of the current political parties that constitute the ruling government. The 2-stage-least-square is part and parcel of the methodology and the modeling at the same time. The data needed to be analyzed appropriately, econometrically, before the rules of permutations and combinations can be used to select the most appropriate model(s). The table below is the tabularized results of the 2-stage-least-square analysis for five federal government bond types. These are differentiated by their bond rates. Beginning from model one through to model five, they are namely, 3year bond rate, 5year bond rate, 7year bond rate, 10year bond rate and 20year bond rates respectively. Table 1 below showed the results of the estimation of models one through to five, using the 2-stag- least-square-technique. All the models have an R2 value of 99%. This shows that 99% of variations in federal government bonds are explained by variations in all the explanatory variables. These are DMO dummy, budget balance, 3year, 5year, 7year, 10year, 20year bond rates and federal government bonds in the previous year. The adjusted R2 of the five models are (0.99) show that all the models are a good fit. The F-statistic values explain that the independent variables jointly and significantly explain variations in Nigerian federal government bonds in the five models. Table 1 Summary of estimation results for models 1 – 5 Independent Variable → FGN bonds Model 1 Model 2 Model 3 Model 4 Model 5 Constant 3585.745 -4689.046 -1213.881 -18438.87 4204.570 DMO 73872.48 1312083 843696.3 1746919 85701.40 Budget Def. 0.076728 0.89738 -0.020726 -0.397179 0.094046 3yr bond rate 19553.48 – – – – 5yr bond rate – -70802.91 – – – 7yr bond rate – – -43363.79 – – 10yr bond rate – – – -98072.67 – 20yr bond rate – – – – -51231.54 FGB(-1) 1.349963 1.07861 1.236736 0.789540 1.776012 AR(1) – – – – -0.136178 R2 0.997144 0.995334 0.996752 0.993471 0.997480 Adj. R2 0.996787 0.994750 0.994750 0.992628 0.997098 F-statistic 2793.096 1707.632 2453.603 1186.461 2611.387 4. DISCUSSION The AR(1) process was necessary for the fifth model – 20year bond model. The AR (1) process is also referred to the Cochrane-Ocrutt correction mode. This signified that the fifth model is more volatile than the first, second, third and fourth models. Based on feasibility the first four models are more marketable than the fifth one. The AR (1) process enlightens us on the need to invest with minimal risks. The risk here is politically inclined. One term of government rule in Nigeria is four years. Plans are being made to reduce this to two years. To monitor and improve a policy by yourself as a president, it is possible only during your tenure in Nigeria. Policies with 20 – year implementation gap may be abandoned. There are five models. One is volatile. There are 5P4 x 5P3 x 5P2 x 5P1 = N —————————————————-(12) Where, N is the number of times the first four models can be selected based on marketability per time. Based on the results of the 2-stage-least-square models tabularized above, the combination models that are also appropriate, are: – = 5C4 ————————————————————(13) = 5C3 ————————————————————(14) = 5C2 ————————————————————(15) 5C1 ————————————————————(16) assuming three to four bond models are ‘sociable’ enough to encourage public participation. Sometimes two or even one model may be sufficient. Equation 13 refers to four bond models and equation 16 refers to only one bond model. The most marketable is the first model. The coefficient for 3-year bond rate is positive. This signifies that with more Federal government 3-year bond issues the higher the interest rate, as long as there is no government ‘ceiling’ on that particular interest rate. The other bond rates have negative coefficients. The federal government prefers to promote the 5-year bond rate more due to the significance of the coefficient of budget deficit in model two. The rest are also promoted. Effeh (2019) commented on information asymmetry associated with Nigerian bonds generally. When to take advantage of the bond market is determined by who you know and not what you have to pay with. The results in the table above, emphasize the fact that government securities are for investors that will tolerate low interests. The majority of the bond models analyzed in this paper, promotes lower bond rates with higher number of issues that are over-priced. To attract investors with higher rates are necessary, sometimes. Budget deficit does not significantly impact on FGN bonds in any of those models. Rather, the tendency to float more FGN bonds is informed demand for bonds within the bond market. Garba, Njifort and Effeh (2019) purported that there are some political issues that influences economic decisions at higher levels of government within the Nigerian state that could make it difficult to enforce borrowing limits.

From the analysis carried out so far, the existence of the debt management office and the budget deficit are the major cause of increases in domestic debt. This implies that apart from the fact that government expenditure is quite high in relation to the nation’s earnings and government is borrowing heavily to make up the difference, the DMO’s issuance of FGN bonds far exceeds the need to borrow. At present, FGN bonds make up the largest share of public domestic debt in Nigeria. According to a communiqué by the trade and exchange department of the Central Bank of Nigeria, the restriction placed in February, 2007 on foreign investors from investing in FGN bonds and Treasury Bills that have a maturity of less than one year has been removed as at June 2011. Thus, foreigners are now free to purchase and trade in FGN bonds and Nigerian Treasury bills irrespective of their maturity dates. This implies that substantial aspects of public debt, recorded as public domestic debt are partly, government external debt. There is need to address the ‘visiting’ investing public with care. The federal government has a mandate that can be exploited to improve business climate within this economy. This should encompass the interests of the public that are qualified to vote within the Nigerian economy.