Peter Njiforti and  Mashin Muhammad

Department of Economics, AhmaduBello University, Zaria




The study set out to investigate the relationship between public sector borrowing and deficit financing on the one hand, and private sector saving and investment on the other, in the Nigerian economy.Statistics on these variables were sourced from appropriate Nigerian data banks. Econometric approaches were enlisted for data analysis and results formed basis for conclusions. 


Keywords:      Deficit financing, Private saving and investment,  Crowding in, Crowding out.



The economic significance of government deficits is commonly constructed in terms of their effects on private savings and investments (capital formation) in any given economy. Government deficits represent negative government saving, and this reduces the pool of savings available for investment by the private sector (Palley, 1996:1). Given that the theories of individual behaviour provide a complete set of inter-dependence within an economy and picture the implications of the demand-and-supply relationships among all economic agents in the system, the impacts of government spending (deficit spending) on private sector have constituted one of the central issues in empirical and policy debates (Badawi, 2002:2).



However, the economic growth and overall economic performance of Sub-Saharan Africa over the past decades have been described as “tragic” and of “crisis proportion” (Elbadawi and Mwega, 2000:415). To overcome this scenario, the World Bank measures the resource gap in sub-Saharan Africa (1986-1990) and found that, for it to continue with its progress toward economic growth and adjustment, low income Africa will need at least US$11 billion yearly in concessional flow during the period and allowing for known and expected aid commitment, a gap of US$2.5 billion existed. The World Bank also postulated that if Africa’s economic quagmire is to be reversed, more resources for investment (domestic and foreign sourced), efficient use of the existing resources and control of its population growth rates are imperative with additional resources from higher domestic private savings and investment in order to stimulate steady growth (The World Bank, 1986:2, 11).


As a result, the governments of Nigeria, since independence, have shown commitment through their increased expenditure as a measure to overcome the fundamental economic problems of unemployment, inflation, poverty, Balance of Payments (BOPs) problems and the desire to be the heart of Africa in the sphere of socio-political and economic activities. This has made the government sector directly responsible for a large part of economic activities and through its spending and resource mobilization, directly or indirectly influences the way resources are utilized in the private sector (Adedeji, 1969:46). Thus, the oil boom of 1970s impacted positively on government expenditure as a critical tool for translating the oil revenue into the bases for economic growth and development in Nigeria, accounting for over 20% of Gross Domestic Product (GDP) and hence government spending decisions become major key to macroeconomic stability. Therefore, the fiscal operations of government in Nigeria and its role in economic activities as postulated by Keynes cannot be overemphasized.


The international oil market glut of early 1980s, with government zeal to continued maintaining its planned expenditure level at the facet of falling revenues, resulted into chronic budget and BOPs deficits and huge debt burdens (Adubi et al, 1994:188-89 & 192-93). And an analysis of the fiscal operations of the Nigerian government have shown a continued huge deficit as its main features since the late 20th century (NCEMA, 1991) as cited by Adubi et al (1994:196).  But the issue of deficit financing has been much debated and historical division between the two main schools of economic thought: classical and Keynesian. While the classical economists suggest keeping public undertakings such as borrowing as minimum as possible due to crowding-out of private investment effect, the Keynesians see no harm in public borrowing in case of necessity. The Keynesian argument was based on the principle of the multiplier effect that explains how a change in the public expenditure generates a greater change in output. They however, were not unaware of the crowding-out effects of public borrowing. Keynes (1936) hinted at such effects in “The General Theory” by mentioning the multiplier limitation arising from possible adverse reactions on private investment (Majumder, 2007:2-5).



What happens to deficit finance in an open economy? Does it have crowding-out effect on the private investment? In this situation, an increase in demand for capital in an open economy due to government deficits has little effect on global demand and therefore little or no effect on interest rates. Any upward pressure on interest rates causes funds to flow-in from abroad, and crowding out of private investment in such a case is minimal. But the inflow of funds from abroad does have an effect as an increase in the supply of dollars will cause the Nigerian naira to appreciate; hence net exports are crowded out rather than domestic investment. But crowding out of net export will have repercussion on aggregate demand and thus a transcend effect on private investment.



Within the current trends of policy reforms in Nigeria in order to initiate private sector led-growth economy and the involvement of government in the domestic market to finance deficit over the years, an investigation into the impact  of deficit financing on private savings and investment is imperative. 


Public borrowing and deficit financing in Nigeria

In conformity with the orthodox method of operating public finances in the British colonies, it was a fiscal rule to follow closely the practice of generating budget surpluses or balancing the budget as the last resort which was made possible before independence due to budget and marketing board surpluses. But after 1960, coupled with reduction in the growth rate of tax revenue and greater acceleration in government expenditure, deficits resulted. Between 1965 and 1970 budget deficit increased from N48m to N465.6m, then decreased to N58.8m in 1972; mainly financed through domestic borrowing (24.7% in 1962, 44.1% in 1968) while foreign financing for the first time became significant in 1968 (69.39%). Domestic financing relative to other sources of financing rose from 27% in 1965 to 66.2% in 1969 and 49.8% in 1970. In a six years period (1964 – 1970), it financed almost 80.0% of budget deficits in Nigeria (CBN, 2007).


For the periods between 1986 and 2007, deficit ruled except for 1995 and 1996. In 1986, net domestic borrowing to finance deficit was N499.2m which increased to N8349.4m in 1987 among which commercial banks and non-bank public accounted for 39.2 per cent and 40.0 per cent respectively while foreign source was N708.1m in 1986 and N832.7m in 1987. Increased lending to the government by investors other than the Central Bank, particularly the non-bank public was attributable to enhanced yields on government securities. Despite the fact that surplus of N2100.00m was projected for the fiscal year 1992, it was the year of huge deficit which amounted to N44,158.5m, about 9.8 per cent of the GDP (about 23.5 per cent increase over the deficit of 1991), all of which were above 8.7 per cent recorded in the four year period (1988 – 1991) as compared to the acceptable bench mark of 3 – 4 per cent of GDP set under the SAP (CBN, 1987:81-83; CBN, 1992:59-61). This trend continued throughout the 20th century as shown in fig. 1 below.


Fig. 1: Deficit financing and public borrowing in Nigeria


Within the era of the 21st century, foreign sources of deficit financing in Nigeria became zero, specifically as from year 2000 and domestic source continued to dominate the financing of deficit. According to the estimated 2009 budget, a deficit of N1.09 trillion was to be incurred as the planned expenditure amounted to N2.87trillion while the derivable revenue was N1.78trillion. Given that the GDP estimate was N27.67trillion, the deficit was 3.95% of the GDP. This deficit was planned to be financed through application of the unspent balance of the 2008 budget of N330billion; Federal Government shares of signature bonus of N125billion; privatization proceeds of N100billion; returns from African Development Bank to the tune of N25billion; while domestic borrowing would be N449.7billion (40.61%); and foreign borrowing (International bonds) will be N62.5billion (New Nigeria, 2009:36).

But in order to meet with the global trend of growth and development, Nigeria has since 1986 implemented series of reforms so as to make private sector the engine room of growth and development (SAP of 1986; National Economic Empowerment and Development Strategy I and II (NEEDS I of 2004–2007; NEEDS II of 2008–2011); and 7-Point Agenda of 2007–2011). While on the other hand, the Central Bank of Nigeria has one time or the other adjusted Monetary Policy Rate (MPR) which is the strong determinant of the interest rate upon which the banking sector transacts business with the private sector of the economy. In other words, it is the rate that determines the cost of lending investible funds to the private sector for their business undertakings.


The financial crisis that began from United States of America (USA) in 2007 through 2009 has been called the worst financial crisis since the Great Depression of 1930s as it contributed to the failure of key businesses, declines in consumer wealth estimated to trillions of U.S. dollars, substantial financial commitments incurred by governments (increase deficit financing around the world).    One of the immediate reactions to this crisis, since 2008, has been a rescue plan by governments around the globe in order to reduce the long term effect of the crisis on the global economy (Dean, 2009:3; Amadeo, 2009:1 and, 2009:1). Since 2008, a US$700 billion and US$825 billion (US$1.525 trillion) bailout packages were passed into law in the US, US$850 billion in Britain, US$50.33 billion in Germany and N500billion in Nigeria (expected to hit N1 trillion) among others (Wikipedia, 2009a:3−4; Amadeo, 2009:1; and, 2009:1).  Nigeria’s deficit financing since year 2007 when the global financial crisis began, was N117.237 billion in 2007, N47.379 billion in 2009 and estimated to be over a trillion naira in 2009 (CBN, 2009:93).


One of the immediate consequences of the bailout/rescue plans was to escalate deficit financing of governments involved (abs-cbnnews, 2009:1) as shown in table 1 below.


Table 1: Bailout/rescue plans on global financial crisis






















% of GDP




















% of GDP




















% of GDP




















% of GDPt









       Kubarachi, 2009:2; abs-cbnnews, 2009:1; and Finance Counsels, 2009:2 – 4.

           ˔ Estimates and Projections.

       t Real GDP is used for Nigeria (CBN, 2008:118)




Methodology and data source

Data for this study are from secondary sources.  The variables considered include deficits, private savings, private investment, lending interest rate, amount of domestic and foreign borrowings to finance the deficits, foreign excess reserves and private disposable income. These data are obtained from the publications of Central Bank of Nigeria (CBN), National Bureau of Statistics (NBS), National Dailies, and the internet.


Private savings deposit with Deposit Money Banks (DMBs) is used as a proxy for private savings in Nigeria. The macro model of the form Ydp = Cp + Ip           and Ip = Ydp – Cp (where subscript p means private) is used for obtaining private investment as well. In obtaining Private Disposable income (Ydp) for Nigeria, National Disposable income has been decomposed. The technique used for the decomposition of national disposable income has been adopted from Jhingan (2003:28-30). In line with this and in accordance with the available data in Nigeria, social security (pension and gratuity) have been subtracted from while interest on public debt is added to the national disposable income and the result proxy to private disposable income.

More so, in order to observe common ratio of measurement all data, except those in percentages (interest rate, inflation rate, e.t.c) are expressed in terms of current purchaser’s value obtained from CBN and NBS publications.


Theoretical model

The Keynesian framework of deficit which is a short time static equilibrium analysis is used as the basis upon which the impact of deficit financing on private sector savings and investment in Nigeria is analyzed. In so doing, two sets of models are identified in accordance with the set objectives. Two models are independently specified- each for private savings function and investment function in order to analyze the effect of deficit on them in Nigeria:

Model 1:

St = α0 + α1Yt + α2Rt + α3Dt + α4ρt + ε1t ……………………………eqn1

Where Yt is private disposable income; Rt is savings interest rate; ρt is inflation rate; and Dt is deficit. α0…α4 are coefficient to be estimated and ε1t is the stochastic error term.

Hypothesis 1

H0: = 0,      i.e. Deficit financing has no impact on private savings in Nigeria.

H1: ¹ 0,      i.e. Deficit financing has impact on private savings in Nigeria.


Model 2:

It = β0 + β1Yt + β2rt + β3Dt + ε2t ……………………………………eqn2

Where It is private investment; rt is lending interest rate; Yt, Dt, and ε2t are as defined above. Β0…β3 are also coefficients to be estimated.


Hypothesis 2

H0: β3= 0,        i.e. Deficit financing has no effect on private investment in Nigeria.

H1: β3¹ 0,        i.e. Deficit financing has effect on private investment in Nigeria.


Determinants of deficit in Nigeria

Given that deficit has been recurring in Nigeria, deficit (DF) is taken to be a function of domestic borrowing (DMb), foreign borrowing (FRb), Private Consumption Expenditure (PCe), Capital Expenditure (CEe), Recurrent Expenditure (RBEe)  and external reserves (ERe), among others.


The choice of these variables are based on the fact that the Nigerian budget estimate is broadly divided into capital and recurrent expenditure; borrowing (foreign and domestic) and external reserves accounted for more than 98% of the financing sources (CBN, 2008:62−63) while the inclusion of private consumption expenditure is based on the argument for government deficit financing to enhance economic activities of a country during depression or economic down turns (Jhingan, 2003:646−655).


            DF = ƒ(DMb, FRb, PCe, CEe, RBEe ERe…)        …………………….eqn3

Model 3:

            From eqn3 above, the general representation is given as:

            Dt = α0 + α1DBt + α2FRt + α3PCE + α4CBE + α5RBE + α6ERt + ε1t        ……eqn4

Where t denotes time period

Hypothesis 3

H0: Ωi = 0,       i.e. Deficit is not being determined by any of these variables in Nigeria.

H1: Ωi ≠ 0,       i.e. Deficit is being determined by at least one of these variables in Nigeria.

Where Ωi = α1, α2, α3, α4, α5, α6.


A test for crowding-out effect

Another effect of deficit investigated is whether it crowds out private investment in Nigeria or not. In so doing, the relationship between interest rate and deficit as a proportion of gross domestic product (i.e. ) is examined. The positive sign implied a crowding-out of private investment or otherwise.


Results and discussions


The private savings and investments

Equation S1 to S6 (EqnS1 to S6) show the estimated model for private savings.  In order to maximize goodness of fit of the models, the incremental or marginal contribution of an explanatory variable which is an extension of analysis of variance (Gujarati, 2003:260-264) has been employed. The science and art of the application of this system requires either dropping off some variable(s) or adding new variable(s) (or both) to the model until goodness of fit improves. Hence, the application of the technique led to eqnS1 to eqnS6 for the saving function, and eq1I and eqn2I for the investment function.  Eqn D1 is the estimated deficit function.


(I)                The private savings estimated results

The estimated savings models are presented below:

D(PSAV) = −0.0143 + 0.1748D(PDIN) + 0.1102D(SAVDR) – 0.0270D(DFCIT) – 0.0109D(INFR)

      (-0.0644)        (2.3244)                 (0.8199)                        (−0.4862)                     (-0.6485) ……… eqnS1

R2 = 0.3609     R2 Adjusted = 0.1052  F-statistics = 1.4116     Prob (F-statistics) = 0.2991      DW = 2.25


D(PSAV) = 0.0012 + 0.1740D(PDIN) + 0.0954D(SAVDR) – 0.0318D(DFCIT) – 0.0086D(INFR) + 14.7572D(PHDS)

                (0.0044)            (2.1929)          (0.5611)              (−0.4824)          (−0.3778)                      (0.1569) …. eqnS2

R2 = 0.3626     R2 Adjusted = 0.0085  F-statistics = 1.0241     Prob (F-statistics) = 0.4580      DW = 2.28


D(PSAV) = 0.0229 + 0.1656D(PDIN) + 0.0524D(SAVDR) − 0.0347D(DFCIT) + 37.2450D(PHDS)

     (0.0969)        (2.2733)                   (0.4339)                        (−0.5551)                     (0.5346)           …………… eqnS3

R2 = 0.3525     R2 Adjusted = 0.0935  F-statistics = 1.3611     Prob (F-statistics) = 0.3144      DW = 2.32


D(PSAV) = −0.0180 + 0.1599D(PDIN) + 0.0671D(SAVDR) – 0.0181D(DFCIT)

     (-0.0830)          (2.2944)                 (0.5901)                       (−0.3444) ………………… eqnS4

R2 = 0.3340     R2 Adjusted = 0.1524  F-statistics = 1.8389     Prob (F-statistics) = 0.1984      DW = 2.32


D(PSAV) = −0.0694 + 0.1493D(PDIN) −0.0076D(DFCIT)

                    (-0.3598) (2.2800)               (-0.1585)     ………………………………………………………… eqnS5

R2 = 0.3129, R2 Adjusted = 0.1984, F-statistics = 2.7327 Prob (F-statistics) = 0.1052, DW = 2.33


D(PSAV) = 0.1487D(PDIN) −0.0056D(DFCIT)

                        (2.3512)                       (-0.1216)                     ………………………………………… eqnS6

R2 = 0.5255, R2 Adjusted = 0.5021, F-statistics = 5.7188, Prob (F-statistics) = 0.0326, DW = 2.30



(II)             The private investment estimated results

D(PVIN) = 1.3257 –3.8464D(PDIN) −2.1785D(LEND) −0.3433D(DFCIT)

             (0.4391)          (−3.2623)           (−2.6624)                (−0.4706)                        …………… eqnI1

R2 = 0.5407     R2 Adjusted = 0.4154  DW = 2.54       Fc = 4.3166

D(PVI N)* = −0.01314 −0.2296D(PVDIN)* −0.4541D(LEND)* −0.3254D(DFCIT)*

                     (−0.0974)        (−0.8815)                        (−2.4318)                     (−3.5256)         ……. eqnI2

R2 = 0.6387     R2 Adjusted = 0.5304  DW = 2.374     Fc = 5.8934



(III)          The Determinants of Deficit Financing

In meeting the second objective of this research study, the estimated result from the deficit determinant model is presented below:

D(DEFCIT) = 0.1159 + 0.9957D(DMBR) + 1.5102D(FRBR) + 0.0162D(PVCEXP) + 0.0372D(CBEXP) – 0.0633D(REBEXP)

                   (0.3632)    (7.1350)                       (3.2929)                       (0.6915)                          (0.3040)             (−0.3596)


                        + 0.0217D(FRRESV)

                                   (0.4543)                        ……………………………………………… eqnD1

R2 = 0.9577     R2 Adjusted = 0.9259              DW = 2.05                   Fc = 30.175


All the values in parenthesis in the equations above are the t- ratios.  Based on the savings function (eqn S1 to eqnS6), Private disposable income is found significant in explaining private savings in Nigeria. These equations indicate a positive relationship between private savings and private disposable income. This empirical findings supported the views established by Life-Cycle Income Hypothesis and the findings of Juster and Taylor (1975), Modigliani (1970), Madison (1992), Bosworth (1993), Caroll and Weil (1993), Schmidt-Hebbel, Sarven and Solimano (1996), Modigliani (1992), Jappeli and Pugano (1994), Edwards (1995), Collins (1991) and Uremadu (2006).  Savings deposit rate in eqnS1 to eqn S4 is found to be a positive function of private savings but is statistically insignificant in explaining changes in private savings in Nigeria. This empirical finding is in contrast with the findings of McKinnon (1993), Shaw (1993), Molho (1986), Balassa (1989), Soyibo and Adekanye (1991), Gupta (1970) and Chaudavarkar (1971) which argued that high interest rate induces savings. But the result is in harmony with the findings of Williamson (1968), Boskin (1978), Juster and Taylor (1975), Howard (1978) and Uremadu (2006) who found negative correlation between real interest rates and savings. The rate of inflation is inversely correlated with private savings in eqnS1 and eqnS2 but it is insignificant in providing explanations on the variations in private savings in Nigeria. However, the result is in contrast with the findings of Deaton (1977), Gylfason (1981) and Chete (1999) as they concluded that inflation creates a feeling of uncertainty and pessimism about the future and thereby encourages savings.


In eqnS6, deficit financing is negatively related with private savings in Nigeria although; it is statistically insignificant in explaining changes in private savings. This is in contrast with the findings of Vit (2003) and Ngongang (2007).  It therefore supports the crowding-out hypothesis.


In the investment equation (EqI1 and EqI2), Private disposable income is inversely related with private investment and is insignificant in explaining variations in private investment. The result is in contrast with the findings of Greene and Villanueva (1991) that private investment is a positive function of private disposable income.  Lending interest rate is also found to be negatively correlated with private investment and is statistically significant in explaining changes in private investment. But the result is in disagreement with the findings of Chhiber and Van Wijnbergen (1988) and Rossiter (2002).


An inverse relationship is found to exist between private investment and deficit financing in Nigeria and it is significant in determining the trend of private investment. This finding is in conformity with the Keynesian deficit theory adopted for this study. It states that as deficit financing increases, private investment would decrease as a result of the effect of interest rate. More so, it also supported the findings of Marshall and Schmidt-Hebbel (1994).  Hence both lending interest rate and deficit financing are inversely correlated with private investment and statistically significant in explaining changes in private investment in Nigeria, and consequently supported crowded-out  hypothesis as proposed by the theoretical framework adopted in this study.


In the deficit function (eqnD1), the individual variables; private consumption expenditure, capital expenditure, recurrent expenditure, and foreign reserve are all statistically insignificant. But domestic and foreign borrowings are statistically significant. This implies that domestic and foreign borrowings are the main determinants of deficit financing in Nigeria with domestic borrowing accounting for the largest share.


From the foregoing empirical investigations, it is found that deficit financing inversely affected private savings in Nigeria. This finding is contrary to the theoretical basis of the Classical and Keynesian) that deficit financing would encourage private sector to save more through interest rate inducement. But according to CBN (2007:25), savings deposit rate (SDR) has been 3% ≤ SDR ≤ 6% since 1997.


Deficit financing is also found to be negatively affecting private investment in Nigeria. This empirical result is in support of the theoretical argument that deficit financing increased lending interest rate as was verified from CBN (2007:25) and found that lending interest rate (LIR) was such that 16% ≤ LIR ≤ 25% since 1997. The margin between savings deposit rate and lending interest rate is as shown in table 2 below:


Table 2:           Interest rates for some selected periods


Savings Rate (%)

Lending Rate (%)

Range (Margin) %





















Source: CBN, 2007:25



Trend of deficit, private saving and investment in Nigeria.

Interest rate is the cost upon which the financial sector transacts business with the private sector. Savings deposit with the financial institutions attracts interest payment to the depositors while borrowers of funds from the financial sector are charged to pay certain interest, usually above what is being paid to the depositors. But deficit financing implies government dissaving, and in this case is sourced within and outside the economy. Table 3 below shows the summary of deficit financing, interest rates (savings and lending) domestic borrowing, private savings and investment


Table 3: Deficit and private sector in Nigeria (in N’m and %)


























































































































































            Sources: CBN Statistical Bulletin, Vol.18, No. December 2007.

                            NBS National Account of Nigeria (1981-2006).


From table 2  deficit increased from N39,532.5 million to N107,735.3 million in 1993, deposit rate also increased from 16.1% to 16.66% while lending rate decreased from 29.8% to 18.32%; consequently, both private savings and investment also increased within the period (which could be attributable to interest rates). When deficit decreased to N70,270.6 million in 1994, savings rate also decreased to 13.5% while lending rate increased to 21% and both private savings and investment increased within the period as well. Between 1995 and 1996 when deficit is N0.00 million, both interest rates decreased from 12.61% to 11.69% and from 20.18% to 19.74% respectively both private savings and investment are relatively stable. When deficit resumed in 1997 at N5,000.00 million with non-domestic borrowing and N13,382.6 million foreign borrowing, deposit and lending rates decreased from their previous level to 4.8% and 13.54% respectively.


Since 1997 through 2007, deposit rate has been less than 6% and in most periods, both deposit and lending rates move disproportionately. From this period, deficit failed to induce high deposit rates while lending rate is also not kept as low as deposit rate.

Implications drawn from these scenarios are: increased domestic borrowing coupled with decreasing lending rate results from significant foreign borrowing as shown between 1992 and 1993 which is N16,963.5 million in 1993 from N0.00 million in 1992. Deficit is then explained by domestic sources and/or increasing private disposable income (Ydp):  1998 – 99; Deficit ↑, domestic borrowing ↑, foreign borrowing↑, private investment ↑, private savings ↓, deposit rate ↓, and lending rate ↑.


Summary and conclusion

Deficit financing in Nigeria has been found to crowd-out private saving and  investment and due to its inability to influence savings deposit rate upward, savings have not been induced (instead, it reduces private savings) and therefore the complete effect of deficit operations fell on private investment. Private disposable income is found significant in determining private savings instead of deficit and interest rate as argued on the theoretical basis; and in relation to private investment, lending interest rate and deficit are major determinants. The wide margin between lending interest rate and savings deposit rate has made private savings in Nigeria insignificant to respond to deficit operations. Domestic source of deficit financing has become the major determinant of deficit financing and is highly positively correlated with deficit operations in Nigeria. 


Although, oil has been the bench mark of public budget, foreign reserve has no role in influencing deficit operations in Nigeria. The message transmitted from this finding domestic financing of deficit in Nigeria has been detrimental to private sector to effectively participate and take its position within the growth and developmental policy matrix.




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