Nigeria: Inflation as tool to erode the foreign debt

The greatest threat and the major contributory factor in the undermining of a given economy and its currency is inflation. The monetary well being of a nation can go under and deteriorate drastically when inflation rears its ugly head and a once buoyant economy can become sickened with depressing currency, GDP and lower productivity. But in most cases Inflation could become a tool to erode the debt of a nation; a country with large domestic and foreign debts can utilize the inflationary trends to reduce the burden of its debts. In the 2006 negotiation for the payment and the final settlement of the Paris Club debt, Nigeria was granted the famous 18% write-off that reduced the debt. But the reduction that inflation could have offer was not wholly taken advantage by Nigerian negotiators. Inflation with regards to debt can be use to grind down a given debt. Nigeria do not have to be necessarily overjoyed and satiated with the 18% write off because net debt would have gone down to 45-50% by the application of inflation – debt ratio. The bad era of the double digit inflation would have be effectively utilized and applied to erode the country’s debt.

Nigeria would not be the first country to inflate away her debt; America did it during Great depression, Second World War and in 1970s debilitating recession. Renowned economists Joshua Aizenman and Nancy P. Marion stated in a paper that “Inflation can rise, eroding the real value of the debt held by creditors and the effective debt ratio.” Aizenman and Marion in the 2009 paper emphasized that “we examine the role of inflation in reducing the Federal government’s debt burden. We conclude that an inflation of 6% over four years could reduce the debt/GDP ratio by a significant 20%.”

Therefore we can extrapolate that Nigerian payment of the foreign debt in 2006 would have been way lower, the so-called 18% write off notwithstanding. Applying the model used by Joshua Aizenman and Nancy P. Marion, the Nigeria’s average inflation since the IMF’s structural Adjustment Program (SAP) to the time of the debt settlement was hovering between 15%-25% that will significantly and drastically reduced the total payments that Nigeria made to both Paris and London Clubs of Creditors.

In furthering thesis of the application of inflation as a tool to inflate away debt, it makes sense to understand what inflation is all about. According Economist Onosewalu Okhiria , “Inflation is one of the most frequently used terms in economic discussions, yet the concept is variously misconstrued. There are various schools of thought on inflation, but there is a consensus among economists that inflation is a continuous rise in the prices. Simply put, inflation depicts an economist situation where there is a general rise in prices of goods and services, continuously. It could be defined as .a continue rise in prices as measured by an index such as the consumer price index (CPI) or by the implicit price deflator for Gross National Product (GNP). Inflation is frequently described as a state where .too much money is chasing too few goods. When there is inflation, the currency losses purchasing power. The purchasing power of a given amount of naira (currency) will be smaller over time when there is inflation in the economy. For instance, assuming N10.00 (Nigeria unit currency) can purchase 10 shirts in the current period, if the price of shirts double in the next period, the same N10.00 can only afford 5 shirts.”

But it must be made perfectly clear that nothing good comes from inflation except the decimation of standard of living with surplus but devalue currency that do not worth the value in the paper it was printed on. This is not a new paradigm in economics where inflation is celebrated, but far from the truth, even with its debilitating effect it can reduce or wipe-off of a given debt. The people of Zimbabwe are testament to the disaster inflation can bring to a nation. The dire poor health of the economy caused by inflation makes lives unbearable. To buy a loaf of bread, one can carry cartoons of the worthless paper notes currency to do the purchase. Even some war historians argued that hyperinflation in the Weimar Republic were among the causative agents of the Second World making it possible for some Germans to become vulnerable to the manipulations of the Third Reich.

The payments and servicing of Nigerian foreign debts owned to both Paris and London Creditors did not happened for the first in 2006. Prior to the final settlements of debts to both international syndicates – Paris Club of Creditor and London Club of Creditors, Nigerian government in early 1990s have started to buy back Nigerian debts and Naira from foreign creditors. But finally the government of President Obsanjo took the initiative to payoff the debts owned to the creditors. Of course it was a good thing to settle the debt for it did help to booster the economy and stimulate the economy due to availability of disposable resources. By this Nigeria will use her resources she accumulated by saving not borrowing to stimulate her economy. The only issue was the payment she made to Paris Club of Creditors was a large sum of money, without putting into account the dynamics of inflationary trends that kicked in after Nigeria borrowed the money from foreign institutions.

In the paper by Joshua Aizenman and Nancy P. Marion on “Using inflation to erode US public debt” – the two academic intellectuals illustrated with graphs shown below how inflation was used to erode US debts in both scenarios of the during Second World War of 1940s/50s and recession of 1970s.

Nigerian government in the year 2006 paid almost $20 billion (including the human capital invested in the negotiation) to two giant international syndicates: Paris Club and London Club of Creditors to settle her foreign debts. The government of President Obasanjo, made the arrangement and secured the $18billion debt relief for Nigeria from the Paris Club of Creditors, and Nigeria pay off her $36 billion foreign debt. Nigeria’s total foreign debt stood at $35.916billion as of June 2005. The largest chunk of the debt $31billion was owed to 15 of the 19 creditor-countries of the Paris Club.

Nigeria paid off $12.4 billion in arrears and debts as was stipulated to fulfill arrangement and concord reached with the Paris club in June 2006. Nigeria paid the final installment of $4.518billion to exit the Paris Club.

Federal government of Nigeria finally paid off the last batch of outstanding debts owed to the London Club amounting to $2.15 billion. For the settlement of both Paris Club and London Club of Creditors, Nigeria paid off almost $20 billion. This is one of the largest transfers of wealth by a third world nation to the first world nations.

Recognizing the impact of inflation in the piece: “Understanding the Nigeria’s debt situation” the then Dr. Ngozi Okonjo-Iweal wrote: We have been implementing our own home grown reform program – NEEDS – and the results for last year have been quite positive. GDP growth was 6% compared to a 5% target. Average annual inflation came down from 22% to 15%, while point to point inflation (December to December) came down from 23% to 10%. This was not the single digit inflation we targeted but we came pretty close at 10%. The fiscal deficit at $25 a barrel was 1.9% of GDP, better than the 2.1% we targeted and the reserves recorded healthy growth again from $7 billion to $19 billion thus ensuring that our exchange rate remains fairly stable.”

By this she acknowledged the severity of inflation in the country and its disablement of the economy. Therefore the negotiators for settlement of Nigeria’s foreign debt must have made their case or override making the case of justifying lower settlement because of inflation.
But in some cases according to Professor Alan Auerbach of University of California, inflating away debt may not be possible because, “Sudden inflation can only inflate away the debt that is (1) not indexed, the way TIPS are; and (2)

not very short term (i.e., not T-bills), so that the interest rates cannot be reset to much higher rates that would compensate for inflation.” Nigerian foreign debt was not indexed against inflation; maybe all the conditional ties appropriated to the debt were not unearthed by the citizens of the country.

To further extrapolate the issue with regards to inflation, Nigeria final payment to both Paris and London Clubs would have been smaller had inflation-debt ratio
been applied.

Inflationary trends and inflation were devouring Nigerian economy in 1970s and 1980s and the era of oil boom notwithstanding. The Statistical bulletin of the Central of Nigeria was keeping statistics of the rate of inflation. In 1970s and 1980s inflationary trends were becoming explosive (1975 and 1984 were 33.9 and 39.6 respectively) except in 1972 and 1973 inflations were modest hovering between 3% – 5%.

Naira was very strong in 1970s and early 1980s even with high inflation. Why this scenario? Because of financial and economic mismanagement, incoherent and uncoordinated monetary and fiscal policies. Together with overtly importation as Nigeria became the center of the dumping of foreign made commodities. It does look like that the party will last forever but then comes the oil bust and the crash of the oil price. Nigeria went on borrowing insanity to appease her spending appetite. Then it happened: IMF stepped in with its structural adjustment programs that encourages the devaluation of the naira. At this juncture inflation shoots up to 22%. Therefore, Nigerian negotiators would have exploited the inflationary paradigm tool to grind down Nigeria’s debt; probably the final payment to the foreign creditors in 2006 would have been half or even one third of what was paid to the foreign syndicates.

Written by
Emeka Chiakwelu
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