Impact of Domestic Banking Sector Debt Financing on Debt Servicing in Nigeria: The Role of Inflation, Fiscal Deficit and Exchange Rate

Abstract

This study investigates the asymmetric effects of domestic borrowing, inflation, exchange rate movements, and fiscal deficits on Nigeria’s debt servicing dynamics between 1982 and 2024. Using the Nonlinear Autoregressive Distributed Lag (NARDL) framework, the analysis distinguishes between the positive and negative shocks of macroeconomic variables to capture potential asymmetries in their short- and long-run impacts. The results reveal that increases in domestic borrowing from the banking sector significantly intensify debt servicing obligations, while reductions in borrowing provide limited relief, consistent with the debt overhang hypothesis. Similarly, inflation and exchange rate depreciations exert stronger upward pressure on debt servicing costs than the corresponding benefits of disinflation and currency appreciation, emphasizing structural rigidities in Nigeria’s fiscal and external debt management. Fiscal deficits also exhibit a persistent long-run effect, reinforcing the twin deficit hypothesis. Diagnostic tests confirm the robustness of the model. Thus, the findings highlight that adverse financial and macroeconomic shocks have disproportionate larger effects on Nigeria’s debt sustainability than favorable movements. The study concludes with policy recommendations advocating for prudent debt management, exchange rate stabilization, inflation control, and institutional fiscal rules to mitigate asymmetric debt servicing pressures.