IMPACT OF DEBT ON EXCHANGE RATE IN A SMALL OPEN ECONOMY

Abstract Purpose: This paper investigates the influence of public debt dynamics on exchange rate stability in Nigeria from 1981 to 2024, focusing on recent currency volatility after the adoption of a floating exchange regime. Methodology: The study utilized an ex post facto research design, employing quantitative secondary data from the Central Bank of Nigeria (CBN) and the Debt Management Office (DMO). An Autoregressive Distributed Lag (ARDL) model was specified to analyze the relationship among the Exchange Rate (EXR), External Debt Stock (EDS), Domestic Debt Stock (DSK), and External Debt Servicing (EDV). Findings: Long-run ARDL results demonstrate that External Debt Stock escalation significantly increases the exchange rate, confirming considerable currency depreciation. Conversely, External Debt Servicing exerts notable negative pressure on the exchange rate. Domestic Debt Stock showed a statistically non-significant long-term effect on EXR. Short-run evidence indicates that current EDS and lagged EDV values are positively and significantly linked to currency movement. The research concludes that elevated public borrowing, particularly external commitments, is a primary factor driving persistent Naira instability and devaluation. Unique Contribution: Theoretically, this study extends the ARDL application to Nigeria's debt-exchange rate nexus across four decades, capturing the floating regime transition and providing robust evidence on transmission mechanisms in a developing economy. For policy, it provides empirical evidence that external debt accumulation directly fuels currency depreciation, challenging assumptions about domestic debt's equal consequentiality. The findings urge the federal government to curb recurrent expenditure and prioritize infrastructure investment to diversify non-oil revenue. Practically, the research offers debt managers clear guidance: borrowed capital must fund ventures capable of generating economic returns to mitigate exchange rate pressures. The contrasting effects of external debt stock versus servicing provide nuanced insights for debt sustainability frameworks and offer policymakers clearer guidance on managing adjustment periods during fiscal reforms.