INTRODUCTION
Problems statement
Over the past three decades, particularly since the 1950s, financial deficits have been widely accepted, with external borrowing seen as a necessary solution for national capital shortages Many countries, especially developing nations, have turned to foreign capital to address significant current account deficits stemming from insufficient savings and investment The situation escalated in 1982 when Mexico declared its inability to service its debt, marking the onset of a severe global debt crisis This crisis highlighted the critical issue of external debt, where a country's liabilities surpass its ability to repay loans, raising concerns about its impact on economic growth.
Policymakers and economists closely examine the relationship between external debt and economic growth to assess its impact and underlying causes As developing countries increasingly engage in globalization and integration, they face a heightened risk of debt crises due to easier access to foreign loans.
In 1985, the risk associated with external debt was characterized as explosive, highlighting its potential threat to the entire economy This concern has consistently remained a significant issue in development economics, making external debt a timeless topic of research for economists and policymakers alike.
Developing countries often face fiscal deficits that necessitate borrowing, primarily from international lenders, due to their underdeveloped private sectors and banking systems This reliance on external sources for capital creates a significant correlation between external debt and economic growth, making it a focal point for research Without a thorough understanding of this relationship and its implications, policymakers may struggle to effectively address the challenges of economic growth in their nations.
Some countries view external debt as a catalyst for economic growth, but this can lead to a debt crisis, as evidenced by Amoateng and Amoako-Adu (1996), who identified a positive correlation between GDP growth and debt service Conversely, other nations fear the burden of debt and limit external borrowing, which hampers their ability to generate economic growth due to insufficient capital.
External debt significantly hampers private investment and economic growth, particularly in developing economies, as highlighted by the debt overhang theory and the crowding out effect When external debt exceeds the borrowing country's economic scale, it creates a capital deficit that restricts private investment and leads to reduced economic growth rates Moreover, relying on exports to service this debt can detract from income-generating activities, further negatively impacting growth However, it is important to acknowledge that external debt can also provide essential capital inputs that may enhance economic growth Therefore, understanding the relationship between external debt and economic growth is crucial for developing countries to implement effective policies that stimulate and sustain their economic development.
Research objectives
This study investigates the relationship between external debt and economic growth in selected developing countries using panel data over a fixed period It aims to determine whether this relationship is positive or negative and explores the possibility of both linear and nonlinear associations, drawing on insights from previous empirical research.
Scope of study
Developing countries often face the challenge of external debt while striving for sustainable economic growth While numerous studies have examined the effects of external debt on the economic growth of specific countries or regions over time, there is a notable lack of comprehensive research covering multiple areas Additionally, much of the existing literature tends to focus on how external debt influences investment and savings, rather than directly analyzing its relationship with economic growth.
Despite numerous studies on this topic in the past, there is a scarcity of recent research that delves into the details of the issue This study aims to investigate the nature of the relationship by examining a sample of two representative developing countries from Africa, Latin America, and Asia: South Africa, Nigeria, Mexico, Brazil, Vietnam, and India The analysis will cover a 20-year period from 1990 to 2009.
Structure of thesis
This thesis is structured into five chapters, each addressing critical aspects of external debt's significance in relation to economic growth It will outline the problem statement to emphasize the importance of this relationship, define the main research objectives to identify key areas for investigation, and establish the scope of the study to delineate the research sample.
Chapter 2, titled "Literature Review," consists of two primary sections The first section provides a theoretical overview, examining the theories and hypotheses regarding the relationship between external debt and economic growth, supported by relevant models and citations The second section emphasizes empirical studies, exploring the relationship and associated determinants, along with citations and concise findings from prior research.
Chapter 3 outlines the research methodology, beginning with a brief overview of the practical problem It then delves into the development of the econometric model, providing a detailed description of the data and clarifying the variables involved in the analysis.
Chapter 4 presents the results from regression with a descriptive statistic dataset Some discussions can be generated in the process of looking back and comparing with the literature review
Chapter 5 concludes the findings and discusses the policy implications regarding the relationship between external debt and economic growth, highlighting the necessary actions to take in this context.
LITERATURE REVIEWS
Empirical Literature Reviews
Numerous empirical studies have explored the relationship between external debt and economic growth, yielding various findings that can be categorized into three main groups The first group demonstrates that external debt can positively impact economic growth up to a certain threshold In contrast, the second group highlights the negative effects of high levels of external debt on economic growth The third group suggests a nonlinear relationship, indicating that the effects of external debt on growth are complex and can vary Additionally, some studies have found no significant relationship between external debt and economic growth at all.
Several studies indicate a positive correlation between external debt and economic growth up to a certain level Chowdhury (1994) explored the relationship between external debt and economic growth through Granger causality tests conducted on Asian and Pacific countries from 1970 to 1988 Using GDP as the dependent variable and considering independent variables such as debt payment, inflation, interest rates, and agricultural labor, the study revealed that increases in GDP are associated with higher levels of external debt, and overall, external debt does not adversely affect economic growth.
A neo-classical model was utilized by Gerald Scott (1994) to examine the relationship between external debt and economic growth, analyzing cross-sectional data from 31 Sub-Saharan African countries The study identified GNP per capita as the dependent variable, while independent variables included exports, domestic capital, technology, imports, and exchange rate, revealing a positive impact of external debt on growth at certain levels In contrast, Schclarek (2004) analyzed data from 59 developing and 24 industrial countries from 1970 to 2002, finding no evidence that external debt affects total factor productivity (TFP), but suggesting that low levels of external debt may correlate with favorable economic growth rates, indicating a positive relationship between low debt and economic growth.
Numerous empirical studies highlight a negative correlation between external debt and economic growth, establishing this topic as a focal point of research This study will explore this relationship further For example, Iyoha (1999) employed a macro-econometric model using a simulation approach, analyzing both the Growth and Investment Equations to assess the impact of external debt on economic growth in sub-Saharan African countries from 1970 to 1994 The findings supported a negative relationship, aligning with the debt overhang theory and the crowding out effect.
Sachs, Cohen and Sachs, and Krugman explored the relationship between external debt and economic growth during the 1980s debt crisis, utilizing debt overhang theory models Adepoju et al (2007) specifically examined this relationship in Nigeria, highlighting the detrimental effects of external debt on the country's economic growth rate.
1962 to 2006, by using the simultaneous model with time series data, Adepoju
Research has shown that external debt significantly hampers economic growth in various countries In Nigeria, a study from 2007 concluded that the accumulation of external debt has historically restricted economic progress Similarly, Hameed et al (2008) examined the impact of external debt servicing, capital stock, and labor force on Pakistan's economy from 1970 to 2003, revealing a negative correlation between external debt and economic growth, primarily through reduced capital and labor productivity Furthermore, Maureen Were (2001) analyzed GDP growth rate determinants and found that factors such as inflation, fiscal deficit, and debt-to-GDP ratios negatively affected growth, while public and private investments and human capital development positively contributed to economic advancement.
(positive) with time series data of Keyna A negative relationship between external debt and economic growth was found as final result
A study conducted by T.K Jayaraman and Evan Lau (2008) analyzed panel data from 14 Pacific Island Countries between 1988 and 2004 to investigate the relationship between external debt and economic growth In their analysis, real GDP was treated as the dependent variable, while external debt, exports, and budget deficit served as independent variables, revealing negative impacts from external debt and budget deficit, alongside a positive influence from exports Additionally, Pattillo's (2004) empirical research, titled "What Are the Channels Through Which External Debt Affects Growth?", examined data from 61 developing countries from 1969 to 1998 This study established a growth-accounting framework, concluding that high levels of external debt hinder economic growth by impeding physical capital accumulation and the growth of total factor productivity (TFP).
Recent empirical studies have increasingly highlighted the nonlinear relationship between external debt and economic growth For instance, Elbadawi et al (1997) utilized fixed and random effects panel data to analyze this relationship, revealing a nonlinear impact of external debt on economic growth that aligns with the debt Laffer curve, which includes a critical threshold Their findings indicated that both linear and quadratic forms of the debt-to-GDP ratio were significant in the regressions, identifying a growth-maximizing debt-to-GDP ratio of 97 percent.
Patillo et al (2002, 2011) employed various estimation methods, including OLS, Fixed effects, and GMM system, to establish a nonlinear relationship between external debt and economic growth using panel data from 93 developing countries Their subsequent research (Patillo et al., 2004) explored the channels through which external debt negatively impacts growth, revealing that one-third of this effect is due to physical capital accumulation, while two-thirds arise from total factor productivity growth (TFP) The study, covering the period from 1969 to 1998, indicated that the detrimental impact of external debt on growth occurs when its net present value (NPV) surpasses 160–170 percent of exports and 35–40 percent of GDP.
Reinhart and Rogoff (2010) pioneered research on estimating debt thresholds and their effects on economic growth Their study employed various econometric techniques to explore both linear and non-linear relationships between external debt and growth The findings revealed a direct negative correlation between debt and initial growth in linear estimations, while non-linear analysis identified a critical threshold of 90% debt-to-GDP ratio, beyond which external debt significantly hinders growth This suggests that, unlike manageable debt levels, high external debt adversely affects economic performance The relationship between external debt and economic growth is characterized by an inverted U-shape, indicating that while increases in external debt up to the threshold can enhance growth by facilitating capital accumulation, surpassing this threshold leads to the risk of debt unserviceability Consequently, the negative impacts of debt overhang emerge only after crossing a specific threshold, resembling the Debt Laffer Curve.
The debt threshold curve identifies point A as the critical level where external debt impacts economic growth in two distinct ways To the left of A, external debt positively correlates with economic growth, as each unit of debt yields a marginal productivity that meets or exceeds the costs of principal and interest payments, as noted by Cline (1985) Conversely, to the right of A, external debt negatively affects economic growth, as interest and principal repayments can deter private investment and alter public spending Increased external interest payments may exacerbate a country's budget deficit, leading to diminished public savings Upon reaching point B, the net present value (NPV) of external debt not only trends downward but also turns negative, indicating a detrimental contribution to economic growth.
Numerous empirical studies reveal three distinct perspectives on the relationship between external debt and economic growth Despite this, ongoing research continues to explore the complexities of external debt's impact on economic development.
Contribution of external debt to economic growth rate
The Net Present Value (NPV) analysis of external debt in relation to exports and economic growth reveals no significant relationship, particularly in the case of Kenya, one of the Heavily Indebted Poor Countries (HIPC) Were (2001) examined the debt overhang issue, utilizing time series data from 1970 to 1995, and found no evidence supporting either a positive or negative impact of debt servicing on economic growth; however, the study did confirm some crowding-out effects on private investment Similarly, Warner (1992) analyzed data from 13 developing countries over two periods, 1960-1981 and 1982-1989, and also failed to establish any empirical relationship between external debt servicing and economic growth.
RESEARCH METHODOLOGY
Overview of external debt and economic growth in developing countrieS
Before delving into the research methodology, it is essential to briefly examine key aspects of external debt and economic growth in developing countries The current state of external debt can be effectively summarized in the following table, providing a clear overview of the situation.
Table 3.1: External debt and GDP in main areas of developing countries
External debt GDP Debt / GDP Export Turn over
The global issue of external debt has escalated rapidly, particularly affecting developing countries in Asia, Latin America, and Africa These nations are grappling with the challenge of achieving sustainable economic growth while managing their rising debt levels, creating a difficult dilemma in balancing debt and growth In Asia, external debt saw a significant increase dating back to the 1990s, driven by the pursuit of economic growth through foreign loans.
In 1991, the debt-to-GDP ratio was around 19%, climbing to a peak of 35% within seven years (World Bank Statistic Yearbook, 2010) The tightening of interest rates by the US Federal Reserve in 1994 led to a withdrawal of funds from Asian developing countries, forcing governments to abandon their currency pegs to the dollar due to insufficient foreign reserves This situation resulted in challenges related to currency devaluation and the inability to meet debt service obligations.
In 2008, Asian developing countries aimed to limit their external debt to GDP ratio to 15%, but the global financial crisis led to significant capital misallocation and economic stagnation This situation compelled these nations to seek external capital to support their economic recovery efforts Initially viewed as a catalyst for growth, excessive external borrowing has since become a substantial debt burden, as many countries now struggle with repayment capabilities The challenge of managing external debt poses a potential crisis, particularly when the relationship between external debt and economic growth remains unclear Consequently, developing countries, including Vietnam, face heightened risks associated with short-term external debt exposure.
In 2011, Vietnam faced a significant level of short-term external debt, similar to India and Indonesia, which posed a risk of exposure to external shocks Despite not experiencing a debt crisis, as the external debt remained within acceptable limits relative to foreign reserves, underlying risks persisted Additionally, economic growth in these countries showed a downward trend accompanied by various challenges Asian developing nations continue to grapple with external debt issues and their effects on economic performance Consequently, it is crucial for policymakers and economists to carefully consider the relationship between external debt and economic growth.
The external debt crisis has long been a significant issue for developing countries in Latin America, particularly highlighted by Mexico's inability to service its debt in the 1980s This event marked a dark period for economic growth and national stability across the region Many developing nations at that time struggled with substantial external debt, largely due to a lack of understanding of the relationship between debt and economic growth, which hindered their ability to accurately assess its impact Consequently, several countries, including Ecuador, faced debt restructuring and defaults.
Since 1999, countries like Brazil and Mexico have prioritized the issue of external debt, closely linking it to their economic performance and fiscal balance Policymakers have increasingly recognized the significant relationship between external debt and economic growth, making it a focal point in their economic strategies.
Developing countries in Africa have long faced challenges related to external debt, often borrowing due to insufficient physical capital while struggling with limited repayment capabilities This has led to a debt overhang, stifling economic growth In 1983, Africa's external debt exceeded $150 billion, and by the peak of the debt crisis in the 1990s, over 40% of export earnings were allocated to debt servicing Sub-Saharan African nations particularly depend on foreign loans as part of their development strategies, resulting in a gradual accumulation of unsustainable debt levels For instance, external debt surged from $18 billion in 1975 to over $200 billion by 1995 In South Africa, the external debt-to-export ratio surpassed 300%, compared to an average of 200% for other African countries Consequently, economic growth in these developing nations remains stagnant due to the persistent effects of debt overhang and crowding out.
External debt and economic growth are closely interconnected, particularly in developing countries facing high levels of debt overhang, which can lead to negative economic impacts In such scenarios, the primary motivation for acquiring external loans is to address the initial lack of physical capital investment.
Analytical Framework
The economic performance of a country, represented by the function Y = Af(K,L) according to the Cobb-Douglas model, is influenced by various factors Each factor, capital (K) and labor (L), has its own determinants, expressed as K = H(Debt, X), where H and Z represent additional unlisted influencing factors This system of equations highlights the connection between external debt and economic growth, demonstrating their interrelated impact on a nation's economy.
Economic growth is influenced by various factors beyond external debt, as highlighted in previous literature To understand the relationship between external debt and economic growth, it is essential to establish a framework that clarifies the selection of specific variables for regression analysis All determinants are interconnected with economic growth, illustrating how external debt fits into the broader context This framework serves as a foundational flowchart of ideas, guiding the construction of an econometric model.
Figure 3.2 Extenal Debt and Economic Growth Framework
This article explores the relationship between economic growth and its determinants, particularly in the context of external debt Key factors influencing economic performance include capital and labor, with investment serving as a vital source of capital input and technology transfer Education, represented by years of schooling, contributes to human capital, while savings, imports, and exports are also significant drivers of economic growth Additionally, external shocks, such as inflation, impact economic performance, emphasizing the importance of the external context Lastly, fiscal policy plays a crucial role in guiding the economy and correcting market imbalances to meet targeted goals.
External debt plays a crucial role in the economic growth cycle, directly influencing capital availability and posing repayment challenges that can hinder growth Countries often rely on export revenues to manage interest payments on their external debt, highlighting a significant connection between external debt and export performance, particularly in developing nations While the debt service burden is anticipated to have a negative impact on economic growth, the overall relationship between external debt and growth remains ambiguous An econometric model will be developed to explore the nature of the external debt issue further.
The Econometric Model
This study will utilize the model established by Pattilo et al (2002) to explore the relationship between external debt and economic growth, alongside the Barro Growth Model (2003) which examines the determinants of economic growth The primary regression equation employed in this analysis aims to reveal the connection between debt levels and economic growth outcomes.
Where :Y i,t is the dependent variable which is GDP per capita or LogGDP (in logged term) to represent for economic growth rate
Then, D i,t is the debt variable includes
External Debt Stock in logged term ; and
Total debt services as percentage of GDP to represent for the capabiltity of servicing debt
Finally, X i,t represents the set of explanatory variables, including tthe set of determinants of growth (capital, human capital, macroeconomic environment and fiscal gap)
Investment: represents for the capital input as well as technology input;
Initial GDP: Log of GDP per capita in year t-1 which represents for the benchmark value of economic growth is based on Growth Model of Barro
Schooling: the number of years in secondary grade represents the education for human capital;
Inflation: represents for macroeconomic shock ;
Openness (exports plus imports over GDP): covers the impact of import and export on GDP
Expenditure (government’s expenditure): covers the effects of the fiscal policy due the government’s expenditure can affect the government’s fiscal budget
Savings: plays as a key determinant of economic growth in function : Y = C +I + G + NX (net export)
Equation (1) tests the linear relationship between debt and economic growth Additionally, we explore the potential for a nonlinear relationship by employing a quadratic specification to identify the critical point at which external debt begins to affect economic growth.
This study investigates the potential inverted-U relationship between external debt and economic growth, hypothesizing that the coefficient δ should be negative We aim to mathematically determine the threshold at which external debt begins to negatively impact growth, calculated as -γ/2δ A negative δ is essential for establishing a quadratic function resembling the Laffer Debt Curve, as discussed in the literature Conversely, a positive δ indicates the absence of this nonlinear relationship, suggesting a U-shaped correlation between external debt and growth, which contradicts existing literature Consequently, the focus will shift to exploring the linear relationship in detail in Chapter 4.
Data
This study analyzes panel data from six representative developing countries—Mexico, Brazil, South Africa, Nigeria, India, and Vietnam—over a 20-year period from 1990 to 2010 These nations were selected due to their significant external debt issues, reflecting the challenges faced by Latin America, Africa, and South Asia In the context of global economic conditions, these countries, including Vietnam, are critically examining the relationship between economic growth and external debt to formulate effective development policies Data for this research was gathered from various reputable sources.
4.2 Summary table of variables and data source
This study analyzes data from 1990 to 2009 across six countries and twenty time periods, focusing on GDP as the dependent variable to measure economic growth Key independent variables include investment to GDP, population, and education, represented by years of schooling, to assess human capital Additionally, GDP per capita from the previous year serves as a proxy for policy stability, while the openness index and inflation reflect trade and macroeconomic fluctuations that influence sustainable growth rates.
The analysis incorporates external debt metrics, specifically the ratio of external debt to exports and the overall external debt service A detailed summary of the calculations and data sources is presented in the table below.
Table 3.2: Summary of Descriptive Variables
Dependent variable Description/Calculation Data source
LogGDP GDP in year t World Bank databases
Independent variable with expected sign
External debt stock (in logged term)
Global Development Finance dataset (WB + IMF statistics)
Total external debt service (+/-) Debt indicator (% GDP) Global Development
Initiial GDP GPD per capita in year t-1 (in logged term)
WB Database + Penned World Table 7.1
Investment (+) Private and Public Investment (%
International Finance Corporation (IFC) Savings (+) Savings as a share of GDP WB Database
The sum of exports of goods and services and imports of goods and services as a share of GDP
Inflation (-) Macroeconomic indicator (%) WB databases
Schooling (+) The percentage of secondary schooling education as a whole WB databases
Expenditure (+) Total government’s expenditure as a share of GDP (%)
The analysis reveals that, aside from the debt indicators with an ambiguous sign, the control variables can be categorized as follows: investment and income positively influence economic growth, while population growth negatively impacts it, and schooling also has a positive effect These findings align with the literature on the role of physical and human capital accumulation in enhancing Total Factor Productivity Additionally, terms of trade, openness, and inflation reflect the external shocks experienced in the international market Lastly, government expenditure serves as a key indicator of the influence of fiscal policy on economic stability.
Estimation Approach
Popular estimation techniques for panel data include Ordinary Least Squares (OLS), Fixed Effects, Random Effects, and Generalized Method of Moments (GMM) The choice of method depends on assumptions regarding intercepts, slope coefficients, and error terms There are several scenarios: i) OLS is used when intercepts and slopes are constant across countries and years; ii) a one-way fixed effects model applies when slopes are constant but intercepts vary by country; iii) a two-way fixed effects model is used when slopes are unchanged but intercepts differ across countries and time; iv) a random effects model is appropriate when both intercepts and slopes vary across countries; and v) a one-way random effects model is utilized when both intercepts and slopes change across countries and time.
This study will sequentially employ the OLS method and FIX/RANDOM model to determine the most suitable approach Additionally, various tests will be conducted to refine the model for optimal results Initially, a linear equation will be utilized to identify the best model, followed by the application of a quadratic equation.
RESULTS
Descriptive Statistic Data
The complete dataset comprises of 120 observations over the period of 1990-
2009 from 6 countries including: Brazil, Mexico, South Africa, Nigeria, India and Vietnam The ten variables can be summarized statistically in a table like below:
Table 4.1 Summary Statistics of Variables
Panel data enables researchers to control for unobservable variables such as cultural influences and varying business practices, as well as time-varying factors like national policies and provincial regulations, thereby accounting for individual heterogeneity By integrating time series with cross-sectional observations, panel data provides more informative insights, increased variability, reduced collinearity among variables, enhanced degrees of freedom, and improved efficiency (Gujarati, 2003).
Econometric Results
The results of the regression analysis, including Ordinary Least Squares (OLS), Fixed Effects Model (FEM), and Random Effects Model (REM) for both linear and quadratic equations, are consolidated in a single table for easy reference The linear equation was evaluated using OLS (with and without dummy variables), followed by the application of Fixed Effects and Random Effects methods A Hausman test was conducted to determine the more appropriate model, ultimately leading to the selection of FEM as the most suitable option Consequently, Fixed Effects were applied to the quadratic equation Additionally, tests for multicollinearity and heteroskedasticity were performed to validate the chosen model.
After applying various regression methods, we have compiled a summary table for easier monitoring and comparison of results The table includes coefficients and standard errors, which are indicated in parentheses For more detailed regression results, please refer to the tables in the Appendix Following the summary table, we will discuss specific analyses and presentations in detail.
Table 4.2 Summary of Regresssion Result
Results Expression
In this study, various techniques for analyzing panel data are explored, including Ordinary Least Squares (OLS), Fixed Effects, and Random Effects models, to investigate the relationship between external debt and economic growth The Fixed Effects Model (FEM) is identified as the most effective approach Initially, a linear analysis is conducted to determine the appropriate technique, followed by the application of a quadratic function to further examine the relationship between external debt and economic growth.
3.1.1 All coefficients are constant across time and individual
Using the Ordinary least squares (OLS) method to estimate the function of logGDP as follows: (see table 1 in Appendix)
LogGDP = 17.4060 + 0.1365 logexternaldebt + 0.7457 realGDP + 0.0745 investment - 0.0009 inflation -0.0147 schooling - 0.0241 openess + 0.2891 expenditure + 0.0418 savings +0.0007 totaldebt service - 0.4987 populationgrowth + u it (eq1)
The OLS regression results indicate that out of eleven coefficients, seven are statistically significant, while the primary variable, logexternaldebt, shows no significance with a value of 0.1365 This suggests that the intercept and slope coefficients may not account for variations over time and space Additionally, the coefficients for certain variables, such as schooling, openness, and total external debt, display unexpected signs As a result, the findings from this method highlight potential issues, prompting the need for alternative approaches to achieve more reliable outcomes Consequently, a deeper analysis of these results is not warranted, and attention should shift to the findings from other methods.
The fixed-effect model effectively accounts for all time-variant differences among individuals, ensuring that the estimated coefficients remain unbiased by omitted characteristics such as culture, religion, gender, and race This approach enhances the reliability of data analysis by controlling for these influential factors (Kohler et al., 2nd ed., p.45).
The fixed-effects technique assumes that individual characteristics may influence or bias predictor or outcome variables, necessitating control for these factors This leads to the assumption of a correlation between the entity's error term and predictor variables Importantly, the omitted variables must have time-invariant values and effects (Oscar Torres-Reyna, 2007) By excluding the impact of time-variant variables, the fixed-effects model allows for a clearer evaluation of the net effect of the predictors.
Using the Fix-effects method to estimate the relationship of economic growth and external debt for the function like OLS as follows: (see table 3 in
LogGDP = 23.7580 - 0.1416 logexternaldebt + 0.7369 realGDP + 0.0229 investment - 0.0007 inflation + 0.0116 schooling -0.0015 openess - 0.0015 expenditure + 0.0074 savings - 0.0050 totalexternaldebt service - 0.3475 populationgrowth + u it ( eq3)
The analysis reveals that all anticipated variable signs are accurate, and numerous variables demonstrate statistical significance Consequently, this model will be retained as the final selection prior to exploring alternative regression techniques.
The random effects model operates under the assumption that variations across entities are random and not correlated with the predictor variables included in the model (Green, 2008) This approach posits that the error term for each entity is independent of the predictors, enabling time-variant variables to serve as effective explanatory factors.
Using the Fix-effects method to estimate the relationship of economic growth and external debt as follows: (see table 4 in Appendix)
LogGDP = 17.4060 – 0.003427 logexternaldebt + 0.7457 realGDP - 0.0009 investment - 0.0147inflation - 0.0241 schooling - 0.0241 openess + 0.0289 expenditure + 0.0418 savings + 0.0007 totaldebt service - 0.4987 populationgrowth + u it ( eq4)
The analysis of Table 4.2 and the details in Appendix Table 4 reveals a significant difference between the fixed effects and random effects techniques, particularly in the signs of key variables such as schooling, openness, expenditure, and investment Unlike the fixed effects model, the random effects model shows contrary signs for these variables, resulting in fewer statistically significant outcomes Consequently, selecting the appropriate technique for analyzing panel data is crucial, typically involving a choice between fixed effects and random effects models.
3.1.4 Choosing between Fixed Effect Model (FEM) or Random Effect Model (REM)
The Fixed Effects Model (FEM) controls for variables that do not change over time, such as country group dummies, rather than estimating their effects In contrast, the Random Effects Model (REM) estimates the effects of time-variant variables but may produce biased results due to unaccounted omitted variables To decide between FEM and REM, the Hausman test is conducted to evaluate the null hypothesis (H0) that the estimations from both models are identical.
The Hausman test results indicate a significant difference between Fixed Effects Model (FEM) and Random Effects Model (REM), as the p-value (Prob>chi2) is 0.0000, which is less than the 0.05 threshold Consequently, FEM is deemed more suitable for this analysis, and its results will be utilized for further examination in this study.
After exploring the linear relationship by regressing the function: Y i,t = αX i,t
We aim to investigate the potential non-linear relationship between external debt and economic growth, building on insights from previous empirical studies To achieve this, we utilize a quadratic equation: Y i,t = αX i,t + γD i,t + δD 2 i,t + u i,t, which allows us to analyze the dynamics of this relationship Additionally, we apply the Fixed Effects Model (FEM), recognized as the most suitable regression technique, to our quadratic function to ensure accurate results.
Using the Fix-effects method to estimate the relationship of economic growth and external debt as follows: (see table 6 in Appendix)
LogGDP = 26.7426 - 3.8621 logexternaldebt + 0.7276 realGDP + 0.0229 investment - 0.008 inflation 0.0115 schooling + 0.0015 openess – 0.0015 expenditure + -0.0079 savings + 0.0073 totaldebt service - 0.051 populationgrowth + 0.0051 logexternaldebt_squared +u it ( eq5)
The study examines the nonlinear relationship between external debt and economic growth, anticipated to resemble a U-inverted shape akin to the Laffer Debt Curve For this U-inverted curve to hold, the coefficient δ before the squared external debt variable must be negative However, the analysis reveals a statistically positive coefficient of 0.0051 for log external debt squared, indicating that no U-inverted nonlinear relationship exists within the data range analyzed Consequently, the research shifts focus back to a linear relationship, emphasizing the economic implications of the linear model using the Fixed-effects technique.
3.3 Tests for correcting the chosen model - FEM
After selecting the Finite Element Method (FEM) as the primary model for analysis, it is essential to conduct tests to ensure the model's accuracy This study focuses on two key tests: the multicollinearity test and the heteroskedasticity test, both aimed at enhancing the model's reliability.
The analysis of the data indicates that multicollinearity is not present, as evidenced by a variance inflation factor (VIF) of 4.22, which is below the threshold of 10 Therefore, the dataset is deemed suitable for providing reliable results for economic analysis and evaluation.
The analysis for heteroskedasticity, as presented in Table 8 of the Appendix, indicates the absence of error heteroskedasticity Utilizing the xttest3 command within the fixed effects technique, the null hypothesis (Ho) asserting the presence of heteroskedasticity was evaluated The findings revealed a Prob>chi2 value of 0.0122, which is less than the significance level of 0.05, leading to the rejection of the null hypothesis.
After all, the technique Fixed effects for linear function (eq 3) is quite fit for generating and analyzing the reults
3.4 Analyzing the estimation results and economic meanings of chosen model - FEM (eq3)
The fixed effect model shows an adjusted R² of 92.28%, indicating a strong fit, as it explains approximately 92.28% of the variation in GDP through key explanatory variables such as Logexternaldebt, Real GDP, Investment, Inflation, Schooling, Openness, Expenditure, Savings, Total Debt Service, and Population Growth Furthermore, nearly all estimated coefficients are statistically significant at the 95% confidence level, allowing for meaningful interpretation of individual variable effects while holding other factors constant.
CONCLUSIONS
Conclusions
The relationship between external debt and economic growth is complex and varies based on different perspectives While external debt can serve as a vital source of capital for economic development, neglecting sustainability in borrowing can lead to detrimental effects Consequently, external debt can influence a country's economic growth in both positive and negative ways Ultimately, the nature of this relationship is contingent upon the specific datasets and research periods analyzed.
In this study, with the panel data collected from six developing countries including Brazil, Mexico, South Africa, Nigeria, India and Vietnam in the period of 1990 -
2009, a negative relationship has been found in linear and no nonlinear one is supported by practical regression
The findings diverge from theoretical expectations based on the "Laffer Debt Curve," particularly concerning the defined debt threshold However, a careful review of empirical data from the research period reveals no inherent conflict While external debt can initially foster development in a stable economic environment, its impact becomes overwhelmingly negative during economic fluctuations This explains the mixed results in various studies, with some supporting a positive correlation, others indicating a negative relationship, and some suggesting an inverted-U shape The period from 1990 to 2009 encompassed significant economic crises in 1997 and 2008, which further exacerbated the adverse effects of external debt on economic downturns This analysis highlights a critical concern for the six selected developing countries, as their current conditions closely resemble the indebted phase of the Debt Curve, putting them at risk of falling into an external debt trap.
Analysis of the data reveals a clear connection between external debt and economic growth, influenced by factors such as total debt service, government expenditure, savings, education, and openness External debt serves as a significant explanatory variable for GDP growth trends The observed negative relationship suggests that developing countries must carefully manage their external debt and align it with their economic development policies.
This study challenges the traditional belief that external debt positively impacts economic growth, revealing that while it can initially provide capital and foster technological innovation, its effects become detrimental when analyzed within specific data ranges It underscores the necessity for developing countries to manage external debt carefully due to its negative correlation with growth objectives The research utilizes external debt stock and total debt service to illustrate this relationship, reinforcing the established positive links between economic growth, total factor productivity (TFP) determinants, savings, and expenditures Ultimately, the findings indicate a shared negative relationship between external debt, debt service, and economic growth in developing nations, paving the way for policy implications based on these insights.
Policy Implications
This study aims to explore the relationship between external debt and economic growth over a specific dataset and timeframe The regression analysis reveals a negative correlation, underscoring the need for effective policies to address current external debt issues Notably, the absence of a U-shaped relationship indicates that the connection between external debt and economic growth is linear Consequently, the findings suggest that external debt significantly contributes to fluctuations in economic growth Therefore, implementing stringent policies on external debt is crucial for maintaining sustainable economic growth.
Understanding the detrimental effects of external debt on economic growth is crucial for developing countries as they reassess traditional beliefs and formulate effective problem-solving strategies The implications of policy are central to this study, highlighting the importance of recognizing the true relationship between debt and growth Each developing nation must tailor its approach to address external debt based on its unique economic conditions, political frameworks, and macroeconomic factors However, certain overarching principles can be identified as common policies applicable to all countries facing external debt challenges.
Developing countries should prioritize export promotion as a key policy to enhance economic growth, as indicated by the ratio of external debt to export, where higher exports lead to lower debt burdens By leveraging their comparative advantages across various sectors, including agriculture, industry, and services, these nations can improve their trade balance In particular, Vietnam faces a challenge where import turnover exceeds export turnover, making it crucial to establish effective export promotion policies and supportive frameworks, such as legal and administrative measures A gradual restructuring of trade components is essential for achieving a positive shift in the export-import ratio.
Developing countries need to implement strict policies to reduce external debt stock, particularly by regulating borrowing conditions for the private sector It is crucial for the public sector, especially government entities, to adhere to these regulations to set a positive example Additionally, monitoring debt indicators can help assess the external debt situation, ensuring a safe framework to prevent debt overhang or crises.
A key policy derived from regression analysis highlights the negative correlation between external debt and economic growth, advocating for a shift towards attracting foreign investment rather than relying on external loans Investment demonstrates a strong positive impact on economic growth, presenting an ideal solution for the external debt dilemma faced by developing countries This strategy not only addresses capital shortages but also alleviates the burden of debt repayment, fostering a "win-win" scenario Increased foreign direct investment (FDI) can significantly reduce external debt levels while simultaneously promoting economic growth, making it a crucial policy for developing nations.
While each country faces unique challenges in developing its economy, this section presents typical policies applicable to all developing nations Understanding the link between economic growth and issues related to external debt highlights the broad relevance of these policy implications for countries grappling with debt challenges The primary concerns include the rapid increase in external debt and its inefficient management To address these issues, detailed policies are suggested as benchmarks for creating tailored strategies for individual developing countries, considering their specific economic contexts For further information, these specific policies are outlined in the enclosed Appendix of this study.
Limitation of thesis
Despite various attempts, the study has significant shortcomings in content, primarily due to limitations in the data sample, research methods, and the researcher's capabilities and time constraints The analysis is based on a 20-year data set from a limited selection of representative countries across Asia, Africa, and America, which may not provide a reliable estimate Furthermore, the study solely aims to determine whether a relationship exists between external debt and economic growth, without exploring the complexities of this relationship, such as the potential negative or positive impacts suggested by the "debt overhang" theory and the concept of debt thresholds Additionally, critical factors like the net present value of external debt and various debt indicators are overlooked due to data collection limitations.
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External debt is categorized into public and private sector debt The public sector's external debt encompasses government obligations, debts from provincial governments and central cities, as well as liabilities from state-owned enterprises and financial institutions, including foreign borrowings backed by government guarantees Conversely, the private sector's external debt primarily arises from the borrowing activities of private businesses and economic organizations, excluding personal debts.
External debt can be classified based on various criteria to facilitate effective monitoring, evaluation, and management One of the most prevalent classifications is based on the scope of the release, which helps in understanding the nature of the debt Additionally, several other popular classifications exist that further categorize external debt for better management practices.
2.1 Classified by the conditionality: preferential and non-preferential debt
Concessional loans, as outlined by the Development Assistance Committee, are defined as loans that have an aid element of 25% or more This aid element is calculated by taking the loan's total value and subtracting the present value of debt service payments, using a discount rate of 10% In contrast, loans that do not meet this threshold are referred to as preferential loans.
2.2 Classified by time: short-term and long-term debt
Short-term external debt refers to obligations due within one year, while long-term debt extends beyond that period Current liabilities significantly influence a country's liquidity and pose risks of economic crises, as demonstrated by the 1997 Asian financial crisis Consequently, minimizing short-term external debt is crucial for alleviating liquidity pressure and mitigating adverse economic effects during abrupt withdrawals of short-term capital flows.
2.3 Classified by borrowing entity: official creditors (the public sector) and private debt (private sector)
Public external debt encompasses the financial obligations of the state, including federal, provincial, and local government debts, as well as debts incurred by administrative agencies Additionally, debts from the private sector that are backed by government entities are classified as official government debt, making the borrowing countries responsible for repaying both principal and interest if the borrowing organizations default In cases of local government or corporate insolvency, the central government's obligations may vary based on specific borrowing terms and crisis contexts, as local authority debts are not typically guaranteed by the central government Private creditors, such as bond markets and commercial banks, play a significant role in this landscape Therefore, it is crucial to analyze official and private debts separately, considering the distinct factors influencing each and accounting for potential contingent liabilities.
2.4 Classified by the lenders: multilateral creditors and bilateral creditors
Multilateral external debt primarily originates from United Nations agencies, the World Bank, the International Monetary Fund, regional development banks, and intergovernmental organizations like OPEC In contrast, bilateral external debt is incurred by a country's government through financial assistance and humanitarian aid from entities such as the OECD and other nations, often provided on behalf of a single government.
2.5 Classified by the types of loans: : the official development aids (ODA) and commercial loan
Official Development Assistance (ODA), as defined by the Organization for Economic Co-operation and Development (OECD), encompasses both bilateral and multilateral transfers, where at least 25% of the total amount is not accounted for In contrast, a commercial loan refers to a debt-based funding arrangement between a business organization and a financial institution aimed at trading and development objectives.
Official Development Assistance (ODA) is a type of external debt characterized by preferential conditions, including lower interest rates and extended payback periods of 15 to 20 years, making it particularly appealing for developing countries seeking to enhance their national economies However, ODA comes with certain compulsory conditions that can impact both economic and political aspects In contrast, commercial loans lack these preferential terms, featuring higher and more volatile interest rates tied to the international financial market, which can lead to increased costs and risks Consequently, governments must carefully evaluate the implications of commercial loans and consider them only as a last resort.
To assess the external debt level of an economy, various indicators are utilized by international financial institutions, albeit with limitations, to indicate the sustainability of the debt.
Total external debt / GDP ≤ 40% for the debt sustainability
Total external debt / export value ≤ 150%
Debt service / export value ≤15% is considered sustainable debt
Gain / GNI (Gross National Income);
Short-term debt / Total debt;
• Pay Debt / Total revenues: There are safety limits from 10% - 12%
To maintain the security of national and government debt, countries typically adhere to specific borrowing and repayment criteria These include capping national debt at 50-60% of GDP or 150% of exports Additionally, the cost of servicing national debt should not exceed 15% of exports, while government debt service should remain below 10% of the national budget.
International financial institutions use various indicators to evaluate a country's debt levels and its capacity to finance its economy These indicators serve as benchmarks for assessing national debt and are crucial for strategic debt planning Key factors include the scale of debt, repayment schedules, and the interest paid relative to revenue, which are commonly used to gauge debt levels Unlike domestic debt, external debt is of particular interest to managers, as it not only reflects the economic situation but also indicates the country's ability to attract external financial resources to support macroeconomic objectives.
External debt indicators are essential for evaluating the impact of foreign debt on national security, necessitating a redefinition of criteria to assess overall external debt levels and repayment capacity in the medium to long term Developing countries often enhance their domestic currency value or adopt multi-rate regimes, which can obscure the true severity of their debt situations Therefore, it is crucial to select appropriate criteria for accurately assessing external debt levels and a country's ability to repay in the medium and long term.
A commonly used criterion in empirical research is the ratio of total external debt to total exports of goods and services This indicator reflects the capacity to manage external debt, encompassing both private and government obligations supported by export revenues By assessing commodity export income, this metric highlights a country's ability to meet its external debt commitments In the East Asia Pacific region, however, there has been a noticeable decline in the capacity to repay debts through export income, indicating a need for additional income sources to balance this ratio effectively.
Criteria = (Total external debt / Total export turn over in goods and services)