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 Countries have varied motivations for seeking foreign capital to boost their economies, especially developing nations facing current account deficits due to insufficient savings and investment This reliance on external debt became notably critical in 1982 when Mexico declared its inability to service its debt, marking a significant debt crisis Currently, the issue of external debt and its management remains a pressing global concern, increasingly raising questions about its impact on economic growth.
Policymakers and economists are increasingly focused on understanding how external debt influences economic growth, particularly in developing countries As these nations engage more deeply in globalization, they face heightened risks of debt crises, largely due to easier access to foreign loans This relationship highlights the need for careful evaluation of external debt's effects on economic development.
In 1985, the risk of external debt was identified as a significant threat to the economy, highlighting its explosive potential This concern has consistently remained a focal point in development economics, making it a timeless subject of research for both economists and policymakers.
Developing countries often face fiscal deficits and lack robust private sectors and banking systems, leading them to rely heavily on international borrowing for investment and development This reliance 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 economic growth challenges.
Some countries view external debt as a catalyst for economic growth, often leading to a debt crisis, as highlighted by Amoateng and Amoako-Adu (1996), who found a positive correlation between GDP growth and debt service Conversely, other nations fear the implications of debt and limit external borrowing, which hampers their ability to achieve economic growth due to insufficient capital.
External debt significantly impacts private investment and hinders economic growth, particularly in developing economies The debt overhang theory and crowding out effect illustrate how excessive external debt can create vulnerabilities, leading to a risky capital deficit that stifles private investment and results in negative growth rates Additionally, relying on exports to service this debt can detract from economic growth by diverting income from productive activities However, it is important to recognize that external debt can also provide essential capital inputs that may enhance economic growth Thus, understanding the relationship between external debt and economic growth is crucial for developing countries to implement effective policies that promote sustainable 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 whether it is linear, while also exploring the possibility of a nonlinear relationship based on previous empirical research.
Scope of study
Developing countries face significant challenges in achieving sustainable economic growth, particularly concerning external debt management While numerous studies have explored the effects of external debt on the economic growth of individual nations or regional groups, there is a notable lack of research that encompasses multiple regions Furthermore, most existing studies tend to concentrate on how external debt influences investment and savings, rather than directly analyzing its relationship with economic growth.
Despite numerous studies conducted on this topic in various developing countries in the past, recent research remains limited and lacks detailed analysis This study aims to investigate the nature of relationships by examining a sample of two representative developing countries from Africa, Latin America, and Asia: South Africa, Nigeria, Mexico, Brazil, Vietnam, and India, over a 20-year period from 1990 to 2009.
Structure of thesis
This thesis comprises five chapters, beginning with Chapter 1, which provides a comprehensive introduction to the research topic It outlines the problem statement that highlights the significance of external debt in relation to economic growth Additionally, it presents the primary research objectives aimed at identifying key areas of study within this relationship and defines the scope of the research to narrow down the sample.
Chapter 2, titled "Literature Review," is divided into two key sections The first section, the theoretical review, explores the theories and hypotheses surrounding the relationship between external debt and economic growth, supported by relevant models and citations The second section provides an empirical analysis of this relationship, highlighting related determinants and summarizing findings from prior research Chapter 3 outlines the research methodology, beginning with a brief overview of the practical problem, followed by a detailed explanation of the econometric model construction, data description, and clarification of the variables involved.
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 on the relationship between external debt and economic growth, highlighting key insights and suggesting policy implications for effectively addressing this impact.
LITERATURE REVIEWS
Empirical Literature Reviews
Numerous empirical studies have explored the relationship between external debt and economic growth, yielding varied results that can be categorized into three main groups The first group provides evidence supporting a positive impact of external debt on economic growth up to a certain threshold The second group highlights a negative correlation between high levels of external debt and economic growth The third group suggests a nonlinear relationship, indicating that the effects of external debt on growth can vary Additionally, some studies have found no significant relationship between external debt and economic growth.
Several studies indicate a positive correlation between external factors and economic growth Chowdhury (1994) explored the relationship between external debt and economic growth by conducting Granger causality tests on Asian and Pacific countries from 1970 to 1988 The analysis, which used GDP as the dependent variable and included variables such as debt payment (negative), inflation (negative), interest rate (positive), and agricultural labor (negative), revealed that increases in GDP were associated with higher levels of external debt Notably, the overall external debt was found not to adversely affect economic growth.
A neo-classical model was utilized to examine the relationship between external debt and economic growth, focusing on external debt servicing capabilities across 31 Sub-Saharan African countries (Gerald Scott, 1994) The study analyzed GNP per capita as the dependent variable and identified several independent variables, including exports, domestic capital, technology, imports, and exchange rate, with varying impacts The findings indicated a positive correlation between external debt and economic growth at certain levels In a broader analysis involving 59 developing and 24 industrial countries from 1970 to 2002, Schclarek (2004) found no evidence that external debt affects total factor productivity (TFP), but suggested that lower levels of external debt are associated with favorable economic growth rates, highlighting a positive relationship between low debt and economic growth.
Numerous empirical studies highlight a negative relationship between external debt and economic growth, making this a prominent topic of research This study aims to explore this relationship further For example, Iyoha (1999) employed a small macro-econometric model using simulation methods to analyze the effects of external debt on economic growth in sub-Saharan African countries from 1970 to 1994 The findings supported a negative correlation, aligning with the debt overhang theory and the crowding out effect.
Sachs, Cohen and Sachs, and Krugman explored the negative impact of external debt on economic growth during the 1980s debt crisis, utilizing debt overhang theory models Adepoju et al (2007) specifically examined this relationship in the context of 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 indicates that external debt significantly hinders economic growth in various countries A study by 2007 highlighted that Nigeria's economic progress was adversely affected by external debt accumulation Similarly, Hameed et al (2008) analyzed Pakistan's economy from 1970 to 2003 and discovered a negative correlation between external debt servicing and economic growth, impacting capital and labor productivity Additionally, Maureen Were (2001) examined the GDP growth rate and identified several influencing factors: inflation negatively affects growth, while lagged inflation, real public investment as a GDP ratio, private investment, and human capital development positively contribute Conversely, a high debt-to-GDP ratio and debt service relative to exports are detrimental to economic performance.
(positive) with time series data of Keyna A negative relationship between external debt and economic growth was found as final result.
A study by T.K Jayaraman and Evan Lau (2008) analyzed panel data from 14 Pacific Island Countries between 1988 and 2004 to explore the relationship between external debt and economic growth, identifying real GDP as the dependent variable and external debt, exports, and budget deficit as independent variables Their findings indicated that external debt negatively impacts economic growth, while exports have a positive effect Additionally, Pattillo (2004) conducted a significant empirical study on 61 developing countries from 1969 to 1998, establishing a growth-accounting framework that revealed external debt hampers economic growth by restricting physical capital accumulation and slowing the growth of total factor productivity (TFP).
Recent empirical research increasingly highlights the nonlinear relationship between external debt and economic growth Notably, Elbadawi et al (1997) employed fixed and random effects panel data to estimate a regression model, revealing that external debt impacts economic growth in a nonlinear manner Their findings align with the debt Laffer curve, indicating a critical threshold for debt levels The study demonstrated both linear and quadratic forms of the debt-to-GDP ratio, 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 identify a nonlinear relationship between external debt and economic growth, analyzing panel data from 93 developing countries Their subsequent research (Patillo et al., 2004) delved into the mechanisms through which external debt adversely affects growth, revealing that physical capital accumulation contributed to one-third of the negative impact, while two-thirds stemmed from total factor productivity growth (TFP) The study, which covered the period from 1969 to 1998, concluded that the detrimental effects of external debt on growth became significant when its net present value (NPV) exceeded 160–170 percent of exports and 35–40 percent of GDP.
Reinhart and Rogoff (2010) pioneered research on debt thresholds and their effects on economic growth, revealing both linear and non-linear relationships between external debt and growth through various econometric models Their findings indicated 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 low to moderate levels of external debt can positively impact economic performance, contributing to physical capital accumulation, but exceeding this threshold leads to increased risks of debt unserviceability and negative growth effects The relationship between external debt and economic growth resembles an inverted U shape, highlighting the importance of maintaining debt levels within sustainable limits to avoid detrimental consequences.
Net Present Value (NPV) of external debt to export
Contribution of external debt to economic growth rate
The debt threshold curve identifies point A as a critical juncture that differentiates the effects of external debt on economic growth To the left of point A, external debt positively correlates with economic growth, as the marginal productivity of external debt meets or exceeds the costs of principal and interest payments, as noted by Cline (1985) Conversely, to the right of point A, countries experience adverse effects from external debt, where interest payments and principal repayments hinder private investment and alter public spending Increased external interest payments can exacerbate budget deficits, ultimately diminishing public savings.
And when reaching the point B of net present value (NPV) of external debt, its contribution to economic growth not only has downward trend but also keeps a negative value.
Numerous empirical studies have examined the relationship between external debt and economic growth, revealing three distinct perspectives However, some research has found no significant correlation between the two In a study focused on Kenya, a Heavily Indebted Poor Country (HIPC), Were (2001) analyzed the impact of debt overhang on the nation's low economic growth from 1970 to 1995 The findings indicated no evidence supporting either a positive or negative effect of debt servicing on economic growth, although some crowding-out effects on private investment were observed Similarly, Warner (1992), analyzing data from 13 developing countries between 1960-1981 and 1982-1989, also found no empirical relationship between external debt and economic growth.
RESEARCH METHODOLOGY
Overview of external debt and economic growth in developing countrieS
Before delving into the research methodology, it's essential to briefly examine key aspects of external debt and economic growth in developing countries A summarized overview of the current situation regarding external debt can be illustrated in the following table.
Table 3.1: External debt and GDP in main areas of developing countries
External debt GDP Debt / GDP Export Turn over Debt / Export
According to World Bank and IMF data from 2010, external debt has rapidly escalated on a global scale, 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 growing debt burdens This situation has created a dilemma, as they struggle to find a balance between debt levels and economic growth Notably, Asian countries experienced a significant surge in external debt during the 1990s, driven by the pursuit of economic growth through foreign loans.
In 1991, the debt-to-GDP ratio stood at around 19%, climbing to a peak of 35% by 1998, according to the 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 dwindling foreign reserves This situation resulted in challenges related to currency devaluation and difficulties in meeting 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 However, the excessive reliance on external loans, once viewed as a catalyst for growth, has transformed into a substantial debt burden, as many countries now face repayment challenges that exceed their capabilities Consequently, managing external debt has become a critical issue, with the potential to escalate into a crisis if the relationship between external debt and economic growth remains unclear As a result, nearly all developing countries, including Vietnam, are at risk of exposure to short-term external debt.
In 2011, Vietnam, along with India and Indonesia, faced a high level of short-term external debt, indicating vulnerability to external shocks Despite the absence of a debt crisis, as external debt remained within acceptable limits relative to foreign reserves, significant risks persisted Furthermore, these countries experienced a downward trend in economic growth and encountered various challenges Asian developing nations continue to grapple with the complexities of external debt and its effects on economic performance Consequently, it is crucial for policymakers and economists to carefully assess the relationship between external debt and economic growth.
The external debt crisis has significantly impacted developing countries in Latin America, particularly during the 1980s when Mexico announced its inability to service its debt This event marked a severe downturn in economic growth and stability across the region Many developing nations at the time struggled with substantial external debt due to a lack of understanding of the relationship between debt and economic growth, hindering their ability to evaluate its effects accurately Consequently, several countries, including Ecuador, faced the necessity of debt restructuring and defaulting.
Since 1999, and particularly in 2002 with Arghentia, there has been a significant focus on adjusting economic performance in relation to external debt Key economies such as Brazil and Mexico have closely monitored their external debt issues, linking fiscal balance directly to this challenge This relationship between external debt and economic growth has garnered considerable attention from policymakers.
Developing countries in Africa have long faced challenges related to external debt, which has hindered their economic growth These nations often lack the necessary physical capital, forcing them to borrow from external sources despite limited repayment capabilities This has led to a debt overhang situation, with Africa's total external debt exceeding $150 billion in 1983, as reported by the U.N Economic Commission for Africa By the peak of the debt crisis in the 1990s, over 40% of African countries' export earnings were allocated to servicing external debt (IDA and IMF, 2009) Sub-Saharan African nations, in particular, have increasingly relied on foreign borrowings as a key component of their development strategies, resulting in a significant accumulation of unsustainable debt—rising 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 (World Bank report, 1975-1995) Consequently, economic growth in these developing nations has stagnated, remaining at low levels due to the adverse 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 This situation often leads to a negative impact on economic progress The primary reason for seeking external loans is to address the initial deficit in physical capital investment.
Analytical Framework
The economic performance of a country, represented by the function Y = A f(K, L) according to the Cobb-Douglas model, is influenced by various factors The inputs, capital (K) and labor (L), can be further defined by their own determinants, such as K = H(Debt, X), where H and Z denote additional unlisted factors This system of equations illustrates the connection between external debt and economic growth.
In addition to external debt, various factors influence economic growth, aligning with findings from previous literature Consequently, the connection between external debt and economic growth can be clearly illustrated.
The Education Human Capital Fiscal Policy framework serves as a foundational tool for understanding the selection of specific variables in regression analysis By examining the interconnectedness of these determinants with economic growth and external debt, a comprehensive overview emerges This straightforward framework facilitates the development of a flowchart of ideas, paving the way for the construction of an effective 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 the primary source of capital input and technology transfer Education, measured by years of schooling, contributes to human capital Additionally, savings, imports, and exports positively impact economic growth External shocks, such as inflation, must also be considered, as they affect growth depending on the external environment Fiscal policy is crucial for guiding the economy and correcting market imbalances External debt plays a significant role in this cycle, directly linked to capital issues, and its service can burden economic growth Countries often rely on export returns to manage external debt repayments, establishing a close relationship between external debt and exports, particularly in developing nations While debt service is generally expected to have a negative impact, the overall relationship between external debt and economic growth remains an area for further investigation, leading to the development of an econometric model based on this framework.
The Econometric Model
This study will utilize the model proposed by Pattilo et al (2002) to examine the link between external debt and economic growth, alongside the Barro Growth Model (2003) which focuses on the determinants of economic growth The foundational regression equation employed to analyze the relationship between debt and economic growth is structured as follows:
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 (2003)
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 incorporating a quadratic specification to identify the marginal point at which external debt's impact on economic growth shifts.
This study aims to investigate the potential inverted-U relationship between external debt and economic growth We anticipate that the coefficient δ will be negative, indicating a non-linear impact of external debt on growth The threshold at which external debt begins to negatively affect growth will be calculated as -γ/2δ A negative δ is essential for the quadratic function resembling the Laffer Debt Curve, as discussed in the literature Conversely, if δ is positive, it suggests that a non-linear relationship akin to the Debt Curve does not exist within the studied data, leading to a U-shaped relationship between external debt and economic growth This finding contradicts existing literature, prompting a focus on the linear relationship, which will be explored in detail in Chapter 4.
Data
This study analyzes panel data from six 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 challenges, representing key regions in Latin America, Africa, and South Asia As they navigate economic development amidst global debt pressures, these countries, including Vietnam, are critically examining the relationship between economic growth and external debt to formulate effective development policies Data for this analysis were sourced from various reliable channels.
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, human capital, policy stability, macroeconomic factors, and external debt indicators Specifically, the investment-to-GDP ratio serves as a proxy for investment, while population and education, represented by years of schooling, reflect human capital Additionally, GDP per capita from the previous year is utilized to indicate policy stability, and the openness index along with inflation rates accounts for trade dynamics and macroeconomic fluctuations, all of which influence sustainable growth rates.
External debt metrics encompass the ratio of external debt to exports and the total external debt service A detailed description, calculation methods, and data sources for these variables are summarized 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 uncertain implications, the control variables can be categorized as follows: investment and income positively influence economic growth, while population growth has a negative impact, and schooling contributes positively These variables reflect the role of physical and human capital accumulation on Total Factor Productivity, aligning with findings in the literature review Additionally, terms of trade, openness, and inflation account for external shocks in the international market Lastly, government expenditure serves as an indicator of fiscal policy's effect on economic stability.
Estimation Approach
Popular estimation techniques for panel data include OLS, Fixed and Random Effects, and GMM system, with the function's formulation depending on assumptions regarding intercepts, slope coefficients, and the error term Various scenarios arise in this context: (i) when both intercept and slope are constant across countries and years, OLS regression is appropriate for estimating GDP; (ii) if the slope remains constant while the intercept varies by country, a one-way fixed effects model is used; (iii) in cases where slope coefficients are unchanged but intercepts differ across countries and time, a two-way fixed effects model applies; (iv) when both intercepts and slope coefficients vary across countries, a random fixed effects model is utilized; and (v) if both change across countries and time, a one-way random effects model is employed.
This study will sequentially apply the OLS method and FIX/RANDOM model to identify the most suitable approach Additionally, various tests will be conducted to refine the model and achieve optimal results Initially, a linear equation will be employed to determine 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 the control of unobservable variables, such as cultural influences and varying business practices, as well as time-varying factors like national policies and provincial regulations, thus accounting for individual heterogeneity By integrating time series with cross-sectional observations, panel data provides more informative insights, greater variability, reduced collinearity among variables, increased degrees of freedom, and enhanced efficiency (Gujarati, 2003).
Econometric Results
The regression results, encompassing OLS, fixed effects, and random effects methods for both linear and quadratic equations, are summarized in a comprehensive table for easy monitoring The linear equation is analyzed using OLS (with and without dummy variables), fixed effects, and random effects methods, followed by a Hausman test to determine the most appropriate model The findings indicate that the Fixed Effects Model (FEM) is the most suitable choice, leading to its application in the quadratic equation analysis Additionally, tests for multicollinearity and heteroskedasticity are conducted to validate the selected model.
After conducting regression analyses using various methods, we have compiled a summary table for easier monitoring and comparison of results The coefficients and standard errors, indicated in parentheses, are presented in the table below 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
Linear Quadratic Log External Debt 0.1365 -0.1416 -3.8621 0.1356
Results Expression
This study employs various techniques for analyzing panel data, including Ordinary Least Squares (OLS), Fixed Effects, and Random Effects models, to investigate the relationship between external debt and economic growth Among these methods, the Fixed Effects Model (FEM) is identified as the most effective Initially, a linear analysis is conducted to determine the appropriate technique, followed by the application of a quadratic function to further explore this relationship.
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 analysis reveals that seven out of eleven coefficients are statistically significant; however, the primary debt variable, logexternaldebt, shows no significance with a value of 0.1365 This suggests that the assumption of constant intercept and slope coefficients may overlook temporal and spatial variations Additionally, the unexpected signs of coefficients for variables such as schooling, openness, and total external debt indicate potential issues with this method Consequently, due to these limitations, a deeper analysis of these results is not warranted, and alternative methods should be explored for more accurate outcomes.
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.
The fixed-effects technique assumes that individual characteristics may influence predictor or outcome variables, necessitating control for these biases This approach relies on the correlation between the entity's error term and predictor variables, with the requirement that omitted variables maintain time-invariant values and effects (Oscar Torres-Reyna, 2007) By excluding 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, with numerous variables demonstrating statistical significance Consequently, this model will be retained for the final selection prior to exploring alternative regression methods.
The random effects model is based on the premise that variations among entities are random and uncorrelated with the predictor variables included in the model (Green, 2008) This approach assumes that the error term for each entity is independent of the predictors, enabling time-variant variables to serve as 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
The analysis of panel data reveals a significant distinction between fixed effects and random effects techniques, particularly in the signs of key variables such as schooling, openness, expenditure, and investment Unlike the fixed effects approach, the random effects method produces contrary signs for these variables, leading to fewer statistically significant results Consequently, selecting the appropriate technique for analyzing panel data, typically between fixed effects and random effects, is crucial for accurate interpretation.
3.1.4 Choosing between Fixed Effect Model (FEM) or Random Effect Model (REM)
The fixed effects model (FEM) controls for time-invariant variables, such as country group dummies, without estimating their effects In contrast, the random effects model (REM) estimates the effects of time-variant variables, but may yield biased results due to unaccounted omitted variables To determine whether to use FEM or REM, the Hausman test is conducted to assess the null hypothesis (H0) that the estimates from both models are equivalent.
The Hausman test results indicate a significant difference between the Fixed Effects Model (FEM) and the Random Effects Model (REM), as evidenced by a Prob>chi2 value of 0.0000, which is less than the 0.05 threshold Consequently, the Fixed Effects Model is deemed more suitable for further analysis in this study.
After exploring the linear relationship by regressing the function: Y i,t = αX i,t
In our analysis, we aim to explore the potential non-linear relationship between external debt and economic growth, drawing on insights from previous empirical studies To achieve this, we utilize a quadratic equation represented as Y i,t = αX i,t + γD i,t + δD² i,t + u i,t We apply the Fixed Effects Model (FEM), recognized as the most suitable technique for conducting regression analysis, to examine the nature of this relationship effectively.
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 explores the nonlinear relationship between external debt and economic growth, hypothesizing a U-inverted shape akin to the Laffer Debt Curve For this U-inverted curve to manifest, the coefficient δ of the squared log external debt must be negative However, the analysis reveals a statistically positive coefficient of 0.0051 for log external debt squared, indicating that no expected nonlinear relationship exists within the analyzed data range Consequently, the study shifts focus back to a linear relationship, emphasizing the economic implications of the findings using the fixed-effects technique.
3.3 Tests for correcting the chosen model - FEM
After selecting the Finite Element Model (FEM) as the primary analytical framework, it is essential to conduct tests to ensure the model's accuracy This study focuses on two critical tests: the multicollinearity test and the heteroskedasticity test, both of which are vital for enhancing model reliability.
The analysis of the dataset, as indicated by the VIF value of 4.22, confirms the absence of multicollinearity, as it is below the threshold of 10 This suggests that the dataset is suitable for delivering reliable results for economic analysis and evaluation.
In the analysis of heteroskedasticity, the results presented in Table 8 of the Appendix indicate that there is no presence of heteroskedasticity in the errors Utilizing the fixed effects technique with the command xttest3, the null hypothesis (Ho) asserting the existence of heteroskedasticity was tested The outcome yielded 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's adjusted R² value of 92.28% demonstrates a strong fit, indicating that 92.28% of GDP variation can be explained by key 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 precise 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 crucial source of capital for economic development, neglecting sustainability in borrowing practices can lead to detrimental effects Consequently, external debt may influence a country's economic growth in both positive and negative ways, depending on the specific dataset and research period 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 of this study reveal a nuanced relationship between external debt and economic growth, particularly when analyzed through the lens of the Laffer Debt Curve While external debt can initially support development in a stable economic environment, its benefits diminish during periods of economic fluctuation, leading to predominantly negative effects on growth This duality explains the varying conclusions in existing literature, with some studies advocating for a positive correlation, others indicating a negative impact, and some suggesting an inverted-U relationship The analysis of the period from 1990 to 2009, which includes the significant economic crises of 1997 and 2008, underscores the detrimental role of external debt in economic downturns Consequently, the research highlights the precarious situation of six selected developing countries, suggesting they risk falling into an external debt trap, as their current economic conditions closely resemble those associated with high indebtedness on the Debt Curve.
An analysis of the quantity determining method 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 negative correlation 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 external debt can initially provide capital and foster technological innovation, it ultimately demonstrates a negative relationship with economic growth in developing countries when analyzed within a specific data range The research highlights the necessity for stringent management of external debt, given its adverse effects on growth objectives By examining external debt stock and total debt service, the study confirms that these factors are negatively correlated with economic growth, despite previous literature indicating a positive association between growth and determinants like total factor productivity, savings, and expenditure Overall, the findings underscore the importance of addressing external debt issues to inform policy implications aimed at fostering sustainable economic growth in developing nations.
Policy Implications
This study aims to investigate the relationship between external debt and economic growth over a specific dataset and timeframe The regression analysis reveals a negative correlation, highlighting the need for effective policies to address current external debt challenges The absence of a U-shaped relationship indicates that the connection between external debt and economic growth is linear Consequently, the negative impact of external debt on economic growth suggests it contributes to fluctuations in economic performance Therefore, implementing stringent external debt policies 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 key policy implications derived from this study highlight the importance of recognizing the unique circumstances of each nation in adopting appropriate measures to foster economic growth While strategies may vary based on specific economic conditions, political frameworks, and macroeconomic factors, several general principles can be established as common policies to address the external debt challenge effectively.
Export promotion is crucial for developing countries, as it directly impacts economic growth by reducing external debt burdens A key indicator for debt evaluation is the ratio of external debt to export levels; higher exports correlate with lower debt Countries should leverage their comparative advantages across various sectors, including agriculture, industry, and services In the case of Vietnam and similar nations, import turnover currently surpasses export turnover Therefore, implementing effective export promotion policies and supportive frameworks, such as legal and administrative measures, is essential This approach requires gradual restructuring of trade components to improve the trade balance between exports and imports.
Developing countries must implement policies aimed at reducing external debt levels by enforcing strict borrowing regulations, particularly for the private sector Additionally, the public sector, including government entities, should adhere to these regulations to set a positive example Regular monitoring of debt indicators is essential for assessing external debt conditions, which can help prevent debt overhang and potential crises.
To address the negative impact of external debt on economic growth, developing countries should prioritize attracting foreign investment over incurring external loans A strong positive correlation exists between investment and economic growth, making it an ideal solution for capital shortages without the burden of debt repayment By focusing on foreign direct investment (FDI), countries can create a "win-win" scenario, where external debt levels decrease alongside economic growth This approach not only alleviates financial pressures but also fosters sustainable development through increased capital inflow from both domestic and international sources.
While each country faces unique challenges in economic development, this article outlines general policies applicable to all developing nations It emphasizes the connection between economic growth and external debt issues, highlighting the widespread relevance of these policy implications for countries grappling with external debt The primary concerns include the rapid increase of external debt and its inefficient utilization To assist in addressing these challenges, the article presents detailed policies as benchmarks for tailoring specific strategies to each developing country's current economic situation For further information, these specific policies are available in the enclosed Appendix.
Limitation of thesis
Despite various efforts, the study has significant shortcomings related to its data sample and research methods, as well as limitations in personal capability and research duration The analysis is based on a 20-year dataset from select representative countries across Asia, Africa, and America, which may not provide an accurate estimation Furthermore, the focus is solely on determining whether a relationship exists between external debt and economic growth, without exploring the complexities of net present value of external debt or various debt indicators, as data collection constraints hinder a more comprehensive analysis.
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External debt is categorized into public and private sector debt The public sector's external debt encompasses government debt, provincial government debt, and state-owned enterprises' debt, along with foreign borrowing by financial institutions and state organizations that have government guarantees In contrast, the private sector's external debt primarily arises from the borrowing activities of private businesses and economic organizations, excluding personal debt.
External debt can be classified based on various criteria to facilitate monitoring, evaluation, and effective management One of the most prevalent classifications focuses on the scope of the release, while other popular classifications also exist.
2.1 Classified by the conditionality: preferential and non-preferential debt
Concessional loans, as defined by the Development Assistance Committee, are financial loans that include an aid element of 25% or more This aid element is determined by the loan's value minus the present value of debt service payments, calculated using a discount rate of 10% In contrast, preferential loans do not meet this aid threshold.
2.2 Classified by time: short-term and long-term debt
Short-term external debt, defined as obligations due within one year, poses significant risks to a country's liquidity and can trigger economic crises, as evidenced by the 1997 Asian financial crisis To mitigate these risks, it is crucial to minimize short-term external debt levels, thereby enhancing liquidity and reducing the adverse effects of sudden capital outflows on the economy.
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 municipal debts, as well as debts incurred by administrative agencies This category also includes private sector debts that the government guarantees, making the borrowing countries liable for repayment if the borrowing entities default In cases of local government or corporate insolvency, the central government's responsibility may vary based on borrowing terms and crisis contexts It is important to note that external debts incurred directly by local authorities are not backed by the central government Private creditors, such as bond markets and commercial banks, play a significant role in this landscape Therefore, it is essential to analyze official and private debts separately, as they are influenced by different factors and require consideration of contingent liabilities.
2.4 Classified by the lenders: multilateral creditors and bilateral creditors
Multilateral external debt primarily originates from entities such as 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 loans or financial assistance from other nations, including OECD countries, or through international organizations providing humanitarian aid.
2.5 Classified by the types of loans: : the official development aids (ODA) and commercial loan
Official Development Assistance (ODA), as defined by the 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 arrangement between a business and a financial institution aimed at facilitating trade and development objectives.
Official Development Assistance (ODA) is a type of external debt characterized by preferential conditions, including lower interest rates, extended payback periods of 15 to 20 years, and favorable grace periods, making it particularly attractive for developing countries aiming to enhance their national economies However, ODA comes with certain compulsory conditions that may 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 should carefully evaluate the implications of borrowing commercial loans and consider them only as a last resort.
To assess the external debt levels of an economy, international financial institutions utilize various indicators that highlight 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 safety of national and government debt, countries typically implement specific criteria for borrowing and repayment These include capping national debt at 50-60% of GDP or 150% of exports, and ensuring that national debt service does not exceed 15% of exports, while government debt service remains below 10% of the budget.
International financial institutions utilize various indicators to evaluate a country's debt levels and financing capabilities These indicators serve as a benchmark for assessing national debt and inform strategic planning regarding debt management Key metrics include the scale of debt, repayment terms, and the ratio of interest payments to revenue, which are essential for gauging overall debt sustainability External debt, in particular, garners significant attention from managers due to its implications for a country's economic health and its capacity to secure foreign financial resources to meet macroeconomic goals.
External debt indicators are essential for evaluating the impact of foreign debt on national security It's crucial to redefine the criteria for assessing overall external debt, focusing on debt levels and a country's repayment capacity in the medium to long term Developing countries often enhance their domestic currency value or employ multi-rate systems, which can mitigate the perceived severity of their debt Therefore, it is vital to carefully select appropriate criteria for assessing external debt levels and repayment capabilities to ensure a comprehensive understanding of a nation's financial health.
A widely used criterion in empirical research is the ratio of total external debt to total exports of goods and services, which effectively illustrates the capacity to manage external debt, including both private and government obligations This indicator reflects the revenue generated from commodity exports and services that a country can utilize to meet its external debt obligations In the East Asia Pacific region, this indicator has revealed a declining ability to repay debts through export income, highlighting the necessity for additional income sources to compensate for this shortfall.
Criteria = (Total external debt / Total export turn over in goods and services)