External Debt-Economic Growth Nexus in Developing Countries: Evidence from Ethiopia

Abstract

This paper aims to explore the role of external debt (both stock and service) on economic growth in Ethiopia over a period of about 35 years starting from 1981/82 to 2015/16 using Johansen co-integration test and Vector Error Correction Model (VECM).Granger causality test is also performed to check the direction of the causation in the short run. The result of cointegration test using Johansen maximum likelihood approach reveals the existence of multiple long run equilibrium relationship between the debt variables and economic growth. The empirical result from the Growth equation shows that external debt stock has a significant and positive long run relation to economic growth as measured by the growth of real GDP while its square has significant and negative relation with the growth suggesting that there exists a none linear relationship and it has a positive contribution only up to some optimum level. External debt service on the other hand, has significant and negative relation to the long run growth of the country. The main conclusion of this paper is that the outflow of domestic capital which is needed to service external debt has negative impact on an economic growth both in the long run and short run. Whereas debt stock has a positive impact on economic growth in the long run if it is kept at its optimum level.

Keywords: Economic growth, Vector Error Correction Model (VECM), External debt, Cointegration, Granger causality