The Impact of Public External Debt on Economic Growth in Ethiopia: The ARDL Approach to Co-integration

Abstract

Governments need extensive amount of capital funding to achieve the sustainable economic growth. And due to lack of adequate capital, most developing countries such as Ethiopia rely on borrowings from external sources to bridge the resource gap. This study aims to analyze the impacts of public external debt on economic growth in Ethiopia by ARDL approach using a time series annual data from 1983-2018. The model considers annual GDP growth rate as a dependent variable. The debt variables including  public external debt stock to GDP (PEDSGD), the ratio of debt service stock to GDP (DSSGD) and debt service stock to export (DSSEXP) and other macroeconomic variables such as trade openness(TRD), rate of inflation(INFL)  and public expenditure to GDP ratio(NEXPGD) are explanatory variables. The study used bound testing for co-integration in the long-run and ECM for short-run dynamics. The study showed long-run co-integration, while the speed with which the disequilibrium caused by lack of proper  management external fund  in earlier years  returns to long-term equilibrium is 60.96% in the current year as indicated by coefficient of error correction term. The result of this study revealed that the variables PEDSGD and DSSGD are significant debt variables and have the negative impact on economic growth of Ethiopia in long run and short run. The other debt variable, DSSEXP negatively affects economic growth and is significant but only in the short run. This shows that there is the evidence of crowding out effect of public external debt in the short run. Also, the negative sign and statistical significance of the variable DSSGD shows that there is debt overhung effect of public external debt in the country. The negative impact is probably due to lack of proper management and/or investments of the funds borrowed from external sources into unproductive activities and projects.  As a result government should properly allocate its external debt for the productive investment and maintain proper and efficient debt management policy.

Keywords: Public external  debt, Debt service, Debt Overhang, Debt Crowding out, Economic Growth, ARDL

DOI: 10.7176/JESD/11-11-03

Publication date:June 30th 2020