The Effect of External Debt on Economic Growth in Developing countries

اقتصاد و توسعه منطقه ای

Article 6, Volume 22, Issue 10, March 2016, Pages 191-224   

Document Type: Research article

DOI: 10.22067/erd.v22i10.44740

Authors

gholamreza zamanian¹; javad harati²; Hojat Tagizadeh^{* 3}

¹University of Sistan and Baluchestan

²University of Bojnord

³, University of Sistan and Baluchestan

Abstract

Introduction
In 1980s many countries to finance their spending,used internal resources, especially bank credits. Government spending financing by non-bank was used in low level, because capital markets had not formed or were not strong in most countries and also financial assets were not available. After World War II and the effectiveness of US aid to Europe, several articles were written about the impact foreign aid. Some theories believe that foreign aid such as loans, block grants can provide economic growth, but increased lending to developing countries in the 1970s and followed debt crisis in 1982 quesioned the impact of external debt on economic growth.
According to International Debt Statistics published by the International Bank for Reconstruction and Development in 2015, total external debt of developing countries is about 5506 billion dollars, which Iran's share is 7647 million dollars . According to the report, China is the largest debtor among developing countries so that the external debt of this country is about 874 billion dollars. China's external debt in 2013 has increased more than 6 times than 2000.
One of the main challenges which most developing countries facing, is ways of financing the budget deficit and its impact on economic growth in these countries. Choosing financing instruments, especially liabilities are important for rapid economic development and being aware of the impact of these policies on macroeconomic variables is very important. How to finance the budget deficit is the key to financial sector reform. The purpose of this study was to estimate the effects of external debt, budget deficits and exports on economic growth in developing countries. For this purpose,panel data for the period 2003-2013 and GMM estimation method have been used.
Theoretical frame work
In general, there are three views to the use of external resources. The first view is theories that consider external sources important for growth and economic development. This view suggests that developing countries are known poor economies in terms of low savings and capital and low investment. In fact, developing countries because of low saving rate can not finance expenditures related to depreciation and replacement of capital goods. As a result, for such countries, external resources are critical to reach ideal economic growth. The second view includes theories that foreign aid is not essential for growth and development. Bauer and Yamey (1989) believe: "For developing countries, foreign aid is not necessary or sufficient for liberation from poverty, but it is possible to grow and develop without foreign aid if necessary conditions are provided and economic and social projects are done. Also if these conditions are not provide, economic development is not possible, even with the presence of foreign aid and foreign resources will be wasted ".The third view includes those views which know foreign unsufficient condition for economic growth, but believe that proper management of external debt, provides the possibility economic growth and development. The management includes allocated loans to the production of export goods and prevents the losses of received aid and so on (Gharabaghi, 1993).
Theoretical models about growth and foreign aid includes two gap patterns, Griffin theory, model three gaps and overhang hypothesis. Before the two-gap model, growth patterns often proposed based on the savings gap, But Chenery & Bruno (1962) showed savings gap is not the only limiting factor. Griffin (1970) by statistical analysis revealed that only 25 percent of the external debt is allocated to growth activities. In the other words , 75% foreign loans taken for consumption expenditures. One of the main criticisms about the two gap pattern was that received foreign loans apart from the savings and exchange gap may be due fiscal gap and budget deficit reduction. So third limitation was introduced for the growth, was the limitation of public financing gap. Bacha (1990) suggests that the economy could fill three gaps savings, foreign exchange and Budget deficit by external sources and enter the growth path. One of the main channels which external debt impact on economic growth through it, is Debt overhang (Krugman, 1988; Sachs, 1989). Large debt burden is an obstacle to investment, because investors expect return on investment reduce due to foreign creditors.
Methodology
In this study, the model Jayaraman & Liu (2009) is used:

That, RGDP represents real production as a numerical index, ED real external debt (GDP%), EXP real exports of goods and services (GDP%), BD real budget deficit (GDP%) and ε random error term. consumer price index (CPI) is used for real nominal variables. In this study the generalized method of moment's (GMM) is used to estimate the model. GMM estimator is developed by Arellano & Bond (1991) and Arellano & Bover (1995). Gmm estimation method used the two sets of cross-sectional data and time series data. The method can solve the endogeneity problems between explanatory variables. In this method, dependent variable is added to the equation with a lag as an explanatory variable (Abrishami et al., 2006). To solve the correlation between the lagged dependent variable and the error term, lag variables are used as instruments in GMM. Also consistent estimators of GMM, depends on the validity of the instruments used. To test this, the use of statistics proposed by Arellano & Bond (1991) and Arellano & Bover (1995), which is called Sargan test and validate the instruments used to measure (Yavari, et al.2010).

Results & Discussion
Based on the results, the total external debt and budget deficits have negative impact on economic growth so that one percent increase in the total external debt reduced economic growth by 0.7%. Also increase one percent in the budget deficit reduced economic growth 0.035%. While exports have a positive impact on economic growth so that one percent increases in exports increase economic growth 0.21%.
In the second model, short-term external debt has positive effects, but long-term external debt has a negative impact on economic growth. So that a one percent increase in short-term external debt, increases economic growth 0.032% and with an increase in long-term external debt, reduces economic growth of 0.12%. Budget deficit has a negative impact on economic growth, while exports had a positive effect, as a one percent increase in budget deficit, reduced economic growth 0.005% and a one percent increase in exports increased 0.24%.
Also estimated results for the two groups of countries: countries with upper-middle per capita income and lower-middle and lower-income countries , have been reflected. According to estimates, total external debt in both countries has a negative impact. While short-term external debt has positive impact on economic growth, but long-term external debt has negative impact on economic growth. Budget deficit and exports in countries with low and lower-middle income have positive impact on economic growth, while the upper-middle income countries have negative effects.
Conclusions & Suggestions
The results show that, long-term external debt and budget deficit have significant negative effects on economic growth in developing countries. However, exports and short-term external debt have positive impact on economic growth in developing countries. While the external debt is divided into 2 groups: short-term and long-term external debt, the results show that short-term external debt have positive impact on economic growth but long -term external debt have negative impact on economic growth. However, the budget deficit is a negative impact on economic growth but exports have positive impact n economic growth. According to the results, measures to reduce long-term external debt should be taken in developing countries and prevent the adoption of long-term debt or long-term debt become short-term debt. Also, due to the positive impact of exports on economic

Keywords

External Debt; Budget deficit; Exports; Economic Growth; Panel Data; developing countries

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